author: HabRon:

text:
    Affiliated Enterprises, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96603.
    Promulgated July 19, 1940.

      Albert J. Gould, Esq., for the petitioner.

      R. P. Rertzog, Esq., for the respondent.
   OPINION.

HabRon:

Issue 1 — 0ompensoMon for personal services. — Under section 23 (a) of the Revenue Acts of 1934 and 1936 a taxpayer may deduct as business expense all ordinary and necessary expenses paid or incurred, including a reasonable allowance for salaries or other compensation for personal services actually rendered. The respondent has made a determination, which is prima facie correct, that a reasonable allowance for compensation for the personal services of Clover Yaeger is $1,200 and $600 for 1935 and 1936, respectively. He has disallowed in full deductions claimed for sums paid to Maizie Ricketson for the services performed by her. The burden is upon petitioner to introduce evidence to overcome the prima facie correctness of respondent’s determination.

Petitioner relies upon the facts as set forth in the findings of fact to sustain the burden of proof upon it to show that a reasonable allowance for compensation for the two officers in question, for purposes of deduction under section 23 (a), is a total of $19,500 for 1935 and $33,800 for 1936, as claimed on the returns for those years. This proceeding has been submitted on a stipulation of facts. As stipulated, the facts show that each of the individuals in question rendered services to petitioner in each taxable year, but the facts do not show how much time each individual devoted in the respective services; and they provide little by which to measure the value to petitioner of the services performed. The question requires determination of what is a reasonable allowance as an ordinary and necessary business expense for compensation for the services actually rendered by each of the persons involved.

Both persons rendered some services to petitioner in each taxable year, the nature of which is not as fully described, as we think it should be; and Clover Yaeger’s services were more extensive than those of Maizie Ricketson. The evidence also shows that each was a stockholder and director; that each was a wife of one of the two men who built up petitioner’s business; that the board of directors comprised C. U. Yaeger, Rick Ricketson, Clover Yaeger, and Maizie Ricketson; that the undivided profits of petitioner, according to balance sheets, were $14,855 in 1984; $122,352 in 1935; and $287,537 in 1936. There is no evidence as to the amount of dividends distributed to stockholders in 1935 and 1936, if any. There is no evidence as to the salaries paid in the taxable years to C. U. Yaeger and Rick Rick-etson, who were also officers and stockholders, so that it is not possible to judge the value to petitioner of the services of the two officers in question by means of any comparison with the services rendered to petitioner by the other officers. Also, there is no evidence to show what petitioner would have had to pay to get others to do what Clover Yaeger and Maizie Eicketson did. It also is a fact that the compensation paid to each person in question was almost twice as great for 1936 as for 1935, but there is no evidence to show that there was a commensurate increase in the services of each person or in the value thereof to petitioner to justify allowance of the increases as ordinary and necessary business expenses. While Maizie Eicketson had been engaged previously in newspaper work, there is no evidence as to the compensation paid to her by other employers for, perhaps, similar work. Further, there is no evidence to prove that the payments in question were not influenced by family considerations and were not disguised distributions of profits. Botany Worsted Mills v. United States, 278 U. S. 282. In short, aside from showing that each of the officers and stockholders- in question rendered some services to petitioner in the taxable year, the petitioner has introduced only very meager evidence in support of its allegation that the services were reasonably worth, as ordinary and necessary business expense, the large sums deducted in the returns. The approval of the compensation paid in the taxable years by petitioner’s board of directors is not conclusive of the reasonableness of the compensation for purposes of deduction as an ordinary and necessary business expense. L. Schepp Co., 25 B. T. A. 419; East St. Louis Finance Co., 34 B. T. A. 1085.

The amounts in question constituted high annual salaries. The total amount paid Clover Yaeger in 1935 represented an increase of $10,000 a year over the total amount paid to her in 1934; and the sum paid to her in 1936 represented an increase of $8,300 over the sum paid to her in 1935. But it appears that Clover Yaeger rendered greater services in 1935 and 1936 than she had done in 1934. It also appears that in July 1936 she discontinued some of the office work she had been doing in 1935. Maizie Ricketson’s services in the taxable years do not appear to have been worthless, nor do they appear to have increased in 1936 over what they were in 1935. Upon due consideration of the evidence it is held that a reasonable allowance, under section 23 (a), for compensation for services performed by Clover Yaeger is $2,400 in 1935, and $1,800 in 1936; and, for services performed by Maizie Ricketson, $1,200 in each year. This has been found as a fact. See L. Schepp Co., supra; Long Island Drug Co., 35 B. T. A. 328; affd., 111 Fed. (2d) 593; Wagegro Corporation, 38 B.T.A. 1225, 1229; New York Talking Machine Co., 13 B.T.A. 154; cf. Cohan v. Commissioner, 39 Fed. (2d) 540, 544; Frederick L. Watson, 25 B.T.A. 971; Atlas Plaster & Fuel Co., 18 B.T.A. 1123; affd., 55 Fed. (2d) 802.

Issue 2 — Was petitioner a personal holding company? — The respondent determined that 80 percent of petitioner’s net income for the taxable years was properly attributable to royalties as that term is used in section 351 of the Revenue Acts of 1934 and 1936, and as defined in article 351-2 of Regulations 86 and 94. Accordingly, respondent determined that petitioner was subject to surtax in 1934, 1935, and 1936, under section 351.

The question is whether or not petitioner is a personal holding company, subject to surtax, within the definition of section 351 (b). The answer to this question turns upon whether or not petitioner’s income in 1934, 1935, and 1936 was derived from royalties.

The facts were stipulated and have been set forth at length in the findings of fact. Briefly, the nature of petitioner’s business was to sell to theatre operators an idea and to provide them with a few simple articles to execute the idea, both for charges covered by contracts. The so-called system was a sales promotion or advertising plan, intended to increase patronage of moving picture theatres. From the beginning petitioner was aware of the difficulties involved. First, while petitioner hoped to obtain an exclusive right to its system by obtaining a patent, it knew in January of 1934, when a patent application was rejected, that it was extremely doubtful whether exclusive control over the use of the system could be obtained. Second, petitioner was fully aware of the possibility that the system could be attacked as a lottery. In spite of the apparent dangers, petitioner obtained many contracts from theatre owners, who paid petitioner a stated sum on a weekly basis for the use of the system. The contracts were in the form of licensing agreements, and this gives rise to respondent’s claim that the income from the agreements constituted license fees or royalties. A license fee is, generally speaking, synonymous with royalty. See 48 C. J. 276, par. 447.

But petitioner had no property rights in its idea or system on which it could give licenses to others. The means of carrying on the system were not patentable. We should not and need not ignore judicial determinations relating to petitioner’s business, such as the following decisions: Affiliated Enterprises v. Gantz, 86 Fed. (2d) 597, decided December 3, 1936, by the Circuit Court of Appeals for the Tenth Circuit; and Affiliated Enterprises v. Gruber, 86 Fed. (2d) 958, decided December 18, 1936, by the Circuit Court of Appeals for the First Circuit. In the Gantz case, petitioner sued to enjoin Gantz from using petitioner’s system or one similar to it, upon a claim of ownership of a property right therein on the basis of copyrights held on the instruction sheets and a claim to trade-mark rights in the name “Bank Night” in the State of Oklahoma. In the Gruber case, petitioner sued to enjoin a competitor from using a similar system under the name of “Parlay Cash Night.” Petitioner alleged ownership of property rights in its system on the same grounds as in the Gants case, and petitioner alleged unfair competition. In deciding each case adversely to petitioner’s claims, the respective courts held as follows: (1) That petitioner was not entitled to restrain others from the use of the system; that the use of the system could not be covered by copyright; that petitioner had no right at large in a trade-mark to constitute an exclusive right to use the system described by the name Bank Night; that the system was so closely akin to a lottery as to be not entitled in the protection of a court of equity; (2) that petitioner had no property right in the system, which, having been disclosed to the public could be copied along similar plans and used by others in the same way; that the system itself, being in no sense a writing, could not be copyrighted, and in fact was not copyrighted; that the use of a similar system by others did not constitute unfair competition; that petitioner had no property right in the system, although it had expended time and money in developing the system.

In the Gruber case the court said:

While the plaintiff restricts operating under the System to its licensee, by its very nature, in order for it to operate, knowledge thereof must be thrown open to the public and any property right based upon secrecy was lost as early, at least, as the first public exhibition, and there was no surreptitious appropriation of knowledge of the system by the defendants.

In the face of the above situation, it is the essence of respondent’s position that petitioner actually did obtain income through license of its system to others under a purported ownership of a property right, the use of which purportedly could be licensed; and that, therefore, the income received constituted royalities within the meaning of the definition prescribed in section 351 (b).

Petitioner contends that, in spite of the form of its contracts as license agreements, since payments were made on a weekly basis in a fiat sum, regardless of use of the system, the income from the contracts was in the nature of rents and was not royalties. Petitioner argues that the wording of the statute “can not be extended by implication, and in case of doubt, construction must be against the government”, citing Commonwealth v. Philadelphia Rapid Transit Co., 134 Atl. 455.

The facts are that at least 80 percent of petitioner’s income was derived from the so-called license agreements and more than 50 percent of its stock was owned in each taxable year by not more than five persons.

Upon due consideration of all the facts, we are of the opinion that petitioner was not a personal holding company within the statutory definition. Petitioner had no exclusive property rights in its system. In January of 1934 the first application for a patent was rejected. The copyrights covering instructions and descriptive material did not extend to, and could not extend to, covering the entire system so as to give petitioner exclusive rights in the use thereof. Petitioner’s income was in reality, income from a sales-promotion scheme for which many believed it worth the payment of fee. They received certain services by way of receiving all materials assembled for use under written instructions, in addition to the idea of operating the system.

We said in Kiesau Petroleum Corporation, 42 B. T. A. 69, that “our first resort should be to the natural, ordinary and familiar meaning of the words used” in the statute in construing the terms of section 351 (b). In this case, we are of the opinion that the ordinary and familiar meaning of the term royalties does not extend to the sort of income which petitioner succeeded in obtaining under its bold contracts. Accordingly, it is held that respondent erred in determining that petitioner was subject to surtax under the provisions of section 351.

Reviewed by the Board,

Decision will be entered wnder Rule 50.

DisNey concurs only in the result.

M/up,bock, AeNOld, and Opper dissent.

       SEC. 351. SIJRTAX ON PERSONAE HORDING COMPANIES.
      * * * * * * •
      (b) Definitions. — As used in this title—
      (1) The term “personal holding company” means any corporation * * * if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.

       Art. 351 — 2. Glassification of a personal holding company. — * * *
      *******
      Prom the standpoint of the nature of the gross income, a corporation comes within the definition of a personal holding company for any taxable year when 80 per cent or more of its gross income for such taxable year was derived from the following sources:
      (1) Royalties. — The term “royalties” includes amounts received for the use of or for the privilege of using patents, copyrights, secret processes and formulas, good will, trade marks, trade brands, franchises, and other like property. It does not include rents, nor over-riding royalties received by an operating company. As used in this paragraph the term “overriding royalties” means amounts received from a sublessee by the operating company which originally leased and developed the natural resource property in respect of which such overriding royalties are paid.


source: Caselaw Access Project

author: Disney: Leech,

license: Public Domain

text:
    George H. Whiteley, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92899, 92900.
    Promulgated July 23, 1940.

      Frederick H. Spotts, Esq., Robert O. Fluhrer, Esq., and A. Ghcmi-cey Newlin, Esq., for tbe petitioner.

      Brooks Fullerton, Esq., for tbe respondent.
   OPINION.

Issue 1.

Disney:

The major difference between the parties here is whether the form or the substance of the transaction should prevail; that is, whether petitioner or his wife should be treated here as the grantor of the trust. The gist of the petitioner’s argument is that his wife was the grantor both in substance and form, upon the ground that she received the bonds and note from him unconditionally. He contends that the situation here is no different from what it would be if the trust had been created by his wife out of property which had never belonged to him. Respondent insists upon brief that, with the exception of the insurance policies, the value of which, he says, was negligible, the property transferred in trust belonged to the petitioner, and that it was mutually understood that the transfer was made to secure the wife against loss of her property then at risk in his stock trading account and not to pass ownership. Respondent relies upon sections 166 and 167 of the 1932 Act. He makes no contention that the question is governed by section 22 (a).

Petitioner’s wife, at the request of Livingstone and Smith, applied for, paid the initial premiums on, and was made the beneficiary of, the insurance policies. The insurance was not taken out as protection to her for the loans of stock and cash she had made to petitioner. They were secured in other ways. It does not appear that the insurance had a cash surrender value at the time of its transfer to the trustee. It was an expense of the trust, not an income-producing asset thereof. The presence in the trust of this insurance does not, in our opinion, demonstrate that petitioner is not the real grantor of the trust, as the respondent contends him to be.

It is clear that the statutory provisions relied upon by the respondent are not controlling if petitioner’s wife is to be regarded as the grantor of the trust, for sections 166 and 167 relate only to grantors of trusts. In determining whether petitioner or his wife should be regarded as the grantor of the trust we are not limited to the bare terms of the instrument. Numerous cases hold that transactions between husband and wife must be closely scrutinized to determine their real character. In a case involving the deductibility of a loss resulting from the sale of property to a corporation wholly owned by the taxpayer, the court, in Higgins v. Smith, 308 U. S. 473, said:

* * * The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.

In Johnson v. Commissioner, 86 Fed. (2d) 710, affirming 33 B. T. A. 1003, involving the deductibility of interest on an amount borrowed by the taxpayer from a trust created by his wife with funds furnished by the taxpayer, the court said that: “Despite such purpose [to avoid or minimize taxes], the question is always whether the transaction under scrutiny is in reality what it appears to be in form.”

In Richardson v. Smith, 102 Fed. (2d) 697, the collector contended that certain shares of stock transferred by Richardson to his wife and by her shortly thereafter set up in trust continued to belong to the husband. In ordering a new trial to determine additional facts, the court remarked:

* ⅜ * s0 ⅛ this ease the transfer may in fact have been intended only to deceive the taxing authorities. It is not necessary that such a mutual understanding shall be explicit or verbal; it may be gathered from the conduct of the parties in a series of transactions, or in any other way. Johnson v. Commissioner, 2 Cir., 86 F. 2d 710. All that need appear is that the donor did not intend to divest himself of control over the res, that the donee knew of the donor’s intent and assented to it, and that the donor knew of the donee’s assent. If all this is fairly inferable from the relations, the gift, however formal, is a sham; but the donor’s belief, though well founded, that he can prevail upon the donee to comply with his demands, is alone not-enough; it does not put the donee’s will under any constraint, and the property becomes unconditionally his. Marshall v. Commissioner, 6 Cir., 57 F. 2d 633; Smith v. Commissioner, 7 Cir., 59 F. 2d 533; Kell v. Commissioner, 5 Cir., 88 F. 2d 453; Bardach v. Commissioner, 6 Cir., 90 F. 2d 323.

In Lehman v. Commissioner, 109 Fed. (2d) 99; certiorari denied, 310 U. S. 637, a case involving reciprocal trusts, tire court said that-“The law searches out the reality and is not concerned with the form” and recognized that one who furnishes the consideration for a trust is a settlor.

Under the general contention of petitioner that his wife was the unconditional owner of the property transferred by her in trust, he argues that the bonds and note “were given outright to the wife” because of the existence of a very large obligation to her for loans of stock and cash. While upon brief he used terms synonymous with the word “gift”, he does not specifically contend that the bonds and note were conveyed by way of gift. Such argument would be contrary to a statement made by his counsel at the hearing that he would show a consideration for the transfers. He merely refers to testimony regarding protection to his wife for the financial assistance she had given him as the motive for the transfers. He argues that the facts are unusual, if not unique, and asserts that there is no occasion here to decide the precise character of the transfers, alleging that it is sufficient that the named settlor of the trust was the absolute owner of the property transferred under the instrument.

A brief statement of the facts at this point will be of assistance. The petitioner operated a stock trading account in which there was a debit balance of about $260,000 at the close of 1931 and May 1932. He had on deposit as collateral in the account all of his own stock acceptable to the broker and 6,000 shares of preferred stock of the Commonwealth & Southern Corporation which he had borrowed from his wife. In addition he owed his wife $53,000 for cash borrowed to help carry the account. Petitioner was able with some difficulty to meet calls made at various times by the broker for more collateral. In and after December 1931 petitioner and his wife were alarmed about the condition of the account. Petitioner characterized the situation as “critical” and his wife testified that he was “desperate.” In their dilemma, petitioner consulted Smith, his father-in-law, and Livingstone, a banker, and “put myself in their hands,” and petitioner’s wife turned to her father for guidance. Smith had no faith in the ability of petitioner and his wife to solve their financial difficulties. Smith and Livingstone consulted with each other about the matter and at times with petitioner’s wife, and in May the former concluded that some definite action should be taken to correct the situation. A trust was thought of by Livingstone as early as December 1931; in May 1932 the one in controversy was executed.

The evidence clearly shows a willingness on the part of the petitioner and his wife to conform their acts under the circumstances to the wishes of Livingstone and Smith. Petitioner testified: “I was in a very humble frame of mind, and I was willing to do anything.” He informed Livingstone that w* * * I wanted him to — anything that I had which I could put up to show my good faith and my willingness to repay my wife and settle my affairs I was perfectly glad and willing to do.” Petitioner also testified that he would have executed a note in favor of his wife for a larger amount if she had requested it. The wife testified that she “would have given him [petitioner] everything I had to help him,” and, upon being questioned as to whether the bonds and note constituted a charge against petitioner for the help she had given him, she testified: “I was not charging him anything, was I? You see, this is very vague to me.” Her lack of understanding of what was being done appears well founded. Livingstone, who alone conceived the idea of having petitioner take out more life insurance, and with Smith requested the execution of the note, in response to a question of whether the note was a charge for the financial assistance the wife had given the husband, testified: “Mrs. Whiteley hasn’t anything to do with it. She never thought of $200,000 or twenty-five cents. Mrs. Whiteley was entirely instructed by Mr. Smith and myself.” We conclude that the bonds and note were no such charge.

Petitioner also testified that he never consulted his wife about the formation of the trust. However, at least as early as May 24, 1932, when he submitted to a physical examination for life insurance for transfer as part of the corpus of the trust, he was aware of what was being done on his and his wife’s behalf, for his wife testified that, when she consulted him about the insurance and creation of the trust, he objected to it. Petitioner became familiar with the terms of the trust about the túne he was called to go to the doctor for an examination for insurance. For some time Livingstone, Smith, and petitioner’s wife urged him to take insurance, and he objected and refused to go to the doctor for examination, but finally agreed, and took the examinations and on May 24 signed the usual applications. Other testimony is that Livingstone never consulted the petitioner about the trust. The reason is obvious. , Petitioner had expressed to Livingstone and Smith a desire to do whatever they deemed best under the circumstances and the evidence of record clearly shows that under this delegation of authority the whole plan was conceived and carried out. At all times petitioner’s wife acted according to and as she received instructions from Livingstone- and hér father.

Petitioner contends that the execution of the note under seal imports a consideration. He cites William Park, 38 B. T. A. 1118, now on appeal, involving the deductibility of interest paid on a sealed note executed and delivered in Pennsylvania as a gift. The- question there turned upon whether an indebtedness had been created within the meaning of section 23 (b) of the Revenue Acts of 1932 and 1934. The issue here is entirely different, and the principle of that case is not controlling.

The record contains no definite proof as to the reason for obtaining the note or why the amount was $200,000. Though there is some evidence that it was regarded by Livingstone and Smith as protection to petitioner’s wife, yet Livingstone also testified that the corporate bonds had nothing to do with fixing the amount of the note at $200,000, that the shares of stock of the Commonwealth & Southern Corporation at risk in petitioner’s trading account or the greater part of them were secured by petitioner’s Dentists’ Supply Co. stock, and that the $126,000 par value bonds and the Dentists’ Supply Co. stock were ample security for the wife. He testified further:

A. My understanding of the $200,000 is absolutely vague. The only thing I know of is those were hectic times. Mr. Smith and myself and possibly Mr. Whiteley agreed that that was probably — in case of — in fact, I don’t know actually, except we thought at that time that was the best thing to do, that was the best arrangement we could make.
Q. Well, was that the only-
A. I don’t think that those bonds and that sort of thing came in as any differential or difference between what she had loaned and so forth. I don’t think — I don’t know but I don’t believe that was the pertinent point there.
Q. Well, what did you mean by “differential”?
A. The note itself probably would be considered the settlement at that point of the difference of Mr. and Mrs. Whiteley, so that if either one Bad died at that point, and the note would have been paid off, I think that is approximately what it was. I can’t say definitely. I am sorry.

Tile note provided for interest without specifying the rate. Interest at the rate of 4 percent per annum was paid by petitioner in tile face of a legal rate of 6 percent prevailing in tbe State of Pennsylvania. The failure of the trustee to collect the legal rate is not explained in the record. "We aie unable to find from the evidence of record unconditional transfer of the bonds and unqualified execution and delivery of the note by petitioner to his Wife as alleged by him.

The respondent alleges that the whole arrangement was put into effect as a pledge to secure petitioner’s wife against loss on account of the money and stock she had at risk in petitioner’s stock account. There is evidence to support such view. But other evidence, the terms of the trust, and the acts of the nominal grantor and beneficiary under it, tend to leave the matter in confusion. Petitioner’s wife testified as to protection intended for her; but plainly her view is not to be given great weight, for she also testified when asked the purpose of the trust: “I think you had better ask Mr. Livingstone that question, because — I am sorry; the trusts are quite beyond my comprehension”; also, asked whether she considered the $200,000 note as interest or charge for the help she was giving her husband: “It was arranged for, everything, by the Western National Bank, and you will have to ask them those questions, because everything is too complicated for me.” Livingstone, too, is inconsistent in his account, for he also refers to protection for the wife, yet is positive that the insurance was not necessary for her protection, because she had the Dentists’ Supply Co. stock for her protection. He says also that they could not figure on the bonds as a base of their plan. The bonds under the trust arrangement were obviously no protection for the wife, for the husband could, under the trust, and did on June 1, the day after the trust agreement was signed, authorize all of the bonds to be withdrawn from the trust and pledged to secure a loan for him, he expressing his desire to secure the proceeds of the loan as soon as possible. The entire corpus of the trust was, in the same way, subject to the command of the petitioner. We conclude that a theory of protection of the wife does not explain the reason for the trust.

We do find evidence strongly indicating that the whole plan was conceived and put into effect for the purpose of forming a taxable entity charged with the duty of paying insurance on the life of petitioner. This is shown by the testimony of Livingstone. He testified that the insurance did not result from the wife’s loans of stock to petitioner; also that it was decided upon at a time other than when the conclusion was reached to obtain a note from petitioner for $200,-000; and that the wife’s loans of stock and cash were adequately protected without the insurance. Other testimony of Livingstone, quoted above, acknowledges inability to give a reason for obtaining the note. Livingstone could not rely upon the bonds as corpus for the trust because they were in the estate of petitioner’s father and it was not known at the time the trust was being prepared when they would be distributed, and they were not, in fact, received by petitioner until May 26, the day after the wife had assigned his note to the trustee, and the second day after the insurance was applied for and in large part issued. It thus appears that if the bonds had not been available for transfer to the trustee the corpus of the trust would have consisted of merely petitioner’s note, an income-producing asset, and life insurance, an expense item, with the plain effect of a life insurance carrying trust. That the bonds were in fact added would not change the situation. Petitioner was to receive any income in excess of premiums. Though unable to figure the bonds as base of the plan, the parties did figure the note as the base. Though nothing was ever paid upon the principal of the note, the interest was paid regularly each year, within 30 days of the due date of the interest and the insurance premiums. The effect of the arrangement has been the carrying, by the note, of insurance. Admittedly, the insurance was not necessary to protect against the wife’s advances or loans. The remainder of the trust corpus, the bonds, was immediately used by the petitioner, and only a small part is now on deposit with the trustee. The $53,000 has been paid. Yet the note remains in trust, -wholly unpaid, producing interest annually at the time when the insurance premiums are due. We conclude and hold that the real object of the trust was to carry insurance on petitioner’s life.

In addition, we believe that there was mutual understanding and agreement between husband and wife that the trust, of his note and property, was for his benefit. There was evidence that Livingstone never consulted petitioner in regard to the formation of the trust, but petitioner knew that a trust was under consideration some time before May 24, 1932, on which date he submitted to a medical examination for the insurance policies. There is evidence that he objected to it, but at what stage of the matter is not shown, and it is apparent that the objection' was later waived or withdrawn, since on May 24 he joined his wife in signing the insurance applications, executed and delivered to her on May 25 without objection the note which she the same day assigned to the trustee, and thereafter, on May 26, delivered the bonds to her. He had then at least known of the trust for some time. It has not been shown that he did not know the terms under which his wife would place the bonds and note in trust. Asked whether at delivery of the note on May 25 there was understanding as to its being placed in trust, petitioner’s answer was not a denial, but only: “Not that I remember.” Livingstone consulted petitioner’s wife on the terms of the trust and although she testified that the subject was vague to her, nothing of record is opposed to a conclusion that she did have advance knowledge of at least the general terms of the trust, such as that petitioner would have broad powers of control over the property after it had been transferred in trust, and that her control would be of no significance. She testified : “Mr. Livingstone and I had been talking about this trust for some time.” The fact of petitioner’s objection and her insistence, and later acquiescence, shows mutual understanding. He was “willing to do anything.”

The bankers arranged the trust. There is nothing to indicate that petitioner did not know the terms of the trust when he delivered the note and the bonds, and he acted under it by authorizing withdrawal of the bonds to secure a loan the next day after the trust instrument was signed. In any event, petitioner and his Avife were at all times acting through common agents authorized to act for them, and knoAvledge and acts of the agents were those of the petitioner. Taxpayers who A'oluntarily authorize others to rearrange their property rights and then comply with requests made upon them as the petitioner and his wife did here, are in no position to assert that they were not aware of the consequences of their acts and in agreement thereon. We think a meeting of the minds of petitioner and his wife has not been negatived. Not only their words but their conduct may, and we think did, prove their understanding that petitioner did not intend to divest himself of control of his property, that the wife knew of, and assented to, petitioner’s intent, and that he knew of her assent. Richardson v. Smith, supra. See also Johnson v. Commissioner, supra. Livingstone, asked whether he was conversant with the effect of the trust on income tax matters, answered indecisively, but said: “I have — Our laAvyer has sort of guided us on that.” The respondent determined that the trust corpus belonged to the petitioner and that he was taxable upon trust income. No evidence sufficient to overcome the presumption of correctness of the determination has been adduced. The respondent committed no error in regarding the petitioner as the grantor of the trust. Section 166 therefore applies. As the designated beneficiary of the trust, petitioner (a) was entitled to all of the net income of the trust; (b) could, with the consent of the nominal settlor, require the trustee to distribute to him amounts of principal for his maintenance, support, comfort and enjoyment and any other purpose; (c) could vote and exchange the stock and otherwise exercise rights attached to ownership; (d) exercise power of appointment on the corpus by will; and (e) hypothecate, sell, exchange or loan the property of the trust to any person, firm or corporation he should designate and specify the terms thereof. These powers are sufficient to make the income of the trust taxable to petitioner under section 166. Percy M. Chandler, 41 B. T. A. 165. Petitioner’s wife had no substantially adverse interest in the corpus or income.

The trustee was directed to use income of the trust to pay insurance on the life of the petitioner. The amount so used is also taxable to petitioner under the provisions of section 167 (a) (3).

Issue 2.

In bis determination of the deficiency for 1935 the respondent taxed the petitioner on all of the income of the four trusts created for the benefit of his children upon the ground that as the settlor of the trusts he reserved the right to direct the trustee as to the use of the income during his life.

The petitioner contends that since no part of the income of the trusts was used for the support and maintenance of his children or in discharge of any of his own obligations, the income of the trusts is not taxable to him. He relies upon E. E. Black, 36 B. T. A. 346, and other cases in which it was followed. In the Blach case and like cases, the discretion to use the income of the trusts for maintenance, support, and education of the settlor’s children was vested in the trustee or trustees. Here the petitioner, as settlor, reserved power to receive and apply the income of the trusts for the support, maintenance, education, and enjoyment of his children. Where such a right exists the income of the trust is taxable to the settlor. J. S. Pyeatt, 39 B. T. A. 774. Even if the Pyeatt case is not applicable, the income of this trust is nevertheless taxable to petitioner. The income of each trust herein was payable “to the Donor, as, if and when ordered in writing by him to do so, during the minority of (his daughter, Virginia Whiteley), to be used solely and entirely by him for her support, maintenance, education and enjoyment.” The Henry A. Loeb case, 40 B. T. A. 517, holds, following strictly section 167 (a) (2), that if the trust income “may in the discretion of the grantor * * * be distributed to the grantor”, then such part thereof shall be included in computing-net income of the grantor, regardless of whether any part of the income actually was distributed to the grantor. In fact, in the taxable year, Carl Loeb, Jr., received none of the income and Henry Loeb received $5,000 out of approximately $50,000, the remainder going to their mother and sister.

Since under the language of the instant trust the income “may * * * be distributed to the grantor,” is the rule of the Loeb case prevented from applying merely because the trustor, if he should receive the income, must use it “solely and entirely * * ⅜ for * * * support, maintenance, education and enjoyment” of his minor children, whom he has a duty to support? We think that such restriction, entailing only what would cause grantor’s tax-ability under Douglas v. Willcuts, 296 U. S. 1, can not logically prevent the application of the rule in the Loeb case. Moreover, since the income might be spent for the “enjoyment” of the minors, an element which is beyond the legal obligation of the' father and under which it would appear that he might spend the income almost at his will, there is in such respect no essential difference or distinction from a mere distribution to tlie grantor. The respondent did not err in taxing the income of the trusts to the petitioner.

Reviewed by the Board.

Decision will be entered for the respondent.

Mttkdock and Mellott dissent.

Leech,

dissenting: This decision must rest, of course, upon the record in this proceeding alone. Since that record does not include any part of the record in any other proceeding, I have grave doubt as to the correctness of the conclusion of the majority on the first issue.

The conclusion on the second issue is, I think, not only wrong but clearly inconsistent with a long line of Board decisions.

The income of the irrevocable trusts was to be paid to the grantor if and when requested by him during the minority of each beneficiary and was thereupon to be used solely for the support, maintenance, education, and enjoyment of the minor beneficiary. However, no part of the trust income Avas paid to the grantor during the taxable year. Nevertheless, the grantor is held taxable on all of this trust income, under section 167 (a) (2), because he could have obtained and used it to meet his legal obligation to support, maintain, and educate his children. That result requires a linkage of the rationale of Douglas v. Willcuts, 296 U. S. 1, with the language of the cited section, which, I think, is unjustifiable and barred by that section itself. See dissent in Dorothy Whitney Elmhirst, 41 B. T. A. 348, 368.

Moreover, the Board, in a number of cases, including such recent promulgations as George H. Deuble, 42 B. T. A. 277, and Percy M. Chandler, 41 B. T. A. 165, has refused to apply this rationale in construing that statutory provision where a trustee had the power to distribute such income to the grantor. See J. Edward Johnston, 41 B. T. A. 550; Dorothy Whitney Elmhirst, supra; Arthur Letts, Jr., 41 B. T. A. 1172; E. E. Black, 36 B. T. A. 346; Martin F. Tiernan, Trustee, 37 B. T. A. 1048; Hudson v. Jones, 22 Fed. Supp. 938. These cases hold that a grantor, in a situation like the present, is taxable only on such trust income as was actually received and used to discharge his legal obligation. The majoi’ity attempt to distinguish those cases on the ground that the discretion to distribute the trust income was there vested in a trustee while here it was reposed in the grantor himself. This distinction is clearly untenable. A mere trustee has no interest substantially adverse to that of the grantor, Reinecke v. Smith, 289 U. S. 172, and, therefore, under the explicit terms of section 167 (a) (2), the possibility of the existence of any such distinction is wholly eliminated. See Randolph E. Paul, “Five years with Douglas v. Willcuts,” 53 Harvard Law Review 8, note. Furthermore, this attempted distinction is implicitly rejected in the recent case of Alfred C. Berolzheimer, 40 B. T. A. 645. It is true that J. S. Pyeatt, 39 B. T. A. 774, is consistent with the result in this proceeding, but it is, I think, wholly inconsistent with the line of cases cited above, and should be overruled on this point.

Henry A. Loeb, 40 B. T. A. 517, upon which the majority alternatively rest their conclusion, is obviously distinguishable. In that case the trust income was payable to the grantors, in the discretion of the trustee, without restriction a,s to its use, and was thus expressly taxable to the grantors under section 167 (a) (2). Here, the use of the income was restricted to that of meeting the legal obligation of the grantor. If that use had been limited to any other than that of paying a legal obligation of the grantor or directly benefiting him, such income, even if paid and so used, would not have been taxable to the grantor. See Corliss v. Bowers, 281 U. S. 376; Higgins v. Smith, 308 U. S. 473; Helvering v. Clifford, 309 U. S. 331; Burnet v. Wells, 289 U. S. 670; Commissioner v. Morton, 108 Fed. (2d) 1005. Thus, the only possible basis, constitutionally and otherwise, for taxing the contested trust income to the grantor here, is under section 167 (a) (2) on the ground, implicitly barred by that section itself and inconsistent with decided cases, that he could have secured and used it to meet his legal obligation.

It is argued that the added prescribed use of the income for the “enjoyment” of the beneficiary nullified the effect of any prior limitation and left the income, when received by the grantor, without substantial restriction as to its use.

But, the “enjoyment” had to be the enjoyment of the beneficiary and not the grantor. That those uses are certainly not synonymous contradicts any nullification of the earlier restrictions — particularly here where “enjoyment” is coupled conjunctively with the “support, maintenance, [and] education” of the beneficiary. And if disjunc-tively construed, “enjoyment” of the beneficiary, since it was no obligation of the grantor, would have relieved the grantor of tax. See Jay C. Hormel, 39 B. T. A. 244, reversed on another ground, 111 Fed. (2d) 1.

At all events, I think the restrictions here on the use of the trust income were undoubtedly substantial. Cf. Mary E. Wenger, 42 B. T. A. 225. And, since none of this income was received by or used to meet a legal obligation of the grantor, under every decision of the Board of which I know, except J. S. Pyeatt, supra, it is not taxable to him.

Smith, Van FossaN and Tyson agree with this dissent.

       SEC. 166. REVOCABLE TRUSTS.
      Where at any time during the taxable year the power to revest in the grantor title to any part oí the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (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 for such taxable year shall be included in Computing the net income of the grantor.
      SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      # * * * * * ⅜
      (3) 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, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.


author: Turner: Mellott,

text:
    Anna Eliza Masterson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93517.
    Promulgated July 23, 1940.

      G. H. Refer, Esq., Harry G. Weeks, Esq., and R. B. Gannon, Esq., for the petitioner.

      James H. Yeatman, Esq., Ralph F. Staubly, Esq., and Vernon F. Weekley, Esq., for the respondent.
   OPINION.

Turner:

The commissioner determined a deficiency of $88,876.92 in petitioner’s gift tax for the year 1935. The question presented is to determine what property or property rights constituted the subject matter of gifts made by petitioner to her six children by an instrument of transfer executed by her on August 19,1935.

The petitioner, bom February 5, 1868, is a resident of Amarillo, Texas, and is the widow of R. B. Masterson, who died on August 1, 1931. Besides his wife Masterson was survived by two children by ■a prior marriage and four children by his marriage to the petitioner. At the time of his death he and petitioner owned a substantial estate, all of which was community property.

On December 6, 1928, the pétitioner and her husband executed a joint will and covenant, wherein they expressed the desire to dispose of all their estate in the manner set forth therein, such disposition “to take effect at the time of the- death of either of us, and at the time of the death of the survivor of us.” It was mutually agreed that all of the property belonging to either of them was community property and that in the disposition thereof all of the children above mentioned, being six in number, would be treated and considered as of the full blood, share and share alike. Other provisions of the will read as follows:

3. In consideration of said mutual agreements, and in consideration of the further mutual agreement that the survivor of us shall in all things be and remain bound by tbe provisions hereof, and upon our mutual solemn covenant and agreement with each other that neither of us shall hereafter execute any will, other than as mutually agreed, dealing with our said estate, we have entered into this mutual covenant and the execution of this joint will, expressly agreeing and covenanting with each other that the same shall not hereafter, unless by our mutual written consent, be in any manner changed, modified or revoked, and that all the terms, provisions and conditions hereof shall be from and after the execution hereof binding upon us and the survivor of us as the agreed means and method of making effective our desires and directions as to the disposition of our said community estate. And for such purposes, we each waive our respective community rights and interest in said estate, and here agree that the same shall remain intact, subject to the terms, conditions and provisions hereof.
II.
It is our will and desire that the survivor of us, It. B. Masterson or Anna Eliza Masterson, as the case may be, shall, with the rights and authority below given, have all the estate of every description, real, personal or mixed, which either or both of us may own, to be used, occupied, enjoyed and expended by and during the life of such surviyor, with the full management and control thereof, with the right to receive all rents and revenues, invest all moneys of the estate, pay all taxes and assessments, indebtedness and other proper and just claims and charges against said estate and joint property; but with the limitation, however, that neither of us as such survivor shall have the right or power to sell and dispose of any of said property of said estate except for the purpose (1) of paying proper and legal charges and claims against said estate, (2) provide for the maintenance and support of the survivor of us, and (3) such sale and disposition of all or any portion of said property may be made at any time during his or her life by the survivor for the purpose of distributing said estate share and share alike among the children named in Paragraph 2, Subdivision I, hereof, after discharging the special bequests herein made. The survivor, however, shall in any event have the full right, power and authority to make, execute and deliver oil and gas leases or renew or extend existing oil and gas leases on any portion of our estate, and said oil and gas leases and renewals thereof may be made for any period or term of years agreed upon, and such period shall be in no wise lessened or diminished by reason of the death of either of us, but the property herein demised and bequeathed by this will shall vest subject to all of the terms and provisions of said leases.
2. The survivor of us shall have the right, power and authority at any time when he or she may deem best to distribute one-half of ouy joint estafe to the children hereinabove named in Paragraph 2, Subdivision I, of this will, share and share alike.
3. In the event of the remarriage of the survivor of us one-half of all of our estate shall immediately vest in our children, share and share alike, such children being named in Paragraph 2, Subdivision III of this will, and shall vest in accordance with the terms of said paragraph.
III.
Upon the death of the survivor of us, or upon our simultaneous death, we mutually agree and here jointly direct that said joint estate shall be disposed of as follows:
1, (a) We desire and direct that all our just debts be first paid out of said estqte. ,(b) We have heretofore made gifts in equal portions to ail of our children in about the sum of $40,000.00 each, except to our daughter Mary, and in order to make such gifts equal as nearly as it is possible so to do we devise and bequeath to our daughter Mary Masterson Fain the home place, including the real estate, improvements and all furniture and fixtures located in the residence located thereon, and being the property at 1620 Polk Street, Amarillo, Texas, said property to vest in our said daughter free and clear of all estate or inheritance taxes, such taxes to be paid by the estate, (c) We bequeath to Mrs. Flora Masterson, of Oklahoma City, Oklahoma, stepmother of R. B. Masterson, $1000.00 in cash, and to Mrs. Bettie McGregor, of Amarillo, Texas, sister of R. B. Másterson, $1000.00 in cash.
2. Thereupon and after the payment of said special bequest to our daughter Mary Masterson Fain and the special bequests to Mrs. Bettie McGregor and airs. Flora Masterson, we desire and direct that our executors hereinafter named shall as soon as possible consistent with the welfare of said estate divide, transfer, convey and deliver the residue of same, share and share alike, to our children, R. B. Masterson, Jr., T. B. Masterson, Sallie Lee Scott, Anna Belle Kritser, Fannie Fern Weymouth and Mary Masterson Fain. In the event, however, that any of said children should predecease the survivor of us, then and in such event the interest in our estate herein devised to such child shall vest in the issue of his or her body, share and share alike; but in the event any of said children die without living issue or descendants thereof, then and in such event such deceased child’s husband or wife, as the case may be, shall inherit one-half of the interest herein devised to such child, and the remaining one-half interest shall pass to the remaining surviving children herein named in this paragraph or their living descendants, share and share alike; and in the event that any of said children predecease the survivor of us leaving neither surviving husband or wife or surviving children or descendants thereof, then and in such event the entire interest in our estate devised to such child shall pass to the remaining surviving children herein named in this paragraph, or their living descendants, share and share alike. Descendants of deceased children, however, shall take under this will per stirpes and not per capita.
3. In making final distribution of our estate our executors hereinafter named shall collect from the devisees and legatees herein named any sums of money owing by them, or either of them, to either of us, whether evidenced by note or open account, said debts being considered as a part of our estate, and said sums shall be collected prior to any distribution of said estate.
4. We and each of us ask our devisees and legatees to in all things aid our executors hereinafter named in carrying out our wishes as expressed in this will, and in order, if possible, to insure this it is our will and we do now here expressly provide and make it a condition precedent to the taking, vesting, receiving or enjoying of any property, benefit or thing whatsoever under and by virtue of this will that no such devisee or legatee shall in any manner contest the probate thereof or question or contest the same or any part or clause thereof in any judicial proceeding; and we further will and provide that should any such devisee or legatee so contest or question or in any manner aid in such contest or questioning he or she shall thereupon lose and forfeit all right to any benefit and all right or title to any property or thing herein directly or indirectly devised or bequeathed to him or her; and every such right, title, property or thing is now by us expressly given, devised and bequeathed to and shall thereupon vest in such of our devisees and legatees herein named as our children as do not so question or contest or give aid in such questioning or contest of this will or the probate thereof or any clause or provision thereof in the same proportion as to value in which they otherwise take in value of our estate under this will, and in lieu of the property herein given to such contesting devisees or legatees we bequeath the sum of $1000.00 each, and no more.
5. We hereby constitute and appoint the survivor of us as independent executor of this our joint will, without bond, with the rights and powers enumerated under Subdivision II hereof; and upon the death of the survivor of us, or upon the failure or refusal of the survivor of us to qualify as executor, we hereby constitute and appoint H. E. Exum, T. B. Masterson and O. E. Weymouth as independent executors of this our joint will, without bond, giving and granting unto them full power and authority to do all things whatsoever that may be requisite and necessary to reduce said estate to possession, including the power to sell and/or all real and/or personal property and to convert the same into cash or securities approved by said executors, in order that said estate may be fully distributed as promptly as possible to the beneficiaries herein named; and in the event that either one of the said H. E. Exum, T. B. Masterson or C. E. Weymouth should fail or refuse or be incapacitated to qualify as executor, the remaining two executors shall select a third; * * *

The will was admitted to probate in the County Court of Potter County, Texas, on August 17, 1931, and letters testamentary were issued to petitioner on that date. Thereafter and until August 19, 1935, petitioner administered the entire estate.

On August 19, 1935, petitioner executed an instrument purporting to release and relinquish a certain interest in the estate to the six children named in the joint will. This instrument provided in part-as follows:

Whereas, it is the desire of the undersigned, Anna Eliza Masterson, at this time to release and relinquish unto the said 11. B. Masterson, Jr., T. B. Masterson, Sallie Lee Scott, Anna Belle Krltser, Fanny Fern Weymouth, and Mary Masterson Fain all of her right, title and interest in and to the limited life estate reserved unto herself in and to her undivided one-half interest in and to the whole community property of herself and deceased husband, R. B. Masterson, with the exceptions hereinafter stated, and desires also to relinquish and release unto said persons any right of control that she might have in and to the accretions to said undivided one-half interest since her husband’s death, so that henceforth she will look only to the limited life estate granted her by said will in the portion of the joint estate formerly belonging to R. B. Masterson for her support and maintenance, and she will have no interest in any of said joint estate, or its accumulations, save the right to manage and control under the terms of said will the one-half of said joint estate formerly belonging to R. B. Masterson, and will look to the residue of said one-half for her future support and maintenance:
Now, Therefore, in consideration of One Dollar ($1.00) to me in hand paid, receipt of which is hereby acknowledged, and the further consideration of the natural love and affection that I bear for the grantees herein, I, Anna Eliza Masterson, a feme sole, of Potter County, Texas, do by these presents release and relinquish unto T. B. Masterson, of Knox County, Texas, Sallie Lee Scott, of Travis County, Texas, and R. B. Masterson, Jr., Anna Belle Krltser, a widow, Fanny Fern Weymouth and Mary Masterson Fain, all of Potter County, Texas, all right, title and interest of any and every nature whatsoever which I have or claim (the same being the limited life estate above described) in and to the undivided one-half interest which represents my entire community interest in and to the community estate of myself and deceased husband, R. B. Masterson, except as to the reservation and exception hereinafter set out, including any right of control, or other rights, that I might have in and to the increased value of said community interest that has accrued since the death of my husband, R. B. Masterson; so that henceforth said grantees here-inabove named shall have, own and control said entire interest herein relinquished free and clear of the limited life estate heretofore owned and held by me, Anna Eliza Masterson.
It is specifically understood that this relinquishment shall be construed to cover and include my entire community interest in and to the entire community estate of myself and deceased husband, R. B. Masterson, including all property, real, personal and mixed, of any and every nature whatsoever, except as to the reservation and exception hereinafter set out, including the increase in value thereof, so that henceforth I shall have no claim of any nature whatsoever in and to said property. It being distinctly specified that this relinquishment relates to my community one-half in the joint estate formerly belonging to R. B. Masterson and myself, and not to the one-half formerly belonging to him.

The total income of the estate from the date of Mastérson’s death to August 19,1935, amounted to $332.900.16'. During the same period there were expenditures in the amount of $148,799.07, leaving net revenues in the amount of $184,101.09. Of the $148,799.07 so expended, $50,050.45 represented withdrawals by petitioner for her personal living expenses during this period.

Petitioner filed a gift tax return for 1935 reporting the gifts made in the instrument dated August 19, 1935, and placed a value on such gifts in the amount of $44,249.70. After claiming specific exemption in the amount of $50,000, she reported no tax liability. In the return she described the gifts as “Kelinquishment of Limited Life Estate” in property listed in a schedule attached thereto, which schedule shows assets and liabilities having a total net value of $735,189.20. The property thus listed was supposed to represent an undivided one-half interest in the entire estate as of the date of the gifts. The “limited life estate” was supposed to consist of petitioner’s claim against the estate for maintenance and support and the value thereof was determined on the basis of her requirements for living expensés as shown by records kept since her husband’s death and an actuary factor based on her life expectancy.

In asserting the deficiency, the respondent determined that petitioner’s gifts to the six children consisted of a full life interest in one-half of the original community estate; also a fee interest in one-half of all accretions during the period in question. In computing the deficiency, he determined that the total value of the gifts amounted to $284,254.13. After deducting $30,000 to represent sis $5,000 exemptions and a specific exemption of $50,000, be determined that the value of the net taxable gifts was $204,254.13 and that there was a gift tax liability in the amount of $13,710.50.

In the petition it is alleged that the respondent erred in holding and determining that petitioner made a taxable gift in 1935, and in support of this claim of error it is alleged, among other things, that under the terms of the joint will petitioner “except for the powers, rights and duties conferred thereby upon her as executrix and as trustee, * * * had no right, title, interest or estate in and to the property which had comprised the community estate of herself and husband and the fruits and revenues thereof, save and except the right to1 appropriate such amount of the revenues or corpus from said property as might be necessary or proper for her maintenance and support.” In the alternative, it is alleged that if it should be held that petitioner made a taxable gift, respondent’s determination of the value of the gift was erroneous and excessive. In his answer the respondent denied that he erred as alleged in the petition and hearing was had on the issues so drawn.

Thereafter and prior to the expiration of the time allowed for the filing of his brief, the respondent filed a motion to reopen the case for further hearing, requesting that he be permitted to file an amended answer conforming with the facts and proof. At the hearing thereon, the motion was denied. Subsequently, however, and prior to a determination of the issues, the Board vacated the order denying respondent’s motion, granted leave to the respondent to file an amended answer, and ordered that the proceeding be placed on the calendar for further hearing.

Pursuant to the leave given the respondent filed an amended answer and a rehearing was had. In the amended answer it was alleged that the petitioner, instead of owning a life interest in the community property of herself and husband, plus accretions thereto as of the date of the gifts, as originally determined by him, owned an undivided one-half interest in fee in the community property; that by' the instrument dated August 19, 1935, petitioner transferred, by gift, her aforesaid one-half fee interest in the community property, plus accretions thereto, to the six beneficiaries named; that the net value of the property so donated and transferred was $787,132.83; and, in the alternative, if he was mistaken in his belief that petitioner owned a one-half interest in fee in the community estate at the time the’ gifts were made, then she was seized and possessed of a full life interest in the community property of herself and husband, together with accretions thereto. Claim was made for an increased deficiency, the total amount claimed being $83,376.92.

It is the position of the petitioner that upon the death of her husband and her acceptance of the benefits under the will, she was divested of all rights in and to her one-half interest in the community estate except those provided for her in the joint will and covenant, and that under the said instrument she had no right in and to the community estate except the right to support and maintenance, which right she describes as a limited life estate. From this it is claimed that the relinquishment of such a limited life estate in one-half of the community estate to the remaindermen did not constitute the making of a taxable gift. It is the position of the respondent that the joint will and covenant was testamentary only and could not become effective as to petitioner’s share of the community estate until her death And, since the gifts made in the year before us specifically covered her one-half share of the community estate, they were gifts in fee. In the alternative, he contends that the position taken in his deficiency notice is correct, namely, that from and after the death of her husband petitioner was the owner of a full life estate in the entire community estate and her gifts were composed of one-half of the said life estate plus one-half of the accretions* thereto.

The question then is to determine the legal effect of the joint will and covenant and whether it became operative as to petitioner’s Ofte-lialf interest in the community estate. The instrument could have been revoked by mutual consent during the joint lives of the ihákérs, but, after the death of Masterson and the acceptance by petitioner of the benefits conferred thereunder, she could not thereafter repudiate the covenant to the detriment of the other beneficiaries. Larrabee v. Porter (Texas), 166 S. W. 395. In Rossetti v. Benevides (Texas, 1917), 195 S. W. 208, the Court of Civil Appeals Of Texas, Considering a mutual will of a husband and wife, by the terms' of which tlié survivor was to retain a life estate in the homestead and upon the death of the survivor the homestead was to go to two naméd beneficiaries in fee, held, citing Larrabee v. Porter, supra, that upon the death Of the husband and the acceptance of the benefits under the.will by the súr-viving widow each of the named benefieiaries was thereupon vestéd with a remainder interest in an undivided one-half of the homestead. It thus appears that even though an instrument is designated a mutual or joint will it may as to the survivor, by reason of provisions contained therein,- be more than a will which would not be Operative until his oí her death, but may effect the transfer or' conveyance of property of such survivor at the same time it becomes effective as the will of the first spouse to die. As to the intention of the parties in the instant case we have no doubt. The instrument of December 6, 1928, plainly shows that it was the intention of petitioner and her husband that their entire interests in the community estate should pass to the six children and that from and after the death of the first spouse to die the interest of the survivor in the community estate should be limited to that of a life tenant. Under the doctrine of Rossetti v. Benevides, supra, the remainder interests of both Master-son and petitioner passed to the six children and became vested in them in fee in 1981, when Masterson died and petitioner accepted benefits under his will, and after that date the petitioner had no interest in the community estate other than a full life interest plus the added right to invade corpus if necessary for maintenance and support. In other words, upon Masterson’s death in 1931 the said instrument as his will operated to pass a life interest in his undivided one-half interest in the community estate to petitioner, with remainders in fee to the six children, while as to petitioner it operated as a transfer or conveyance to the said children of remainders in fee in her undivided one-half interest in the said estate. The result was exactly the same as if the instrument had been as to petitioner a separate deed of conveyance to become effective on the death of her husband. That it may still operate as her will and control the disposition of other property at her death can in no way affect the fee remainders of the six children in her undivided one-half of the community estate, which remainders passed to and vested in the children in 1931. Rossetti v. Benevides, supra.

According to the terms of the instrument the survivor was to have and retain full use and enjoyment of the community estate for life, and this use and enjoyment specifically included the right to receive all rents and revenues therefrom. The record indicates that during the period from the date of Masterson’s death to August 19,1935, the date of the gifts herein, the total revenues of the estate amounted to $332,900.16 and that expenses, including petitioner’s withdrawals for her personal use during that period, amounted to $148,799.07, leaving net revenues in the amount of $184,101.09. So far as the record shows, the net revenues remained in the estate and no part thereof was withdrawn by the petitioner for her personal use or enjoyment. To the extent of such net revenues, the interest of the petitioner in the estate as it existed at the date of the gifts was that of absolute owner and not that of a life tenant. At the rehearing counsel for the parties agreed that $735,189.20 was the value of one-half of the property “in possession of the Masterson Estate” when the gifts were made. We accordingly conclude that the subject matter of the gifts made by the petitioner consisted of $92,050.55, being one-half of the net revenues not shown to have been withdrawn by her from the estate, and a full life interest in property having a value of $643,138.65, that value being the difference between the stipulated value of one-half of the value of the property then in the estate and $92,050.55, which was one-half of the net revenues not previously withdrawn by petitioner. The value of the property with respect to which the life estate applies being known, we do not understand that there is any difference between the parties as to the method of arriving at the value of the life estate itself.

Under the joint will and covenant the survivor had the right to sell or dispose of any part of the property for purposes of maintenance, and support. In making his determination of the deficiency, the respondent attributed no value over and above the life estate to that right in the survivor. Neither was any claim of additional value made in connection with the alternative contention stated in the amended answer. We conclude therefore that the value of that right, on the facts as they existed, was considered to be inconsequential or negligible.

A considerable portion of petitioner’s brief is devoted to the argument that it was an abuse of discretion on our part to permit the filing of the amended answer. Not only do we find no merit in this contention, but, inasmuch as the case is disposed of on an issue raised in the original pleadings and preserved in the alternative by the amended answer, further or detailed consideration of the contention is unnecessary.

Reviewed by the Board.

Decision loill he entered winder Bule SO.

Mellott,

dissenting: The conclusion reached by the majority seems to me to be erroneous. In the estate tax return filed by the petitioner, as executrix of her deceased husband’s estate, there was returned for taxation one-half of the community property, the whole of which apparently had a value of approximately a million and a half dollars. The opinion states it is the position of the petitioner that upon the death of her husband and her acceptance of the benefits under the will “she was divested of all rights in and to her one-half interest in the community estate except” a right which she describes as “a limited life estate.” This seems to be the holding of the majority, such conclusion being bottomed upon Rossetti v. Benevides, 195 S. W. 208, and Larrabee v. Porter, 166 S. W. 395, the former citing the latter as its principal authority.

Both of the cited cases were decided by Courts of Civil Appeals of the State of Texas and each involved a controversy between those, on the one hand, who would have been entitled to the property or property rights after the joint will had been probated following the death of the last survivor and those, on the other hand, who were claiming in violation of and contrary to the terms of the joint will. Thus in Rossetti v. Benevides, creditors of the wife, she being the last of the makers of a joint will to die, were relying upon a deed of trust given by her which, if effective, would have operated to nullify the agreement which she had made with her husband through the execution of the joint will. In Larrabee v. Porter, the husband was the last to die. He had joined with his first wife in the execution of a joint will devising their property to their children. Subsequently he married and, contrary to the terms of the joint will) made a new will devising all of his property to his second wife, hollowing his death, his second will was probated over the objections of the children, they urging that the first, or joint will, should again be probated. The probate court having ruled against them., they took an appeal to the court of general jurisdiction and also instituted an action to try the title to the real estate involved, for rents and for certain personal property. The cases were consolidated for trial. The court sustained the children’s contention that the first will should have been probated and entered judgment in their favor for the lands, rents, and personalty. The appellate court affirmed the judgment of the lower court.

I think the majority correctly interpret Larrabee v. Porter as holding that, after the death of one of the joint makers of a will and the acceptance by the other of the benefits conferred thereunder, the latter can not thereafter repudiate the covenant or compact to the detriment of the other beneficiaries. I do not agree, however, that under the facts of the instant case “the remainder interests of both Masterson and petitioner passed to the six children and became vested in them in fee in 1931.” As I interpret the facts and the law of Texas with reference to joint wills, petitioner remained the owner of an undivided one-half interest in the community property after the death of her husband. When, therefore, she relinquished to the children “all right, title and interest of any and every nature whatsoever which I have or claim * * * in and to an undivided one-half interest which represents my entire community interest in and to the community estate of myself and deceased husband * * ⅜”, I am of the opinion that she conveyed to them her undivided one-half interest in fee in the community property and should be taxed accordingly. We may not rely upon Rossetti v. Benevides and Larrabee v. Porter as authority to the contrary. Neither hold that the mere probating of the will after the death of one of the joint makers passes the interest of both and the Supreme Court of Texas has specifically ruled otherwise. Thus in Wyche v. Clapp, 43 Texas, 543, it is said:

* * * from the very nature of such an instrument [a joint will] it cannot operate or have effect as the joint or mutual will of the parties while one of them survives; for during such time, if it is a will jt is subject to revocation. It is, indeed, well established that agreements to mate mutual wills are valid. But the effect of such agreements is not to render wills made in pursuance of them irrevocable, though they may be enforced in equity against the estate of the defaulting party after his decease on the ground of an attaching equitable trust. * * * But when one of the parties to such an agreement is a married woman, it could have no binding force against her estate, it would seem, unless it was consummated in the manner prescribed by law for the execution of contracts by femes covert, or she had in some way bound or estopped herself from denying it after she became free from coverture. Be this, however, as it may, it has been held in no case which has come under our observation, and could not in sound principle be so held, as we think, that the mere execution of an instrument in the form of a joint will can be given by construction the effect of a contract or agreement to make mutual wills which will authorize a court of equity to fasten a .trust upon the estate of the defaulting party, much less to warrant its dealing with the survivor as a debtor previous to his death for ins half of a legacy so bequeathed.

An interesting discussion of the general subject of joint and mutual wills may be found in 69 C. J. 1295, et seq. It is there pointed out that a joint will is, in legal effect, the separate will of each of the persons executing it as makers. The text points out that it is sometimes said that a will executed in pursuance of an agreement for mutual wills is irrevocable, especially after the death of one of the parties to the agreement. It is stated, however, that “the true rule is that a mutual will, like every other will, is, as a testamentary instrument, in its essence and by its very nature, ambulatory and revocable throughout the lifetime of the testator, and that it can not be made irrevocable, even by the most express; covenant or terms, although, as a compact, it may be irrevocable, or enforceable notwithstanding its revocation as a will. So, no estate vests under the will of the surviving party to an agreement for mutual wills, on the ground of its irrevocability after the death of the first maker; all that vests, if anything, on the death of the first of the testators is a right of action to enforce the contract against the survivor.”

In the footnote it is pointed out that “it is the contract and not the will, that is irrevocable”, the contract being irrevocable because a court of equity, under its fraud and trust jurisdiction will decree specific performance.

In an opinion by the Court of Civil Appeals of Texas much more recent than the cases relied upon by the majority, i. e., Gorman v. Gause, 56 S. W. (2d) 855, it is said:

The joint and mutual will of John P. Gause and wife cannot be given effect as the joint and mutual will of the parties while one of the parties survives as it is subject to be revoked by the survivor.

In support of the above holding, Wyche v. Clapp, supra, is cited. See also Aniol v. Aniol, 127 Texas, 276, and cases cited. Law of Marital Nights in Texas, Speer, 3d Ed., § 322.

Petitioner’s designation in the instrument of gift or relinquishment to the children of the property conveyed as a “limited life estate” is, of course, not controlling. It is apparent from the instrument, and especially from the last paragraph thereof, that petitioner was relinquishing to the children her “entire community interest in and to the entire community estate of” herself and deceased husband and her “community one-half in the'joint estate formerly belonging to” her husband and herself. This was just as effective to vest in the children all of her undivided one-half interest in the community property as the probate of the will following her death would have been. By means of the instrument, property having a value of approximately three-fourths of a million dollars was transferred to the children. It will never be subjected to the estate tax. Shall it also be exempted from the gift tax. Cf. Sanford’s Estate v. Commissioner, 308 U. S. 39. Being of the opinion that it should not bo, I respectfully note my dissent.

Smith and HaiíeoN agree with this dissent.


author: Murdock:

text:
    Spaulding Bakeries, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96102.
    Promulgated July 23, 1940.

      J. Richard Rigglcs, Jr., Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $1,163.41 in personal holding company surtax for the calendar year 1935. The only issue for decision is whether the Commissioner erred in disallowing a deduction of $17,693.93 in determining the amount of undistributed adjusted net income. The facts were stipulated and the Board adopts the stipulation as its findings of fact.

The petitioner, a corporation, was organized under the laws of New York in 1926. Its certificate of incorporation has been in effect from that time up to and throughout the taxable year. That certificate contained provisions requiring that, on or before the end of each year, the corporation set aside out of the surplus or net profits, after payment of preferred dividends, a sum equal to not less than 1 percent nor more than 5 percent of the largest amount of preferred stock which theretofore shall have been issued and outstanding, to be used in the purchase and retirement of preferred stock. No dividends could be declared upon common stock until the above amount had been set aside. The purchase of the preferred was to be at the lowest prices submitted by preferred stockholders upon sealed offers to sell, in no case to exceed $115 plus accrued dividends. If the funds set aside in any year were not exhausted in such purchases, the excess could be used to retire preferred stock by call or for general corporate purposes.

The largest amount of preferred stock outstanding prior to December 31,1935, was 17,693 shares. Dividends were not in arrears. The corporation set aside $17,693 in 1935 as required by its certificate of incorporation. It deducted that amount upon its personal holding company return in computing undistributed adjusted net income as an amount set aside to retire indebtedness. The Commissioner disallowed the deduction and explained that an amount set aside to retire preferred stock is not set aside to retire “indebtedness” within the meaning of that term as used in section 351 (b) (2) (B) of the Revenue Act of 1934.

The statute allows a deduction for “amounts used or set aside to retire indebtedness incurred prior to January 1, 1934 * * Sec. 351 (b) (2) (B). Another provision is that “the terms used in this section shall have the same meaning as when used in Title I.” Sec. 351 (b) (4). The Commissioner defined “indebtedness” as “an obligation, absolute and not contingent, to pay, on demand or within a given time, in cash or other medium, a fixed amount”, but not including “the obligation of a corporation on its capital stock.” Regulations 86, art. 351-4, as amended by T. D. 4777, C. B. 1937-2, p. 196. The petitioner argues that the above regulation is an attempt to amend the law. He does not contend that the preferred stock itself represents an indebtedness, but argues that the terms of the certificate of incorporation created an indebtedness.

A similar issue was presented in the case of Haffenreffer Brewing Co., 41 B. T. A. 443, where we held under somewhat similar facts that the obligation to set aside funds to retire preferred stock was not to retire indebtedness because no debtor-creditor relationship existed between the corporation and the preferred stockholder. There was no indebtedness here which the petitioner owed any preferred stockholder. The retirement of the preferred stock in accordance with the certificate of incorporation was not the retirement of indebtedness within the meaning of section 351 (b) (2) (B).

Decision will be entered for the respondent.


author: StjsrnhageN :

text:
    Ferdinand Hotz and Clothilde Hotz, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97075.
    Promulgated July 24, 1940.

      Edward J. Metzdorf, Esq., for the petitioners.

      David Altmcm, Esq., for the respondent.
   OPINION.

StjsrnhageN :

The Commissioner determined a deficiency of $515.99 in petitioners’ income tax for 1936. He disallowed several deductions taken by the petitioners on their joint return. None of these is now in issue. The only issue is as to the right of Clothilde Hotz, hereinafter called the petitioner, to a deduction in 1936, not taken on the return and hence not mentioned in the deficiency notice, for loss in respect of a real estate venture which originated in 1924. The facts have all been stipulated and are hereby found as stipulated.

In December of 1924 Ferdinand Hotz, as agent for petitioner, his wife, entered into a joint venture with Murray and Terry for the purchase of a farm in Lake County, Illinois, at a cost of $27,580. Petitioner had a half interest, Murray and Terry each a fourth. The coadventurers agreed to contribute to the purchase, maintenance, and operation of the property in accordance with their respective interests and to share any resulting profits or loss from its operation or disposition. Half the purchase price, $13,790, was paid in cash, $6,895 by petitioner and $6,895 by Murray and Terry, A purchase money mortgage was given for the balance of $13,790. Title was taken in Hotz’ name for the benefit of the coadventurers and he executed the mortgage. No payments were made on the principal of the mortgage. Improvements were made for which petitioner paid her share, $674.84. In 1932 Murray and Terry informed Hotz and petitioner that they would not continue to pay their share of the mortgage interest. Petitioner was able and willing to pay her share and desired to avoid losing the property. Hotz attempted, in petitioner’s behalf, to have the mortgagee take over the shares of Murray and Terry and reduce the mortgage both as to principal and interest. This the mortgagee was unwilling to do.

In November 1934, after saying that he would be willing to pay $500 for a quitclaim, the mortgagee instituted foreclosure proceedings. Decree was entered March 9, 1935, and the foreclosure sale was held by the Master on April 23, 1935, at which time the mortgagee bid $16,000 and received a Master’s certificate. The sale was approved by the court and a deficiency judgment was entered for $628.07. Before the expiration of che redemption period of twelve months applicable to a mortgagor and an additional three months applicable to judgment creditors, Hotz, acting for petitioner, notified the mortgagee that the property would be redeemed and that lie would secure quitclaim deeds from Murray and Terry. He Was advised that this was unnecessary and that it would be sufficient if he paid the redemption money to the mortgagee, who would thereupon assign the Master’s certificate to Hotz’ nominee; and that, after the expiration of the fifteen-month period, the Master would deed the property to such nominee. This was done, and on April 22, 1936, Hotz, in petitioner’s behalf and with her funds, paid $17,894.53 to the mortgagee, who thereupon assigned the Master’s certificate to Bruckner, the nominee. On September 1, 1936, after the expiration of the fifteen-month period, the Master executed a deed to Bruckner, who on September 3, 1936, executed a deed to Hotz as nominee of petitioner, and also executed a release from the deficiency judgment.

The' petitioner contends that she sustained a loss of her original investment in the property, which was realized in 1936 at the expiration of the statutory period for redemption from the foreclosure sale. This can not be sustained. Not until the expiration of the redemption period could she have been regarded as sustaining a loss. Commissioner v. Hawkins, 91 Fed. (2d) 354; Derby Realty Corporation, 35 B. T. A. 335; appeal dismissed, 92 Fed. (2d) 999. Before the redemption period had expired, petitioner had acquired the property by an additional investment. When her husband, in April 1936, paid the $17,894.53 to the mortgagee and the Master’s certificate was assigned to Bruckner, the petitioner saved herself from the' loss which she might otherwise have sustained. Having a right to redeem the property and a means of avoiding its final loss on foreclosure, she accomplished that result. It is not important that the means adopted were not strictly what the Illinois law describes as a redemption. Cf. Herdman v. Cooper, 138 Ill. 583; 28 N. E. 1094; Keller v. Coman, 162 Ill. 117; 44 N. E. 434; Boynton v. Pierce, 151 Ill. 197; 37 N. E. 1024; Hooper v. Goldstein, 336 Ill. 125; 168 N. E. 1; certiorari denied, 281 U. S. 724. For tax purposes the result was' the same as if she had paid off the mortgage before foreclosure. It is not necessary to consider' whether the venture with Murray and Terry still persisted so that her acquisition of the property inuréd to their benefit, Lomax v. Gindell, 117 Ill. 527; 7 N. E. 483, because the only question here is whether petitioner ih 1936 sustained the loss which she relies- upon.

This case is like Commissioner v. Hawkins, supra, in that the effects of the foreclosure were not permitted to become definitive and petitioner’s interest in the property did not in fact terminate. This was regarded as a distinction by the court in Tompkins v. Commissioner, 97 Fed. (2d) 396, which involved a foreclosure with no suspension of title during a redemption period. The Tompkins citation is no support for petitioner’s argument here.

In our opinion, the petitioner sustained no loss in 1936 in respect of her interest in the property, and she correctly refrained from taking a deduction on that account in her 1936 return.

Decision will be entered under Bule 50.