DocketNumber: Docket No. 2667-78
Citation Numbers: 1982 U.S. Tax Ct. LEXIS 94, 78 T.C. No. 59, 78 T.C. 850
Judges: Featherston
Filed Date: 5/25/1982
Status: Precedential
Modified Date: 1/13/2023
*94
Decedent was the trustee of a trust established by his father in 1946 for the benefit of decedent's children. The trust agreement vested the trustee with the same rights and powers over insurance policies held by the trust "as he would have as the absolute owner thereof." As trustee, decedent caused the trust to purchase three insurance policies on his life. Subsequently, decedent as trustee executed assignments of those insurance policies as collateral security for personal obligations and obligations of a corporation in which decedent was an officer, director, and 50-percent shareholder. The assignments were not made for the benefit of decedent's children as beneficiaries of the 1946 trust.
*850 OPINION
Respondent determined a deficiency in the amount of $ 419,942.46 in petitioner's estate tax. After concessions by the parties, the only issue remaining for *851 decision is whether decedent, who was trustee of a trust created by his father, possessed at the time of his death any "incidents of ownership" in three entrusted insurance policies on his life with the result that the insurance proceeds are includable in his gross estate under
*97
All the facts are stipulated. 2
Decedent died testate on September 19, 1973. He was survived by his second wife (Noreen), by three children (Robert H., James G., and Richard E.) from his first wife (Ruth), and by two adopted children (Richard and Deborah). At the time the petition was filed, the First Wisconsin Trust Co., with its principal office in Milwaukee, Wis., was serving as sole personal representative of decedent's estate. Decedent's estate tax return was filed with the Midwest Service Center, Kansas City, Mo.
On or about December 2, 1946, decedent's father, Harry Bloch, Sr., as grantor, entered into an agreement with decedent, as sole trustee, establishing the "Robert H. and James G. Bloch Trust" (the 1946 trust). Decedent continued to serve as trustee of the 1946 trust until his death.
On December 7, 1946, Herman Silverstein established*98 an irrevocable trust (the Silverstein trust) naming the decedent as sole trustee. Pursuant to the Silverstein trust agreement, Mr. Silverstein paid $ 14,389.95 to decedent as trustee, and he placed these funds in the 1946 trust. Under the terms of the Silverstein trust agreement: (1) Mr. Silverstein was to receive a $ 160-per-month annuity for life; (2) decedent as trustee was required to pay Mr. Silverstein's hospital and funeral expenses; (3) upon Mr. Silverstein's death, any remaining property of the Silverstein trust was to be distributed to the 1946 trust; and (4) decedent personally guaranteed the annuity payments to Mr. Silverstein in the event the Silverstein trust estate was insufficient to make the payments.
Also, on December 7, 1946, Mr. Silverstein designated *852 decedent in his capacity as trustee of the 1946 trust as the sole beneficiary of two insurance policies on Mr. Silverstein's life in the total face amount of $ 10,000. As a result of the Silverstein transactions, the 1946 trust received a total of $ 24,389.95 (cash of $ 14,389.95 and $ 10,000 on Mr. Silverstein's death) and disbursed for all purposes of the Silverstein trust a total of $ 33,422.63. The*99 disbursements thus exceeded receipts by $ 9,032.68.
In addition to receipts from the Silverstein trust transactions, the 1946 trust received funds in excess of $ 242,000 from several sources, including Harry Bloch, Sr. (the grantor, decedent's father), Harry Bloch, Jr. (decedent), Hannah Bloch (decedent's aunt), Ruth J. Bloch (decedent's first wife), and the Dayton trust. The Dayton trust was established by Myrtle E. Bloch (decedent's mother) on February 25, 1953, and 17 percent of its income was to be distributed to the 1946 trust. At decedent's death, the 1946 trust owed decedent $ 9,164.51 and owed the Dayton trust $ 1,000.
By the terms of the 1946 trust agreement, the trustee was to hold the trust estate "for the benefit of Robert H. Bloch and James G. Bloch and any other children of * * * [decedent] now or hereafter born, equally, and their issue, per stirpes." The trustee was authorized to acquire, among other things, life insurance policies upon the lives of the beneficiaries and any other person in whom they had an insurable interest. During the lifetime of decedent and until the youngest of his sons reached the age of 25 years, the trustee was to use as much of the net*100 income of the 1946 trust as was necessary to pay any life insurance premiums and was to accumulate the balance. The trust agreement provided that the trust would terminate upon the death of decedent or when the youngest of his sons reached the age of 25 years after decedent's death.
The trust agreement vested the trustee with power to manage and control any insurance policies owned by the 1946 trust to the same extent he would have as absolute owner, including the power to pledge them for loans. Decedent's father as grantor of the 1946 trust reserved the right to designate a successor trustee in the event the trustee died or resigned. A successor trustee would succeed to all the rights, powers, and obligations of the deceased or resigned trustee. The trustee was exculpated from liability by reason of any loss *853 or diminution of value in the trust estate, except when the trustee did not act in good faith or with reasonable care.
On or about February 7, 1947, decedent as trustee of the 1946 trust applied to Prudential Insurance Co. of America (Prudential) for two insurance policies on his life, each in the amount of $ 100,000. On or about February 8, 1947, these two policies, *101 each calling for annual premiums of $ 1,922 for the first 3 years and $ 2,261 thereafter, were issued to the 1946 trust in accordance with decedent's application. On October 26, 1953, decedent as trustee submitted an application to Prudential for a policy on his life in the amount of $ 150,000, and the policy, calling for annual premiums of $ 3,660, was issued to the 1946 trust in accordance with the application. The Prudential policies gave their legal owner (the 1946 trust) certain rights, including the rights to receive dividends, obtain loans, surrender the policies, change beneficiaries, assign the policies outright or as collateral for loans, and select the mode of settlement of the proceeds.
Beginning February 16, 1967, decedent (in his individual capacity) executed a series of collateral pledge agreements and a personal guaranty in connection with loans made by First Wisconsin National Bank (hereinafter the bank) to Bloch-Daneman Co., a corporation of which he was an officer, director, and 50-percent shareholder. On July 23, 1969, following pressure from the bank for more collateral, decedent as trustee of the 1946 trust executed assignments of the 1946 trust's three Prudential*102 life insurance policies as collateral security for the obligations of Bloch-Daneman Co. to the bank. The assignments were for the personal benefit of decedent, and for the benefit of the corporation, not for the benefit of the beneficiaries of the 1946 trust. The bank did not receive any written authorization from the trust's beneficiaries with regard to these assignments, nor did decedent receive any court approval therefor.
On or about June 30, 1970, decedent decided to liquidate Bloch-Daneman Co. by selling the assets of the business. In order to pay creditors and sell the inventory, decedent borrowed additional sums from the bank on behalf of the corporation and as an individual. All of this indebtedness was secured by the cash surrender value of the three Prudential life insurance policies and decedent's personal guaranty.
*854 As early as October 8, 1971, the bank raised a question as to the propriety of accepting the entrusted insurance policies as collateral for the corporation's indebtedness. Decedent's attorney suggested that the corporate obligation be transferred to decedent's name. However, on December 6, 1971, the bank informed decedent that its attorneys *103 had doubts as to whether the 1946 trust's insurance policies could legally be pledged to secure decedent's note and suggested that he pledge other collateral. Decedent responded by again suggesting that the corporation's name be taken off the note. On October 19, 1972, the bank advised that "our attorneys are of the opinion that a pledge of trust assets to secure personal indebtedness of the administrator could be questioned by the courts" and suggested alternative arrangements. The matter had not been resolved when decedent died.
On January 8, 1974, after decedent's death on September 19, 1973, the bank filed a claim against decedent's estate in the amount of $ 112,300 (plus interest) with respect to the corporate note of Bloch-Daneman Co. and two personal notes of decedent. The claim was allowed with minor modifications, and the collateral other than the 1946 trust's insurance policies was liquidated and applied on the claim.
On June 4, 1974, the County Court of Milwaukee County appointed Robert H. and James G. Bloch as successor trustees of the 1946 trust. A claim was filed against decedent's estate on behalf of the 1946 trust on the theory that decedent had diverted trust *104 assets by pledging the three Prudential insurance policies to secure indebtedness of decedent and Bloch-Daneman. After a hearing, the County Court ruled that the claim should be held open as a contingent claim until the final distribution of decedent's estate in order to ascertain whether the 1946 trust sustained any loss as a result of the pledge. The bank and the successor trustees agreed that $ 100,000 of the insurance proceeds would be deposited in a special account pending distribution of the estate, and the remainder of the proceeds were to be released to the trust. 3 The estate ultimately *855 proved to be solvent, and the $ 100,000 was released to the successor trustees.
*105
The value of the gross estate shall include the value of all property -- (1) Receivable by the executor. -- To the extent of the amount receivable by the executor as insurance under policies on the life of the decedent. (2) Receivable by other beneficiaries. -- To the extent of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. For purposes of the preceding sentence, the term "incident*106 of ownership" includes a reversionary interest (whether arising by the express terms of the policy or other instrument or by operation of law) only if the value of such reversionary interest exceeded 5 percent of the value of the policy immediately before the death of the decedent. * * *
One of the objectives in adopting the revised standard was to place life insurance policies in an analogous position to other property. The new provisions were explained by the Senate Finance Committee as follows (S. Rept. 1622, 83d Cong., 2d Sess. 124 (1954)):
The proceeds of life insurance on a decedent are subjected to tax in his estate under present law if the policy is payable to the executor, if the decedent paid the premiums on the policy (in this case includible in proportion to the amount paid), or if the decedent possessed any elements of ownership in the policy at date of death.
No other property is subject to estate tax where the decedent initially *856 purchased it and then long before his death gave away all rights to the property and to discriminate against life insurance in this regard is not justified.
The House and your committee's bill retains the present rule including*107 life insurance proceeds in the decedent's estate if the policy is owned by him or payable to his executor, but the premium test has been removed. To place life insurance policies in an analogous position to other property, however, it is necessary to make the 5-percent reversionary interest rule, applicable to other property, also applicable to life insurance.
Thus, Congress has made taxability turn upon the passing of the insurance proceeds to the decedent's estate "or upon the extinguishment at his death of rights ('incidents of ownership') which he possessed in the policy at the time of his death."
Respondent determined in the notice of deficiency that, within the meaning of
In his opening brief, respondent began with the premise that "life insurance is per se testamentary." 4 From this premise, he argued that
In his reply brief, respondent revised his legal stance and stated that the legislative history of
The respondent has reconsidered his position and is in agreement with the Second Circuit in the
*111 *858
Respondent, having thus conceded that fiduciary powers which were not retained by a decedent and which could not have been exercised for his benefit will not support the inclusion of the proceeds of insurance policies in the decedent's gross estate, we turn to his other contentions. He argues that the 1946 trust agreement specifically vested in decedent powers and rights to deal with the insurance policies as his own property and for his own benefit. On this ground, he maintains that the policies are includable in decedent's gross estate.
Respondent is, of course, correct that "a fiduciary may be authorized by the terms of the instrument creating his powers to do that which in the absence of such provision would be a violation of his fiduciary duty of loyalty."
Respondent relies upon paragraph 15 of the trust instrument. 6 That paragraph vests in the "Trustee" the "same right, *859 title and interest in and to said policies and the insurance represented thereby" and "the same rights, options, benefits, powers and privileges with respect thereto as he would have as the absolute owner thereof." The paragraph further provides that companies issuing the policies "shall recognize the Trustee" as vested with all rights and powers over the policies and that his actions thereon "shall be final and conclusive."
*113 These powers, however, were conferred on decedent as trustee. He was to hold them as long as he served in that capacity. They were not personal to him, and he could not lawfully use them for his personal benefit. He could lawfully exercise them solely for the benefit of the beneficiaries of the trust. Even though they were broad powers of discretion, he was under a duty to exercise them in accordance with the law and with his duties and obligations as trustee of the trust.
Respondent seems to argue, however, that because decedent was given power as trustee to manage the insurance policies as if he were the owner, he could use the powers for his personal benefit. We do not agree. The broad powers conferred on the trustee of*114 the 1946 trust are not unusual in cases where a trust grantor desires flexibility in the administration of the trust. 7*116 *860 In
But those powers could be exercised only within the framework of the trust and not for his own benefit. He still had no interest*115 in the policies and could not effect any change as trustee that would give him any rights therein.
That the powers in the instant case were not intended to be exercised for the benefit of decedent personally is shown, moreover, by a provision in the trust instrument that, upon the death or resignation of the trustee, "The successor trustee shall succeed to all the rights, powers and trusts and shall assume all the obligations of such deceased or resigning trustee." Surely it cannot be contended that the trust instrument was intended to vest the successor trustee, whoever he *861 might be, with authority to exercise the broad trust powers for his own benefit.
Respondent next argues that decedent should be treated *117 as a cosettlor of the 1946 trust because, after the trust's nominal funding in 1946 by his father, decedent allegedly contributed $ 9,800 in 1947 which was used to pay the premiums on the life insurance policies. Respondent seems to argue that we should consider decedent's alleged contribution of cash which he as trustee used to purchase the policies as equivalent to a contribution of the policies themselves to the trust. Because decedent as trustee had certain powers over the policies, respondent maintains that the "retention of powers test" applies.
In citing this "test," respondent refers to the principle that "Congress intended
The facts simply do not fit respondent's scenario. While decedent did contribute $ 9,800 (of the total contributions of over $ 240,000), the record does not reveal when this $ 9,800 transfer was made. We know only that it occurred prior to 1967. Moreover, the $ 14,389.95 paid in connection with the Silverstein trust was transferred to the 1946 trust in December 1946. There is no evidence to show that a portion of the Silverstein trust payment was not used to fund the initial premiums on the two February 1947 policies. As for the 1953 policy, numerous contributions from Harry Bloch, Sr., had been received by the 1946 trust prior to the issuance of that *862 policy, and those contributions could have funded the premiums. 9
*119 To be sure, in this case, decedent acquired his trust powers over the policies through his own action; that is, he signed the 1946 trust instrument as trustee and caused the trust to acquire the policies. His trust powers over the insurance on his life thus did not devolve upon him through fortuitous circumstances as certain powers did upon Mr. Skifter in
We are left with the troublesome fact that decedent pledged the three life insurance policies to the First Wisconsin National Bank to secure his own personal loans and loans to Bloch-Daneman Co., a corporation in which he owned 50 percent of the stock. The policies remained pledged at the date of decedent's death. Respondent argues that decedent thereby, in fact, obtained personal economic benefits from the policies and that they should, therefore, be included in his gross estate.
As indicated*120 by our previous discussion of respondent's "beneficial powers argument," we can find nothing in the 1946 trust agreement authorizing decedent to pledge the policies to secure his personal or corporate loans. When decedent used the life insurance owned by the 1946 trust as collateral for bank loans in which he had a personal interest, he acted contrary to the provisions of the trust agreement and clearly in breach of his duty as trustee of undivided loyalty to the beneficiaries.
Indeed, prior to decedent's death, the bank's attorneys advised the bank that decedent apparently did not have authority to make the pledge, and the bank sought to have *863 decedent substitute other collateral or make other arrangements. As other possible solutions, the bank suggested that its loan be made to the 1946 trust and that decedent then borrow directly from the trust, or that the three Bloch sons, who were beneficiaries of the trust, authorize a pledge of the trust's assets. *121 At decedent's death, none of these steps had been taken. The result was that at decedent's death the policies remained wrongfully pledged to the bank to secure his personal indebtedness and that of Bloch-Daneman Co. Decedent's wrongful use of his trust powers in pledging the policies, however, did not convert those powers into "incidents of ownership" within the meaning of
In the case of a trustee's conversion of other types of entrusted property such as cash which cannot be traced, the victim of the conversion has a claim against the estate which, in computing the estate tax, will offset the unidentified funds included in the estate. 10 If the converted property could be identified, the victim could recover it in kind, and it would not be includable in the decedent's estate. In the instant case, when the successor trustees learned of the pledge, they filed a claim against the estate. The matter was resolved pursuant to an agreement whereby the bank released all except $ 100,000 of the proceeds. That sum was held in a special account until the estate*122 was liquidated and found fully solvent, and it was then turned over to the trust. Although decedent may have benefited from his wrongful use of the policies during his lifetime and thus enhanced the value of his estate, we do not *864 think those benefits permit the proceeds of the policies to be included in the gross estate.
*123 To reflect the disposition of other issues,
1. All section references are to the Internal Revenue Code of 1954 as amended, unless otherwise noted.↩
2. This case was originally submitted to Judge Sheldon V. Ekman who died Jan. 18, 1982. It was reassigned by order to Judge C. Moxley Featherston↩.
3. The records of the bank include a memorandum dated Nov. 15, 1973, which states: "As we do not have proper assignments of this collateral and have found that it was beyond Mr. Block's [sic] power to pledge these trust assets, we wanted to talk" with the successor trustees about arrangements to protect the bank's claim.
A dispute also arose as to the rights of decedent's adopted children (Richard and Deborah) to participate in the trust, and a settlement was reached to allow each adopted child of decedent to receive one-tenth of the net trust assets of the 1946 trust.↩
4. In
5. Respondent's new position, he states, is consistent with
"Under the respondent's new position, the decedent in
"The new position of the respondent with regard to the powers of a fiduciary over life insurance contracts does not affect the respondent's position on the issue in
6. Par. 15 of the trust instrument is as follows:
"If any policies of life insurance shall at any time be held as a part of the trust estate the Trustee shall be vested with the same right, title and interest in and to said policies and the insurance represented thereby and shall have the same rights, options, benefits, powers and privileges with respect thereto as he would have as the absolute owner thereof, including but without limitation the following: To surrender, assign, sell at public or private sale, exchange, convert or otherwise dispose of said insurance policies at such time or times, in such manner, upon such terms and conditions and for cash or credit as the Trustee in his absolute discretion shall deem proper; to borrow under the terms of said policies any sums of money or otherwise to pledge or hypothecate said policies as collateral for any loans, to apply dividends in respect of said policies toward the reduction of premiums thereon, or to exercise dividend options in respect of said policies in such other manner as he in his absolute discretion shall deem proper. The Trustee on the maturity of any of said policies shall have the power to take such steps either by legal proceedings or otherwise as he shall deem proper to collect any and all sums of money which shall then be payable in respect thereto and to pay the expenses of such collection out of the income or principal of the trust estate. The companies issuing said insurance policies shall recognize the Trustee as vested with all right, title and interest in and to said insurance policies and the insurance represented thereby as well as with any other powers granted herein and all his acts and proceedings in respect of said policies and the proceeds thereof shall be final and conclusive upon said companies and all persons interested in the trust estate."↩
7. Under the 1946 trust agreement, decedent was not only given broad powers with respect to insurance policies, but also was vested with the power to manage trust stocks and securities "as fully as though he were the absolute and individual owner" and to deal with trust real estate in the same manner "as it would be lawful for any person owning the same to deal" with it. We also note that decedent as trustee of the Silverstein trust was granted the power to manage the trust estate in such fashion "as he would have the right to do if he were the individual owner."
To buttress his point that settlors, desiring flexibility in the administration of the trust, frequently provide that a trustee shall have power to do all things in relation to the trust property that he could do as outright owner of the property, petitioner points to suggested provisions in standard form books such as 4 J. Rabkin & M. Johnson,
"The Trustee shall be vested with all rights, powers, options, and privileges in and to the insurance policies which are part of the trust estate, and the Trustee may exercise any and all of such rights, powers, options, and privileges as fully as any owner of such policies might do."↩
8. The trust instrument involved in that case provided that the trustee(s) "shall have and exercise the exclusive management and control * * * in any manner that they shall deem for the best interests of the shareholders, with all the rights and powers of absolute owners thereof."
9. It might be argued that, even if a tracing were made between decedent's contributions and premium payments, such a link is irrelevant in light of Congress' elimination of the premium payment test. See
10. In
"If decedent had acted to violate the terms of the partners' agreement by changing the beneficiary on the Fuchs or Pflasterer policies, John or Forrest would have had a valid claim against decedent's estate which would have reduced the gross estate by an equivalent amount. Sec. 2053(c)(2); sec. 20.2053-4, Estate Tax Regs. Thus, if decedent had exercised any of his so-called incidents of ownership, his estate would be liable to John or Forrest for the amount of the insurance proceeds, which liability would, in turn, reduce his gross estate."↩
Christos Laganas v. Commissioner of Internal Revenue , 281 F.2d 731 ( 1960 )
estate-of-hector-r-skifter-deceased-janet-skifter-kelley-and-the-chase , 468 F.2d 699 ( 1972 )
Estate of John J. Connelly, Sr. (Deceased) and Ellen C. ... , 551 F.2d 545 ( 1977 )
Estate of James H. Lumpkin, Jr., Deceased. Christine T. ... , 474 F.2d 1092 ( 1973 )
Nancy C. Terriberry, Bruce T. Terriberry and Sarasota Bank &... , 517 F.2d 286 ( 1975 )
catherine-myers-rose-individually-and-as-trustee-of-eleanor-catherine , 511 F.2d 259 ( 1975 )
estate-of-harry-r-fruehauf-deceased-national-bank-of-detroit-harry-r , 427 F.2d 80 ( 1970 )
Sue Ann Hunter, Marie Joyce Kotsonis, L. Fargo Richardson ... , 624 F.2d 833 ( 1980 )
Dick & Reuteman Co. v. Doherty Realty Co. , 16 Wis. 2d 342 ( 1962 )
United States v. O'MALLEY , 86 S. Ct. 1123 ( 1966 )