Stuart v. Commissioner

John Stuart, Petitioner, v. Commissioner of Internal Revenue, Respondent

Stuart v. Commissioner

Docket No. 97500

United States Tax Court

2 T.C. 1103; 1943 U.S. Tax Ct. LEXIS 16;

December 10, 1943, Promulgated

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Decision will be entered under Rule 50.

In 1930 petitioner executed three indentures by which he created three trusts, one for the benefit of each of his three children. During the taxable years the children were of age. Under the indentures the trustees were to pay to the children for the first fifteen years so much of the income as they deemed advisable, and thereafter the children were to receive the entire net income of the trusts during their respective lives. Petitioner reserved the right to sell the trust corpora and to direct the reinvestment of the proceeds, together with the right to withdraw the corpora upon substitution of securities of equal value. Held, the income of the trusts is not taxable to petitioner under section 22 (a) of the Revenue Act of 1934 as that section affects section 167 of the same act.

Herbert Pope, Esq., and Benjamin M. Price, Esq., for the petitioner.

F. R. Shearer, Esq., and John D. Kiley, Esq., for the respondent.

Harron, Judge.

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HARRON

The respondent determined deficiencies of $ 14,054 and $ 10,588.60 in income tax for the years 1934 and 1935, respectively. The only question for determination is whether petitioner was taxable in 1934 and in the first seven months of 1935 on the entire net income of three trusts which he created for the benefit of his three children. Other adjustments which respondent has made in the income reported by petitioner in his income tax returns for the years 1934 and 1935 are not contested.

Originally, a memorandum findings of fact and opinion was entered in this proceeding on November 29, 1940. It was stated, inter alia, in that opinion that the basic question in the proceeding was controlled by the decision in . It was concluded that the entire net income of the three trusts created by petitioner on March 31, 1930, for the benefit of his three children was taxable to him under section 166 (2) of the Revenue Act of 1934. In the proceeding before the Board, respondent relied on sections 166 and 167 of the act, but in view of its decision the Board did not consider the applicability of section 167. Upon review in the Circuit Court of Appeals for the Seventh Circuit respondent advanced the further contention that the income was taxable to petitioner under section 22 of the act. On December 19, 1941, the Circuit Court of Appeals reversed the decision of the Board, and held that petitioner was not taxable on the income from these trusts under sections 166, 167, or 22 of the Revenue Act of 1934. . The Commissioner filed a petition for certiorari, which the Supreme Court granted on April 27, 1942. On November 16, 1942, the Supreme Court rendered its decision affirming the decision of the Circuit Court of Appeals with respect to sections 166 and 167, but reversing that decision with respect to section 22 of the act, and its effect upon section 167. The Supreme Court's decision directed the Circuit Court of Appeals to remand the cause to the Board "to reach a conclusion on 22 (a) or its effect upon section 167." .

Upon petitioner's motion, an additional hearing was held and the cause is here presented upon the original stipulation of facts and oral testimony, and a supplemental stipulation of facts and oral testimony presented at the further hearing.

FINDINGS OF FACT.

Petitioner is a resident of Hubbard Woods, Illinois, and filed his income tax return for each of the years 1934 and 1935 with the collector of internal revenue for the first district of Illinois.

Petitioner and his wife, Ellen Shumway Stuart, have three children; Joan, born May 31, 1904; Ellen, born June 21, 1907; and John, born January 1, 1912.

On March 31, 1930, petitioner executed three trust indentures by which he created three separate trusts, one for the benefit of each of his three children, and named himself, his wife, and his brother, R. Douglas Stuart, as the trustees of each trust. To the trustees of each trust, petitioner transferred 700 shares of common stock of the Quaker Oats Co., of which petitioner was president.

Prior to the execution of the trusts it had been the established custom of petitioner to make regular periodic allowances to his children. The creation of the trusts by petitioner was due to the fact that the elder daughter had just been married and the younger daughter was about to be married, and petitioner and his wife felt that daughters ought to be made independent to the extent that they could run their homes in a reasonable way. Petitioner thought that a trust should also be set up for his son so that all the children should be treated on the same basis. Petitioner's reason for establishing the trusts, rather than making outright gifts to his children, was that he did not know whether his daughters' husbands or his son had good business judgment, and he felt that the beneficiaries would best be protected by the trusts as they were established. He did not intend to reserve for himself any economic benefit or gain from either the trust corpus or income. At the time he created the trusts petitioner did not know that his brother, R. Douglas Stuart, intended to make similar trusts. In naming petitioner as a cotrustee of the trusts which R. Douglas Stuart created, the latter was not prompted by the fact that he was a cotrustee with petitioner under petitioner's trusts.

Petitioner appointed his wife and his brother as trustees because he knew that they shared his point of view in regard to the children, their needs, and the purposes of the trusts, and he thought that they could better carry out the purposes of the trusts than could a corporate trustee.

The provisions of each of the three trust indentures were substantially the same. For a period of fifteen years the trustees were to pay over to the child designated as the beneficiary of the particular trust "so much of the net income from the Trust Fund as they in their sole discretion should deem advisable" and to add the undistributed portion of the net income to the corpus of the trust. After fifteen years the trustees were to pay the entire net income from the trust to the beneficiary for life.

Upon the death of the beneficiary, the trustees were to pay over the principal of the trust to the beneficiary's issue then surviving or, if the beneficiary left no issue then surviving, to the issue then slrviving of the petitioner; or, if there were surviving no issue of the beneficiary or of petitioner, to Princeton University and the University of Chicago in equal shares.

The trustees were empowered to collect all income; to sell any of the securities held in trust; to invest the proceeds from the sale of securities and the net income added to trust principal in "municipal or government bonds, stock, real estate mortgages, or other income-producing property or securities, real or personal, * * * without being limited or restricted to investments as fixed by the statutes of the State of Illinois"; to execute all necessary "assignments, conveyances, deeds and other instruments"; to exercise the voting power upon all shares of stock held in trust; and to exercise "every power, election and discretion, give every notice, make every demand, and do every act and thing in respect of any shares of stocks and bonds which they could or might do if they were absolute owners thereof"; to unite with others "in carrying out any plan for the reorganization of any corporation" the securities of which were held in trust; to exchange the securities of any corporation for others issued by any corporation; to assent to the consolidation or merger of any corporation; to pay "such assessments, expenses and sums of money as they may deem expedient for the protection of the interest" of the trust in the securities of any corporation; and to employ "such agents and attorneys as may be necessary."

Stock dividends, liquidating dividends, and "proceeds from the sale of any part of the Trust Funds, including profits" were to constitute principal.

Each trust indenture contained a clause providing that the trustees were not to incur any liability "except such as may be due to * * * actual fraud or willful mismanagement" and a clause providing that any person dealing with the trustees was not to be required "to see to the application of any money or monies paid to the Trustees."

Paragraphs eighth and ninth of each trust indenture provided as follows:

Eighth. The Donor reserves and shall have the right at any time and from time to time to direct the Trustees to sell the whole of the Trust Fund, or any part thereof, and to reinvest the proceeds in such other property as the Donor shall direct. The Donor further reserves and shall have the right at any time and from time to time to withdraw and take over to himself the whole or any part of the Trust Fund upon first transferring and delivering to the Trustees other property satisfactory to them of a market value at least equal to that of the property so withdrawn.

Ninth. During the life of the Donor, the said Ellen Shumway Stuart and the said Robert Douglas Stuart, or the survivor of them, shall have full power and authority, by an instrument in writing signed and delivered by them or by the survivor of them to the Trustees, to alter, change or amend this Indenture at any time and from time to time by changing the beneficiary hereunder, or by changing the time when the Trust Fund, or any part thereof, or the income, is to be distributed, or by changing the Trustees, or in any other respect.

On August 3, 1935, Ellen Shumway Stuart, petitioner's wife, and R. Douglas Stuart, petitioner's brother, executed an amendment to each of the three trust indentures, canceling paragraph eighth and changing paragraph ninth to read as follows: "Ninth. This Indenture and all of the provisions thereof are irrevocable and not subject to alteration, change or amendment." This amendment was made at the suggestion of petitioner's attorney and petitioner thought it was made on account of certain provisions in the Revenue Act of 1934.

The provisions of paragraph eighth of the trusts were made because the trusts originally held only stock of the Quaker Oats Co. and petitioner thought that diversification of trust securities was important and that if it became necessary or wise to diversify he, being president of the company, was in the best position to make the decision.

For a number of years prior to the creation of the trusts and during the taxable years petitioner was president of the Quaker Oats Co., and his brother, R. Douglas Stuart, was vice president of the company. During the taxable years there were eleven directors of the Quaker Oats Co., among whom were petitioner and his brother, R. Douglas Stuart.

Originally each trust comprised 700 shares of Quaker Oats common stock. As of December 31, 1934, each trust comprised 1,360 shares. This increase was due to a stock dividend and to Christmas presents which petitioner gave to the children by adding stock to their trusts.

As of December 31, 1930, and December 31, 1934, the total common stock of the Quaker Oats Co. issued and outstanding amounted to 702,000 shares. The preferred stock of the Quaker Oats Co. had no voting power except upon default in payment of dividends on preferred stock for three months, and except upon the question of decrease or increase of preferred stock and mortgage or charge on real estate or the fixed plant of the corporation.

In 1934 petitioner and his immediate family and the three trusts for his children together owned 38,157 shares of common stock of the Quaker Oats Co., or approximately 5.4 percent of its outstanding common stock. Petitioner's brother, R. Douglas Stuart, and his immediate family and the four trusts for his children together owned 34,010 shares of common stock of the Quaker Oats Co., or approximately 4.8 percent. In addition to these shares, 19,708 shares were owned by petitioner's sister, Margaret S. Macdonald, 2,590 shares by petitioner's brother-in-law, George A. Macdonald, 5,648 shares by his mother, Margaret J. Stuart, 3,924 shares by his aunt, Mary Laird, 1,500 shares by his cousin, Robert S. Laird, and 1,037 shares by his sister-in-law, Virginia W. Shumway.

Holders of 99 or less shares of common stock of the Quaker Oats Co. numbered 883 as of December 31, 1930, and 1,785 as of December 31, 1934. Holders of from 100 shares to 999 shares, inclusive, of the common stock of Quaker Oats Co. numbered 399 as of December 31, 1930, and 547 as of December 31, 1934. Holders of 1,000 or more shares of the common stock of Quaker Oats Co. numbered 117 as of December 31, 1930, and 135 as of December 31, 1934.

The trustees voted the stock of the trusts by giving proxies to a proxy committee which consisted of petitioner, Henry P. Crowell, Walter L. Templeton, and William D. McKenzie, the latter two being secretary-treasurer and general counsel of the company, respectively. Only William D. McKenzie and Walter L. Templeton voted as proxies at all the stockholders' meetings, except the meetings in 1933 and 1935, when Harry E. Sheasby, assistant secretary, voted as substitute in place of Templeton.

The percentages of the total stock voted at the stockholders' meetings of the Quaker Oats Co. from 1930 to 1935, inclusive, voted by the proxies, were 83.98 percent for 1930, 77.34 percent for 1931, 80.59 percent for 1932, 75.34 percent for 1933, 80.08 percent for 1934, and 70.79 percent for 1935.

The trust instruments were kept in petitioner's safe deposit box at the Northern Trust Co. from 1930 until about 1935 and then in his wife's box at the same bank. The securities were kept with the instruments and were in the names of all of the trustees for the benefit of the particular child.

A separate bank account was kept at the Northern Trust Co. for each trust, in which the dividend checks were deposited and on which checks were drawn for the respective beneficiaries. Petitioner and his wife determined during the taxable years how much should be paid to the children.

The net income of each of the three trusts in 1934 and 1935 was as follows:

Trust for --	1934	1935
Joan	$ 7,496.74	$ 8,295.00
Ellen	7,496.74	8,295.00
John	7,566.54	9,135.00
Total	22,560.02	25,725.00

Of the total amount of the net income of the three trusts for 1935, $ 16,800 was received by the trustees during the period from January 1, 1935, to August 3, 1935.

In 1934 and 1935 the net income of the three trusts was distributed to the beneficiaries thereof as follows:

Trust for --	1934	1935
Joan	$ 7,496.74	$ 7,675.36
Ellen	7,496.74	7,473.80
John	1,863.33	2,740.50

During the taxable years, Joan and Ellen were married and lived separate and apart from their parents. During these years, John, when not at college, lived with his parents.

Petitioner's net income (not including any income of the three trusts) was $ 157,257.45 in 1934 and $ 185,534.77 in 1935. At the time of the creation of the three trusts petitioner's net worth was in excess of $ 4,000,000, and the property which he transferred to the trusts had a value of approximately $ 575,000.

Economic gain was not realized or realizable by petitioner under the provisions of the trusts. The rights and powers reserved to petitioner by the trust indentures did not constitute the equivalent of ownership of the trust corpus or income.

OPINION.

In the findings of fact new findings have been made in part because a further hearing was held in this proceeding after remand from the Circuit Court of Appeals for the Seventh Circuit. At the further hearing, a supplemental stipulation of facts was introduced in evidence, together with additional testimony. The findings of fact as now made incorporate substantially the facts as originally found, together with additional facts.

Originally, this case was heard with a companion case, R. Douglas Stuart, Docket No. 97501. We held in both proceedings that petitioners were taxable under section 166 (2) of the Revenue Act of 1934, ¹ on the entire net income of trusts which they had created for the benefit of their children because of our conclusion that under paragraph "Ninth" of the trusts, the trustees had the power to revest the title to the corpora of the trusts in the grantors. The proceeding of this petitioner, John Stuart, and the proceeding of his brother, R. Douglas Stuart, were reviewed together by the Supreme Court, .The Court there held that the income from the R. Douglas Stuart trusts was taxable to the grantor under sections 167 (a) (1) and (2) of the Revenue Act of 1934, ² since the beneficiaries of the trusts were the grantor's minor children to whom he owed a parental obligation of support. Respondent has not raised that question in this proceeding, since the beneficiaries of the trusts created by petitioner were of age during the taxable years.

The Supreme Court sustained the conclusion of the Circuit Court of Appeals for the Seventh Circuit that under Illinois law, which controlled the question, the trustees of the trusts created by petitioner, as well as the trustees of the trusts created by R. Douglas Stuart, could not revest the trust corpora in the grantor under section 166, nor could they accumulate the income for, or distribute it to, the grantor directly so as to come within the provisions of section 167. The Supreme Court pointed out, however, that the income of the trusts created by petitioner might be taxable to petitioner under section 22 (a) as that section affects section 167 if petitioner had obtained any economic gain for the taxable years through a control of the trusts so complete that it must be said that he was the owner of its income. In this connection, the Court cited . The Court further pointed out in its opinion that when we first considered this case it was not necessary for us to reach a conclusion under section 22 (a) or to consider the interplay of section 22 (a) on section 167, but that such should now be done. The Circuit Court of Appeals for the Seventh Circuit had previously held that petitioner was not taxable on the trust income under section 22 (a), but the Supreme Court was of the opinion that a proper determination of this question could not be reached in the absence of certain findings of fact. In the original proceeding in this Court and on review in the Circuit Court of Appeals and in the Supreme Court, there was no evidence on the question as to whether petitioner had retained economic benefits in the trusts or could realize economic gain through the possibility of controlling the Quaker Oats Co. through the control of the stock of that company in the trusts. This was particularly important since paragraph "Eighth" of the trust indenture permitted the grantor to recapture the Quaker Oats stock from the trusts upon substitution of securities having an equal value. The Supreme Court, therefore, remanded the proceeding to the Circuit Court for remand to this Court to reach a conclusion on the question of the possibility of such an "economic gain." At the further hearing evidence was introduced on the question of stock ownership and control of the Quaker Oats Co., and additional findings of fact have been made. (Cf. Helvering v. Stuart, supra, p. 148, where the Court stated that "the triers of fact have made no findings upon this point.")

In determining the broad question as to whether petitioner realized or could realize economic gain from a control of the trusts, we have considered section 22 (a) as it affects section 167. Since, however, the Supreme Court has held that the income of the trusts created by petitioner is not taxable to him under the provisions of section 167, the question has been narrowed to the applicability of section 22 (a) as that section has been construed by the Clifford case, supra. Respondent's brief is devoted entirely to this question. He contends that petitioner retained or could realize rights and benefits from the assets of the trusts so as to make him in reality the owner of the property in each trust within the doctrine of the Clifford case.

Respondent's argument that petitioner retained rights and benefits sufficient to constitute him the owner of the corpora of the trusts and so to charge him with the taxable income from the trusts, is predicated upon paragraphs "Eighth" and "Ninth" of the trust indentures. Under paragraph "Eighth" petitioner specifically reserved to himself the right to sell the whole or any part of the trust corpus and to direct the reinvestment of the proceeds, and to withdraw and take over to himself the whole or any part of the trust corpus upon substitution of other securities of a like value which would be satisfactory to the trustees. Paragraph "Ninth" gives petitioner's wife and brother, as cotrustees, the right to alter or amend the indentures, change beneficiaries or trustees, and other broad powers over the corpus and income of the trusts. Respondent argues that under the circumstances petitioner's wife and brother would be subservient to his wishes so that, in effect, petitioner would exercise the rights and powers given to the trustees under paragraph "Ninth" of the trust indentures.

Upon examination of the trust indentures in their entirety and the circumstances attendant upon their creation, we can not say that petitioner retained such complete control of the trusts as to make him the owner of the property or the income, or that he obtained any economic gain from the trusts.

The provisions of paragraph "Eighth" of the indentures were inserted by petitioner to enable him to diversify the securities held by the trusts. He believed that as president of the Quaker Oats Co., and being fully cognizant of its affairs, he would be in the best position to determine whether to sell those securities or to retain them. His primary consideration in reserving this power was to insure the financial security of his children. Under the circumstances, this provision is not unnatural and does not indicate such a retention of control by petitioner over the trusts as to make him taxable on the income therefrom. ; ; ; affd., ; .

The Supreme Court in , in the absence of a specific finding suggested that "Control of the stocks of the company of which the grantors were executives may have determined the manner of creating the trusts." We assume from this that the Court had in mind the possibility that the stock in the trusts might be essential to the maintenance of a stock control of the Quaker Oats Co. by petitioner and his brother. If this were the situation, it would be apparent that petitioner would realize an economic gain from such a control of the trust corpus. However, the facts are otherwise. The corpus of the three trusts originally consisted of 2,100 shares of stock of the Quaker Oats Co., which were approximately three-tenths of one percent of the total stock of the corporation, which amounted to 702,000 shares. Petitioner and his immediate family, together with the three trusts, owned in 1934 only 5.4 percent of the stock of the company. In 1934 petitioner's brother, R. Douglas Stuart, and his immediate family, together with the four trusts for the children of R. Douglas Stuart, owned only 4.8 percent of the stock of the company. At the annual stockholders' meeting in 1930, the year in which the trusts were created, 83.98 percent of the stock was represented, and at the annual meetings for the years 1931 to 1935, inclusive, the stock representation at each meeting was in excess of 70 percent of the total stock. It can not be held, therefore, that petitioner through control of the trust corpus retained any stock control of the Quaker Oats Co.

Under paragraph "Ninth" of the indenture, petitioner himself, either individually or as trustee, did not have the right to change the beneficiaries, the trustees, or the time when the corpus or the income was to be distributed. That power was given specifically by petitioner to the other two trustees. The fact that the other trustees were his wife and his brother is not significant under the circumstances. It is natural that the grantor of a trust will appoint as fiduciaries persons upon whose ability and integrity he may rely. This is particularly true in this case because the wife and brother best knew the needs of the children and the purposes of the trusts. It would have been an abuse of their discretionary powers under the trust indentures if they allowed petitioner to impose his will upon them. In the absence of evidence, it would be unjustifiable to impute such an abuse to them. .

The evidence is uncontroverted that the trusts were created for the purpose of giving a measure of independence to petitioner's children. One of his daughters had just been married and the other daughter was about to be married. Petitioner believed that the income of his sons-in-law was not sufficient to allow his daughters to live without some hardship. The trust for the son was created so that all the children would be treated in the same manner. Petitioner's reason for making the gifts in trust was to afford the maximum of financial security to his children. His son had never been in business, and he had no knowledge of the business acumen of his daughters' husbands.

Under the terms of the trusts, the trustees were to pay to the beneficiary of each trust for the first fifteen years so much of the net income as in their discretion they should deem advisable and they were directed to add any undistributed income to the principal of the trust. After fifteen years the trustees were to pay the entire net income from each trust to the beneficiary for life. Upon the death of the beneficiary, the trustees were to pay the principal of the trust to the beneficiary's issue then living, or if there were no such issue, then to the issue of the petitioner then living, or if there were no such issue then living, then in equal shares to Princeton University and the University of Chicago.

The Supreme Court in , has held that under these trust indentures, neither the corpora of the trusts nor the income therefrom could revest in or be distributed to petitioner. Thus, in this respect, there was no possibility of economic gain either realized or realizable to petitioner. The securities of the trusts were registered in the names of the trustees and they alone had the right to vote the stock. In addition, the trustees were given broad powers of management which point to complete divestment of control of the trusts by petitioner.

The trusts here are entirely distinguishable from the one involved in the Clifford case, supra. There, the trust was for a short term; here, it is for a long term. There, the grantor was the sole trustee and had absolute discretion to pay over to his wife the whole or part of the net income therefrom; here, the grantor was one of three trustees, and he had given over to the other two trustees the exclusive right to change the provisions of the indentures. There, the corpus of the trust was to revert to the grantor on its termination; here, petitioner could never receive the economic enjoyment of either the corpus or its income. There, the trust was for the benefit of the wife living in the same household with the grantor; here, the trusts were for adult children, two of whom had established separate residences from petitioner. A similar distinction was made in , wherein the Circuit Court of Appeals for the First Circuit stated:

Helvering v. Clifford rests on its particular facts, as the court was careful to say * * *. Where the grantor has stripped himself of all command over the income for an indefinite period, and in all probability, under the terms of the trust instrument, will never regain beneficial ownership of the corpus, there seems to be no statutory basis for treating the income as that of the grantor under Section 22 (a) merely because he has made himself trustee with broad power in that capacity to manage the trust estate. * * *

This statement of the law has been quoted with approval by the Circuit Court of Appeals for the Seventh Circuit in See also, ; ; ; ;

Accordingly, it is held that petitioner is not taxable on the net income from the trusts for the taxable years under section 22 (a) of the Revenue Act of 1934, as that section affects section 167.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 166. REVOCABLE TRUSTS.

  Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested --

  * * * *

  (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,↩

  then the income of such part of the trust shall be included in computing the net income of the grantor.

• 2. SEC. 167. INCOME FOR BENEFIT OF GRANTOR.

  (a) Where any part of the income of a trust --

  (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or

  (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; * * *

  * * * *

  then such part of the income of the trust shall be included in computing the net income of the grantor.↩