text:
    J. Edward Johnston, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93768.
    Promulgated March 6, 1940.

      Randolph E. Paul, Esq., Charles Mold. Howard, Esq., and Charles B. Molnnis, Esq., for the petitioner.

      Lewis S. Pendleton, Esq., for the respondent.
   OPINION.

Leech :

Petitioner in this proceeding seeks redetermination of deficiencies in income tax for the calendar years 1934 and 1935, in the aggregate amount of $184,211.14. The principal question involved is whether petitioner is taxable on the ordinary income of any or all of five trusts created by him for the benefit of various members of his family. Two subordinate issues are (1) whether capital gains, arising by reason of the receipt of certain payments on an installment obligation in favor of the trustee of three of the trusts, are properly taxable to petitioner, and (2) whether petitioner may deduct from his gross income, commissions paid to a trustee of a testamentary trust, where the total income therefrom is tax-exempt. The case has been submitted on a stipulation of facts and attached documentary evidence. We find the facts as stipulated.

Petitioner is an individual residing in Baltimore, Maryland. On September 30, 1926, he transferred, in trust, 1,000 shares of class B common stock of the R. J. Reynolds Tobacco Co., to be held by the Safe Deposit & Trust Co. of Baltimore as trustee for the benefit of his mother, Lola E. Johnston. The trust deed provided that the net income from the trust should he paid to Lola E. Johnston for life. Upon her death, the trustee was to return the trust estate to petitioner, or to his estate should he then be dead. Petitioner reserved powers to direct sales and investments and to change the trustee, exercisable during his life, but expressly disclaimed the reservation of any power to revoke, change, or alter the trust. Both petitioner and his mother are still living. Pursuant to the terms of the trust, she received $9,072.15 in 1934 and $9,187.50 in 1935, constituting the net income of the trust for those years. She was not destitute prior to or at any time after the creation of this and the following trusts, and would not have been destitute during the taxable years even if the trusts had not been established.

On June 3, 1932, petitioner created three additional trusts, the terms of which are substantially similar. In each one, the Safe Deposit & Trust Co. of Baltimore was trustee, and the income was payable jointly to petitioner’s mother and one of his three minor cMl&ren. That is, in the first trust one-half of the net income was to be paid to Lola E. Johnston for life, but if in any year this one-half, in the opinion of the trustee, should be insufficient for her support and maintenance in the manner of living to which she had been accustomed, then the trustee was authorized and directed to invade both the remaining half of the income and the corpus to the extent necessary for her proper maintenance and support. In determining the amount necessary, the trustee was directed to exercise a liberal discretion. The remainder of the net income was to be accumulated by the trustee, except that if Lola E. Johnston during her lifetime should determine that all or any part of this remaining net income or accumulations thereof was needed for the support or education of petitioner’s son, the trustee was to apply the income or accumulations to those purposes upon her written request. Upon her death, the trust estate was to be transferred to petitioner, should he then be living, except that any accumulated income was to be retained in trust for the benefit of the child beneficiary on conditions not here material. Should petitioner not survive Lola E. Johnston, the trust was to continue and, in no event, could the corpus revert to petitioner’s estate. Petitioner retained no power of revocation; but Lola E. Johnston was given the power during her life to order a reconveyance of corpus, but not accumulated income, to petitioner.

In the second and third trusts of this group, the provisions were the same as above in all material respects, except that petitioner’s wife, instead of his mother, was given the power to direct the application of remaining income to the education and support of the child beneficiary. Petitioner’s wife and mother did in fact exercise this power and gave directions, operative in both taxable years, that the entire second half of the trusts’ income be applied to the support and education of the respective three children. In other words, petitioner’s mother received one-half the income of each trust, outright, and either she or the wife received the balance on behalf of the respective children. All three children were minors in the taxable years.

The corpora of this group of trusts consisted, in each case, of a block of R. J. Reynolds Co. class B common stock, and of petitioner’s equitable interest in certain assets held in trust for him under the will of R. J. Reynolds, deceased, as appointed by the will of Katharine S. Johnston, deceased. These latter assets comprised additional R. J. Reynolds stock and an account receivable described as “$490,-544.60 Balance Debt of Directors and Employees of the R. J. Reynolds Tobacco Company dated December 21, 1927. Interest at 5%.” Each trust received one-third of petitioner’s interest in this account receivable.

R. J. Reynolds bad died in 1918 and bad left a testamentary trust of R. J. Reynolds Tobacco Co. stock for the benefit of his widow, Katharine S. Reynolds. She married petitioner, appointed her interests in this trust to petitioner by will, and died in 1924. In 1927, the trustee under Reynolds’ will sold 6,733 shares of this stock to the directors and employees of the Reynolds Co. By the terms- of Reynolds’ will, proceeds from any sales of trust assets were to be accumulated, invested only in Government bonds, and distributed to his widow (or her appointee) only upon the termination of all the various trusts created- by Reynolds. This could not occur until the youngest child of R. J. Reynolds reached the age of 28, which did not happen until after 1935. Meanwhile, and on June 3, 1932, petitioner transferred his equitable interest in the unpaid balance of the installment obligations into the group of three trusts presently under discussion. Capital gains from the sale were received on the installment basis and were added, in equal shares, to the corpora of the three trusts. In the taxable, years, these capital gains were in the respective amounts of $109,291.78 and $5,392.04.

On June 3, 1932, petitioner created a fifth trust, the Safe Deposit & Trust Co. of Baltimore again being the trustee, consisting of 4,000 shares of R. J. Reynolds Tobacco Co. class B. common stock and petitioner’s interest in. 1-1,000 shares of the same stock held in trust for-him by the Safe Deposit & Trust Co. under the will of R. J. Reynolds-as appointed by the will of Katharine S.' Johnston, deceased. By this deed, the trustee was directed to pay the net income from the trust to Mathilde Manly Johnston, petitioner’s wife, “for and during her life, but if in the opinion of the Trustee said income be insufficient for her -maintenance and support in the manner in which she has been accustomed to living, then said Trustee is hereby authorized and directed to pay over to her such part or parts of the corpus as it in the exercise of a liberal discretion towards her deems necessary for such purposes.” .Upon her death, the corpus was to be returned to petitioner, if he should then be living, or divided into shares for the benefit of petitioner’s children, should hé then be dead. Petitioner reserved power to control sales and investments of trust corpus, but did not retain powers to revoke or alter. The inter vivos power to direct a reconveyance of corpus to petitioner was vested in the beneficiary, Mathilde Manly Johnston.

The income arising from all five trusts was reported and returned by the respective beneficiaries. -• Respondent" seeks not only to tax this ordinary income to petitioner, but also to add to that amount the capital gains realized by the group of three trusts created for the combined benefit of petitioner’s mother and his three minor children, as above described. In addition, he has denied petitioner’s right to deduct commissions paid to a trustee of a trust, the income from which came, wholly, from tax-exempt interest on Federal and state bonds. These commissions amounted to $510.33 in 1934 and $478.10 in 1935.

The theories on which respondent urges the taxability of the ordinary trust income to petitioner are that the trusts fall under section 166 of the Revenue Act of 1934; that they come within section 167 of the Revenue Act of 1934, and that they are governed by the rule of Douglas v. Willcuts, 296 U. S. 1.

Respondent practically concedes, on brief, that section 166 has no application here. Petitioner is vested with no powers of revocation with respect to any of the five trusts. The fact that he retained a reversion in the corpus by virtue of the trust provisions is not power to revest the corpus, within the statute. Phebe Warren McKean Downs, 36 B. T. A. 1129; John Edward Rovensky, 37 B. T. A. 702; William E. Boeing, 37 B. T. A. 178.

In four of the trusts, a power to revest the corpus in the grantor exists, but in each of these cases it is vested in the holder of a substantial adverse interest. There is nothing, consequently, to justify taxing petitioner under section 166 on this account. Paul W. Litchfield, 39 B. T. A. 1017. Respondent relies chiefly on John N. Fulham, 40 B. T. A. 48, to support his contention that Lola E. Johnston’s adverse interest did not extend to that half of the net income which was set aside for support of the children (or for accumulation as the case might be). The Fulham case is distinguishable in that there the discretion of the trustee to pay anything to the wife was absolute, and she was not regarded in the trust deed as a beneficiary, while here the trustee had discretion only as to the ascertainment of an objective fact, after which it was mandatory upon it to make liberal payments to Lola E. Johnston, who throughout the trust instruments is plainly depicted as a primary beneficiary.

The second theory advanced by respondent requires us to consider only three of the trusts, namely, the group created for the combined benefit of petitioner’s mother and his three minor children. There are no provisions for accumulations of income in the other two trusts.

To recapitulate, each of these three trusts provided that one-half of the net income should be paid, outright, to Lola E. Johnston, and that the other half should be accumulated, except that if Lola, in one trust, and Mathilde Manly Johnston, in the two remaining trusts, should so direct, the accumulations were to be used to support and educate the respective child beneficiaries. In both taxable years all of these halves of the trust incomes were used, pursuant .to appropriate instructions, to support and educate the children. Upon the death of Lola, the corpora, but not the aeowrrmlations of income, were to be returned to petitioner if he were then alive, but otherwise the trusts were to continue. As to such accumulations of ordinary income, the provisions of section 167 do not apply, since there is no possibility of their being accumulated for petitioner’s benefit.

The real question relates to the capital gains which arose, during the taxable years, from the sale in 1927 of Reynolds Tobacco Co. stock, part of the corpus of the R. J. Reynolds trust. The instrument creating that trust provided that such gains were to be accumulated, invested in Government bonds, and not distributed to Katharine S. Reynolds (or in consequence, to her appointee) until the youngest Reynolds child should attain the age of 28 — a fact that did not occur until after 1935. Petitioner, in 1932, had transferred his interest in such gains, received by the testamentary appointment of his wife, in equal shares to the three trusts he created for the benefit of his wife and children. At the time of this transfer, the capital gains were being held for distribution to petitioner only in his capacity as ultimate beneficiary of the Reynolds trust. The issue here is whether these gains, for 1934 and 1935, were taxable to petitioner under section 167, infra. We think they were not.

The partiesi have stipulated that these gains were distributed by the Reynolds trust in the taxable years to the three trusts created by petitioner. If that be so, such distribution and receipt were in direct violation of the provisions of the Reynolds trust in that the trust created therein had not terminated by the youngest Reynolds child becoming 28 years of age. That being so, such distribution and receipt are ineffective here since the trusts created by petitioner received these gains with a concurrent obligation to return them. The result follows that these gains were-not those “of” the trusts created by petitioner but were the capital gains of and taxable to the Reynolds trust. Revenue Act of 1932, sec. 161 (a); Freuler v. Helvering, 291 U. S. 35.

The third reason advanced for taxing the income of the five trusts to petitioner is that these trusts fall within the rule announced in Douglas v. Willcuts, supra, in that their incomes were used to discharge legal obligations of the grantor.

It is stipulated that petitioner’s mother was not destitute. Thus, under controlling Maryland law, petitioner had no legal obligation to support and maintain her. Bagby, Annotated Maryland Code, 1924, art. 27, secs. 91-93. It follows that no such obligation of petitioner was discharged even if the trust instruments did require any of their income to be so used. Consequently he is not taxable on the income of the trust for the mother alone, or on that half of the income of the three trusts in favor of the mother and the children which was payable to the mother.

In the trust for petitioner’s wife, Mathilde, the trustee was directed to pay the net income to her “for and during her life, but if in the opinion of thq Trustee said income be insufficient for her maintenance and support in the manner in which she has been accustomed to living, then said Trustee is hereby authorized’and directed to pay over to her such part or parts of the corpus as it iii the exercise of a liberal discretion towards her deems necessary for such purposes.” The limitation on the right of the trustee to invade corpus for the wife, we think, effectively restricts her use of the income to support and maintenance. Accordingly, the rule of Douglas v. Willcuts, supra, applies and the income so paid to her is taxable to petitioner, settlor.

We consider now that half of the income of the three trusts, created in each instance for the benefit of petitioner’s mother and a minor child, which might be paid to the respective child beneficiary for its support and education. Each of these trusts provided that one-half of the income was to go to the mother outright. The other half was to be accumulated by the trustee, but, if the mother in one or the wife in the two others should so direct, the income was to be paid over to the child.beneficiary for its support.and education. The record shows that written directions of the mother and the wife were operative in the taxable year so that all of the second half of the income of each of these three trusts was in fact paid over to the respective child beneficiary for its support and education.

In view of this actual use of the income to discharge petitioner’s legal obligations to his children, we hold petitioner is taxable' on one-half the income of these three trusts. E. E. Black, 36 B. T. A. 346; Percy M. Chandler, 41 B. T. A. 165; Dorothy Whitney Elmhirst, 41 B. T. A. 348.

The last question is whether the Commissioner properly disallowed deductions claimed by petitioner for commissions paid to the trustee of a testamentary trust, the total income from which is concededly tax-exempt. Since the trust was, of course, a separate legal taxable entity, such deduction is allowable only to the trustee of the trust. Cf. John H. Watson, Jr., et al., Trustees, 35 B. T. A. 706.

Keviewed by the Board.

Decision will be entered under Rule 50.

       The pertinent part of the section is 167 (a) (1) :
      (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.


source: Caselaw Access Project

author: VaN Fossan :

license: Public Domain

text:
    Murray Brookman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95871.
    Promulgated March 7, 1940.

      F. G. Hutchens., Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent..
   OPINION.

VaN Fossan :

The single question for our determination is the tax-ability to petitioner of the income from a so-called alimony trust. Petitioner contends that he was under no continuing obligation to support his wife after the property settlement above described, and that the income from the trust created under the settlement is not taxable to him. He maintains that the ratification of the settlement in the divorce decree definitely settled the obligations of the parties, since the court did not reserve the right to award alimony in the future. He asserts that, in any event, his wife’s remarriage before the taxable year cut off any possible continuing obligation to support her. Finally, he urges that his former wife’s interest in the trust was part of her community property estate and, hence, the income should be taxed to her and not to petitioner. Respondent, on the other hand, argues that the trust income was paid to petitioner’s former wife in discharge of his legal obligation arising under the trust and property settlement agreements and as such was taxable to petitioner. He contends that, even if the entire trust income is not taxable to petitioner, amounts paid the former wife for maintenance and support of the son were includible in petitioner’s gross income.

Respondent relies upon Douglas v. Willcuts, 296 U. S. 1, in his inclusion of the entire income of the trust in the year 1934 in petitioner’s gross income. Since the date of hearing of the present case, the United States Supreme Court has handed down a decision in Helvering v. Fitch, 309 U. S. 149. In holding that the taxpayer had not shown that he was outside the scope of Douglas v. Willcuts, supra, the Court said:

Enough has been said to show that respondent has not sustained the burden of establishing that his case falls outside the general rule expressed in Douglas v. Willcuts, supra. If we were to conclude that this case is an exception to that rule we would be acting largely on conjecture as to Iowa law. That we can not do. For if such a result is to obtain, it must be bottomed on clear and convincing proof, and not on mere inferences and vague conjectures, that local law and the alimony trust have given the divorced husband a full discharge and leave no continuing obligation however contingent. Only in that event can income to the wife from an alimony trust be treated under the revenue acts the same as income accruing from property after a debtor has transferred that property to his creditor in full satisfaction of his obligation — unless of course Congress decides otherwise.

Conforming to this holding, our first inquiry is, therefore, whether either the local law or the trust instrument imposed upon petitioner a continuing obligation to support his former wife.

Both petitioner and his wife were residents of the State of California at the time of her remarriage and during the taxable year 1934. Thus, any legal obligation of the petitioner to support his former wife must be imposed by California law. Under that law, the duty of a man to support his former wife ceases upon her remarriage. California Civil Code, sec. 139, Tremper v. Tremper, 39 Cal. App. 62. See Harry S. Blumenthal, 34 B. T. A. 994; affirmed per curiam, 91 Fed. (2d) 1009. It is apparent that if petitioner had a continuing duty to support bis former wife the obligation must arise from the contract or trust instrument itself.

By its terms, the agreement of March 27, 1929, indicates that it contemplated the settlement of all matters of support, property rights and all other matters growing out of the marital status. In this agreement petitioner undertook to set up a trust “whereby said party of the second part [the wife], out of the trust thereby created, shall be paid the sum” of $425 per month for life in certain contingencies and the sum of $225 per month for life in all events. It is to be noted that the payment was “out of the trust thereby created.” It was not an absolute commitment guaranteed by petitioner. He had no collateral or conditional obligation or duty to make up any deficiencies in the trust income. If the trust, either by earnings or invasion of corpus, supplied the stated amounts, the amounts would be paid to the divorced wife. If there were a deficiency, or if, by invasion, the corpus were reduced to nothing, petitioner had no obligation to supply the deficient amount. Neither the contract nor the trust placed a continuing obligation on petitioner.

Thus it is that there was no continuing obligation of support resting on petitioner either by local law or by contract. Petitioner is not taxable on the trust income paid for the support of his divorced wife.

Respondent contends, however, that the sum of $800 of the amounts paid to the former wife from January 1 to April 30, 1934, represents maintenance and support of a minor child and, hence, is taxable to petitioner under the rule of Douglas v. Willcuts, supra. Under the California law, a father is responsible for the maintenance and support of minor children. Blair v. Williams, 86 Cal. App. 676; 261 Pac. 539; California Civil Code, sec. 196. Petitioner’s former wife received only the sum of $2,682.23 during the taxable year. By a letter dated April 27, 1934, however, petitioner and his former wife directed the trustee to reduce the payments to the wife under the trust from $425 per month to $225 per month, beginning May 1, 1934. The occasion for the letter was petitioner’s assumption of the maintenance and support of their son. Hence, it may be inferred that during those four months the sum of $425 per month was paid to the former wife. The sum of $200 per month was obviously allocated to the maintenance and support of the son. Since the sum of $800 paid petitioner’s former wife for the support of his son relieved petitioner from his obligation to maintain and support the son fro tamto, the sum of $800 is includible in petitioner’s gross income for the year 1934.

Respondent admitted in his answer that petitioner made on overpayment in the sum of $41.47. This will be disposed of under Rule 50.

Decision will be entered under Rule 50.

        Remarriage. Upon the remarriage of the wife, the husband shall no longer be obligated to provide for her support but such remarriage shall not affect his duty to provide for the maintenance of the children of his marriage.


text:
    Marrs McLean, Petitioner, v. Commissioner of Internal Revenue, Respondent. Verna Hooks McLean, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 77419, 77420, 81391, 81392, 86804, 86805, 94402, 94403.
    Promulgated March 8, 1940.

      W. A. Bolinger, Esq., and L. J. Benokenstein, Esq., for the petitioners.

      James E. Teatman, Esq., and M. L. B. Wade, Esq., for the respondent.
   OPINION.

Murdook: The Commissioner has determined deficiencies in the petitioners’ income taxes as follows:

The questions presented for decision are:

1. Whether payments received under provisions (a) and. (b) of a contract dated March 18, 1931, with the Yount-Lee Oil Co., which payments totaled $300,000 in 1931 and $200,000 in 1932, and additional payments received under provision (c) of that contract, during the years 1931 to 1935, inclusive, were proceeds from the sale of capital assets or whether they were ordinary income, and, if they were not proceeds from the sale of capital assets, whether the provisions of section 102 of the Revenue Acts of 1928 and 1932 apply.

2. Whether or not the petitioners are entitled to deductions for percentage depletion based upon sums received by them pursuant to certain agreements with the Gulf Production Co., and, if they are entitled to depletion, should it be computed as a percentage of the gross proceeds from the sale of production from the properties or as a percentage of the actual amount received by the petitioners from the properties.

3. Whether or not the petitioners are entitled to a deduction for percentage depletion based upon the sum of $65,000 received in 1935 as advance royalty or bonus upon the assignment of an oil and gas lease to the Humble Oil & Refining Co.

4. Whether or not the income of the trusts created on December 29, 1934, by the petitioners is taxable to them as community income for 1935.

The remaining issues raised by the pleadings have been settled by stipulation. All of the facts have been stipulated and the Board adopts the stipulated facts as its findings of fact.

The petitioners have resided in the State of Texas as husband and wife at all times material hereto. All of their income is community income. They filed separate returns for each of the years 1930 to 1935, inclusive, with the collector of internal revenue for the first district of Texas at Austin, Texas. They kept their' books and reported their income during those years on a cash receipts basis.

Issue No. 1.

The petitioners in 1919 leased land in Texas for the exploration and production of oil, gas, and other minerals. The leases are known as the Cade leases. The petitioners, lessees, agreed to allow the lessors a royalty of one-eighth of all oil saved from that produced and one-eighth of the net proceeds from the sale of gas, sulphur, and other minerals. The petitioners drilled a number of wells on the Cade leases between October 1927 and March 18, 1931, from which the production of oil was developed in commercial quantities. The principal value of the Cade leases was demonstrated by prospecting, exploration, and discovery work done by the petitioners during that period.

The petitioners, on March 18, 1931, entered into a contract with the Yount-Lee Oil Co. (hereinafter called Yount-Lee) with respect to the Cade leases, the pertinent provisions of which are as follows:

Now, Therefore, Know Ah Men by These Presents : That I, the said Marrs McLean, of Jefferson County, Texas, hereinafter called “Grantor,” for the consideration hereinafter set forth (and subject to the royalty reservation hereinafter contained), have Granted, Sold, Conveyed, Transferred and Assigned and do by these presents Grant, Seel, Convey, Transfer and Assign unto the Yount-Lee Oil Company, a corporation duly incorporated under the laws of the State of Texas, with its principal office at Beaumont, Jefferson County, Texas, the following described oil, gas and mineral leases and the oil, gas and mineral leasehold estates created thereby (together with the hereinafter described physical properties and equipment) covering the following described lands in Galveston County, Texas, to-wit:
[Here follows a description of the property transferred.]
The consideration for this transfer and assignment of said above-described oil, gas and mineral lease and physical property and equipment, is as follows:
(a) The sum of One Hundred Thousand ($100,000.00) Dollars cash, receipt of which is hereby acknowledged by Grantor;
(b) Two Hundred Thousand ($200,000.00) Dollars due and payable six (6) months after the date hereof, and Two Hundred Thousand ($200,000.00) Dollars due and payable twelve (12) months after the date hereof; said deferred payment to bear no interest ;
(e) Two Million ($2,000,000.00) Dollars to be paid out of one-eighth (%) of the (gross) oil produced and saved from the lands covered by this assignment, if, as and when produced and saved, and only in such event; it being expressly understood in this connection that said Yount-Lee Company shall be under no obligation whatever to Grantor herein to drill upon or develop said land, or any part thereof, for oil.
There is reserved and excepted from this assignment a royalty of twenty-five (25%) per cent of the oil produced and saved from the lands covered by this assignment, out of which twenty-five (25%) per cent royalty all outstanding royalties (including royalties due lessors under tbe terms of said leases) and all overriding royalties are to be paid, and Grantor is to receive the balance of said twenty-five (25%) per cent royalty; it being understood in this connection that said Yount-Lee Oil Company shall in any event be entitled to receive seventy-five (75%) per cent of the oil produced and saved from said land, and that all outstanding royalties, overriding royalties and/or interests of any character in the oil in, under or produced from said land shall be charged against the twenty-five (25%) per cent royalty herein reserved. Said Yount-Lee Oil Company shall be entitled to free fuel oil for all operations on said land and the royalty shall be computed after deducting oil used for fuel. Grantor also reserves a royalty of twenty-five cents (250) per long ton on sulphur but Grantor shall be under no obligation to develop said land for sulphur.

The Cade leases were thereafter operated by Yount-Lee in accordance with the foregoing contract. That company drilled numerous wells on the leased property. Those wells produced and still are producing large quantities of oil.

The cash payments provided for in the contract were paid to the petitioners by Yount-Lee as_follows: $100,000 on the date of the execution of the contract, $200,000 on September 18, 1931, and $200,000 on March 18, 1932. Payments on account of the $2,000,000 to be paid out of one-eighth of the oil produced and saved, were made as follows:

1931_ $7,144.09
1932_ 109, 363.36
1933_^_ 127,323.22
1934_189,917. 34
1935_ 105,075.56

The petitioners, on their income tax returns for the years here in question, reported the payments received under provisions (a), (b), and (c) of the contract of March 18, 1931, as proceeds from the sale of capital assets. The Commissioner, in determining the deficiencies, held that those payments were not proceeds from the sale of capital assets, but were ordinary income subject to both normal tax and surtax. He allowed deductions for percentage depletion based upon those amounts.

The petitioners during the taxable years also received payments representing the one-eighth overriding royalty which they reserved, and an interest in the one-eighth royalty reserved by the original lessors, which the petitioners acquired by assignment. Those payments were reported as ordinary income, and deductions for percentage depletion based upon those payments were claimed and allowed. The manner of reporting those payments and the deductions allowed for depletion based on those payments is not in issue in these proceedings.

The contention of the petitioners is that their “transaction [of March 18, 1931, with Yount-Lee] was an absolute sale of all of the McLeans’ right, title and interest in the leases transferred, the estates created thereby, and in 75 per cent of all of the oil to be and which was produced therefrom.” They claim that they retained no interest in that 75 percent of the oil; they sold that interest for payments of $500,000 under provisions (a) and (b) and payments under provision (c) which were to continue until $2,000,000 had been paid out of one-eighth of the oil produced and saved from the lands covered by the leases; and they are entitled to report those amounts as proceeds from the sale of capital assets. They make this argument in direct opposition to that of the Commissioner, which is that the petitioners received the payments as ordinary income; they did not sell their interest in that part of the oil; but retained in it, or in a part of it at least, an economic interest which entitles them to deductions for depletion.

The petitioners argue that their contract of March 18, 1931, was a sale under the laws of Texas. The effect of their contract under the laws of Texas is not determinative of whether the transaction was a sale within the capital gain provisions of the revenue act. The Supreme Court, in discussing similar provisions of an earlier act, had the following to say in Burnet v. Harmel, 287 U. S. 103:

But § 208 neither says nor Implies that the determination of “gain from the sale or exchange of capital assets” is to be controlled by state law. Bor the purpose of applying this section to the particular payments now under consideration, the Act of Congress has its own criteria, irrespective of any particular characterization of the payments in the local law. See Weiss v. Wiener, supra, p. 337 [279 U. S.]. The state law creates legal interests but the federal statute determines when and how they shall be taxed.

The acts of the parties as shown in division orders, monthly statements, accounts, and income tax returns were inconsistent and are of little aid in deciding the present issue.

The decision of this issue turns upon the question of whether the petitioners stand as vendors of 75 percent of the oil, or whether they stand as producers of minerals, retaining and still owning an economic interest in that oil, or in a portion of it, within the meaning of the revenue acts and the decisions of the Supreme Court. This same question has arisen and has been decided in a number of cases. Cf. Charles Pettit, 41 B. T. A. 264. Where a party has retained an economic interest in the minerals in place, his income from those minerals is ordinary income and he is entitled to a deduction for depletion. But where he disposes of his entire economic interest in the minerals in place, he has made a sale, he is not entitled to depletion, and the amounts which he receives may be taxable as capital gain. The parties disagree only as to how the facts in the present case fit into these principles.

The facts in the present case are similar in some important respects to those in the case of Palmer v. Bender, 287 U. S. 551. For the facts in the Palmer case see 49 Fed. (2d) 316. See also L. T. Waller, 16 B. T. A. 574. There was in each case a cash payment, a further cash payment to be made solely out of a percentage of the oil, and a one-eighth royalty, all payable to the taxpayers over and above a one-eighth royalty reserved by the original lessors. The contract-in each case purported to sell an interest in a lease. All payments which Palmer received were reported by him as ordinary income and he claimed deductions for depletion under section 214 (a) (10) of the Revenue Act of 1921. Article 215 of Regulations 62 allowed the lessor of an oil and gas well a deduction for depletion based upon the bonus and royalties received from the lessee. But the Commissioner refused to allow Palmer deductions for depletion, because he thought the transaction was a sale of the lease by Palmer and his partners. The Supreme Court said that the partners had retained a capital investment in the oil in place, an economic interest in the oil in place, because of their retention of royalties, and, further, that not only the one-eighth royalty, but also the payments to be made from the proceeds of a percentage of the first oil produced and saved and the the cash payment, were all royalties, a return of the capital investment in the oil resulting in a diminution in the unit depletion allowance upon the oil later to be produced under the royalties. The result was the allowance of deductions for depletion based upon all of those payments.

Another case on the subject is that of Thomas v. Perkins, 301 U. S. 655. There the owners of oil and gas leases subject to a one-eighth royalty entered into an agreement purporting to “sell” all of their rights and interests in five-eighths of the leases to Perkins. They received a cash payment and were to receive an additional amount out of one-fourth of the oil produced and saved from the premises. Perkins drilled wells and produced oil. He did not include in his income any part of the proceeds that went to his assignors. The Commissioner included those amounts in his income and allowed him depletion based upon those amounts. The Court said that its decision in Palmer v. Bender, supra, supported the view that the assignment did not transfer the one-fourth of.the oil in question. It also stated that the provisions for percentage depletion in the later acts are not to be distinguished from the provisions considered in Palmer v. Bender, because, to entitle one to depletion under either, ownership of oil by that person was essential, citing Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312. It pointed out that the assignors had an economic interest in one-fourth of the oil and were entitled to depletion in respect to that oil. The Court held that the payments made by Perkins to the assignors was their income and not that of Perkins.

Harmel, the taxpayer in Burnet v. Harmel, supra, owned lands in fee, and as lessor executed oil and gas leases of those lands. He received a cash payment and was to receive royalties measured by production. He reported the cash payments as gain from the sale of capital assets. The Commissioner tréated the payments as ordinary income and allowed deductions for depletion. The following quotation is from the last paragraph of the opinion of the Supreme Court:

The court below thought that the bonus payments, as distinguished, from the royalties, should be treated as capital gain, apparently because it assumed that the statute authorizes a depletion allowance upon the royalties alone. See Ferguson v. Commissioner, 45 Fed. (2d) 573, 577. But bonus payments to the lessor have been deemed to be subject to depletion allowances under § 214a (9), Revenue Act of 1924, by Art. 216, Treasury Regulations 65, as well as under earlier acts. § 214a (10), Revenue Act of 1921, Art. 215, Treasury Regulations 62. * * * We see no basis for it [the distinction]. Bonus and royalties are both consideration for the lease and are income of the lessor. We cannot say that such payments by the lessee to the lessor, to be retained by him regardless of the production of any oil or gas, are any more to be taxed as capital gains than royalties which are measured by the actual production. See Work v. United States ex rel. Mosier, 261 U. S. 352, 357-358.

The petitioners argue that their case is unlike the cases above referred to and is in line with Helvering v. Elbe Oil Land Development Co., 303 U. S. 372; Blankenship v. United States, 95 Fed. (2d) 507; and United States v. Spalding, 97 Fed. (2d) 697, wherein it was held that no economic interest in the oil in place was retained by and consequently no deduction for depletion was allowable to the taxpayers. The Spcdding case is easily distinguishable, for there, as the court pointed out, the taxpayer was never the owner or lessee of the property, never produced any oil or gas therefrom, could not have produced any oil or gas therefrom, and did not have any capital investment in the oil or gas in place.

The other two cases are also distinguishable upon their facts. The taxpayer in the Elbe case conveyed all of its interest in certain oil properties, including leases, to the Honolulu Co., for specified cash payments and one-third of the net profits resulting from production and operation. The agreements provided that the taxpayer was to have no interest in the. properties. The taxpayer claimed deductions for depletion based upon the payments which it received. The Government contended that the transaction was a sale of capital assets. The following quotation from the opinion of the Supreme Court, is self-explanatory:

We agree with the conclusion of the Board of Tax Appeals that the contract between the respondent and the Honolulu Company provided for an absolute sale of all the properties in question, including all the oil and gas in place, and that respondent did not retain any interest or investment therein. The aggregate sum of $2,000,000 was paid as an agreed purchase price to which was to be added the one-third of the net profits payable on the conditions specified. We are unable to conclude that the provision for this additional payment qualified in any way the effect of the transaction as an absolute. sale or was other than a personal covenant of the Honolulu Company. See Helvering v. O’Donnell, ante, p. 370. In this view, neither the cash payments nor the agreement for a share of subsequent profits constituted an advance royalty, or a “bonus” in the nature of an advance royalty, within the decisions recognizing a right to the depletion allowance with respect to payments of that sort. Such payments are made to the recipient as a return upon his capital investment in the oil or gas in place. See Burnet v. Harmel, 287 U. S. 103, 111, 112; Murphy Oil Co. v. Burnet, 287 U. S. 299, 302.

The facts in the Blankenship case were similar to those in the Elbe case. There likewise the court held that the taxpayer had sold his entire interest in the minerals in the ground, the cash and the share of the profits were purchase price, and his right to receive profits was not secured by any retained interest in the minerals but was dependent entirely upon the personal covenant of the assignee.

A study of these cases and others shows that the courts have drawn a distinction between contracts in which the consideration is cash and a share of the profits from the operation of the properties, without the retention of any interest in the oil in place, on the one side, and contracts where the assignment is made in consideration of cash and an additional amount of cash payable solely out of a percentage of the oil and gas to be produced from the property. Cf. Charles Pettit, supra. They have held that transactions of the first kind result in an absolute sale, whereas transactions of the other kind do not result in a sale, since an economic interest in the oil is retained. The facts in the present case bring it. within the second class, for here there was not only a payment of a stated amount to be made solely from a percentage of the oil to be produced but there was, in addition, a royalty payable to the assignors, as there was in the Palmer and Perkins cases. Cf. Commissioner v. Fleming, 82 Fed. (2d) 324.

The petitioners make an alternative contention in case the Board holds that the payments are not capital gains. The alternative contention is that section 102 (a) of the Eevenue Acts of 1928 and 1932 applies to the tax on the payments received during 1931, 1932, and 1933. The statutory provision is as follows:

SEO. 102. SALE OF MINES AND OIL OR GAS WELLS. '
(a) In the case of a bona fide sale of mines, oil or gas wells, or any interest therein, where the principal value of the property has been demonstrated by prospecting or exploration and discovery work done by the taxpayer, the portion of the tax imposed by section 12 of this title attributable to such sale shall not exceed 16 per centum of the selling price of such property or interest.

This section gives relief from surtaxes in some cases where section 101 does not apply. However, it does not apply to the tax on all receipts under oil and gas leases but applies only where there has been a sale and taxable income attributable to that sale. Cf. Burnet v. Harmel, supra, where the Court said: “It is evident that the taxation of the receipts of the lessor [under an oil and gas lease] as income does not ordinarily produce the kind of hardship aimed at by the capital gains provision of the taxing act” because the abstraction of the oil is usually a time-consuming operation and the payments, unlike those in the- case of a sale, are spread over a period of years. Section 102 (a) was not intended to give relief where an interest in the minerals was retained and the taxpayer was entitled to depletion. Cf. Anna Taylor, 3 B. T. A. 1201. Here there was no sale (see discussion of the main point in this first issue and the cases cited and discussed). The determination of the Commissioner is sustained on this, the first, issue.

Perhaps it should be mentioned, before leaving this issue, that the contract of March 18,1931, purported to sell material and equipment used on the premises. However, the petitioners do not make any point of this circumstance and the stipulated facts do not indicate what part, if any, of the amounts in controversy were attributable to a sale of the equipment. Cf. Columbia Oil & Gas Co., 41 B. T. A. 38.

Issue No. 0.

The petitioners, prior to the taxable years, entered into separate agreements purporting to sell and assign four oil and gas leases known as the Phoenix, Antoine, Turner, and Gray leases. The other party to the contracts will be referred to, for convenience, as Gulf. The contracts covering the first three leases provided that the petitioners sell and convey to Gulf all of their right, title, and interest in the leases for a cash payment and a stated percentage of the net profits from the operation of the leases, after the payment of all development and operating costs, if, as, and when such net profits were derived by Gulf. Gulf was under no obligation to drill or develop the leases.

Gulf drilled wells on all of the leases and produced oil in commercial quantities during the years 1930, 1931, 1932, and 1935. The petitioners received their share of the net profits from the operations in accordance with the contracts. Royalties payable to the original lessors were deducted by Gulf before computing the net profits shared in by the petitioners. The petitioners reported the amounts received from Gulf under these leases as ordinary income and claimed deductions for depletion equal to 271^ percent of a percentage of the gross proceeds realized by Gulf from the oil produced. The Commissioner, in determining the deficiencies, allowed depletion equal to >27% percent of the amounts actually received by the petitioners in each year, but he now contends that no deductions for depletion should be allowed the petitioners in connection with these contracts, citing Helvering v. Elbe Oil Land Development Co., supra; Blankenship v. United States, supra, and Helvering v. O’Donnell, 303 U. S. 370.

The distinction drawn by the courts and already referred to under the first issue is determinative of this issue also, the distinction being between contracts made in consideration of cash and a share of the profits from the operation of the properties which result in a sale and contracts whereby an economic interest in the oil is reserved. The contracts covering the Phoenix, Antoine, and Turner leases were clearly contracts of the' first kind and resulted in sales of the entire interest which the petitioners had in the leases and any oil covered thereby. Consequently, the petitioners had Ho depletable interest thereafter and are not entitled to any deductions for depletion. Helvering v. Elbe Oil Land Development Co., supra; Blankenship v. United States, supra.

The contract covering the Gray leases is different from the contracts covering the other three leases. It purported to convey only three-fourths of McLean’s interest and provided: “While this contract covers only an undivided three-fourths (%) interest in the two assigned tracts, the Gulf Refining Company of Louisiana shall, as and while it holds hereunder, have exclusive operating rights in such two assigned tracts and exclusive control and management of operation.” There was a cash consideration of $5,500, and the petitioners were to receive one-fourth of any net profits realized from the operation of the leased premises (excluding royalties due and fuel oil used), after deducting all expenses. Gulf was required to commence drilling operations within a stated time and develop the properties or lose its interest. Thus, McLean retained an economic interest in a part of the oil in place and the payments which he was to receive were secured by that interest and were not dependent alone upon the contractual obligation of Gulf. Although the payments were measured by one-fourth of the net profits realized from the operation of the properties, and although there is no statement in the contract that those payments are to be made from any portion of the oil, nevertheless, this contract did not effect a sale of McLean’s interest. It is unlike the contracts in the Elbe and Blankemhip cases, which purported to convey all of the interest of the assignors.. It is more like the contracts in the Palmer, Perkins, and Harmel cases. Consequently, we hold that the petitioners are entitled to depletion in connection with the Gray leases.

The Commissioner allowed the petitioners deductions for depletion equal to 27y2 percent of the amount which the McLeans actually received in each year from Gulf under the agreements pertaining to the Gray leases. The petitioners contend that they are entitled to a larger deduction, equal to 27% percent of one-fourth, of the gross proceeds from the sale of production by Gulf. They apparently concede that the royalties payable to the original lessors are to be eliminated as well as any oil used for fuel by Gulf, but they claim that their deduction for depletion should be computed before deducting the expenses of operation. The statutory provision is that the deduction for depletion “shall be 27% per centum of the gross income from the property during the taxable year.” Sec. 114 (b) (3). That section of the Revenue Acts of 1932 and 1934 also provides that there shall be excluded from such gross income “an amount equal to any rents' or royalties paid or incurred by the taxpayer in respect of the property.” The term “gross income from the property” means the gross income from the property received by the particular taxpayer claiming a deduction for depletion and is synonymous with the amount to be included in the taxpayer’s gross income under section 22. Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312. The gross income from the property, from the standpoint of the McLeans, was the amount which Gulf paid them. They do not even suggest the propriety of including any greater amount in their gross income under section 22. No doubt the amount which Gulf paid them would be considered a rent or royalty paid by that taxpayer in respect of the property in computing its deduction under section 114 (b) (3). The determination of the Commissioner in regard to depletion on the Gray leases is affirmed.

Issue No. 3.

The petitioners acquired an oil and gas lease in 1935 on various parcels of land in Texas. The cost to them of the lease was $1,600. They assigned the lease in that same year to the Humble Oil & Refining Co. for $65,000 in cash and a royalty of one twenty-fourth of the oil produced and saved from the premises. They claimed deductions for depletion on their returns for 1935 based upon the cash payment of $65,000 received in that year. The Commissioner disallowed the deductions in determining the deficiencies for that year. The Humble Oil & Refining Co. forfeited and abandoned the lease in 1938 without ever having produced any oil or gas from the leased premises. The contention of the respondent is that there can be no deduction for depletion, since in fact no oil was removed and no depletion actually took place. He concedes that the payment was an advance royalty taxable as ordinary income and that a deduction for depletion would have been proper had there been any production under the lease.

The case discussed most by the parties, Berry Oil Co. v. United States, 25 Fed. Supp. 97; certiorari denied, 307 U. S. 634, is not in point. There was a cash payment and no production. The court interpreted the contract in that case as an absolute sale of one-half of the oil below a certain level and the retention of the remaining one-half interest in that oil. It said there could be no deduction for depletion in regard to the part sold because no economic interest was retained in that and there could be no depletion in regard to the part retained because there was no production. The court deemed the cash payment consideration for the sale and not an advance royalty. Here the parties concede that the payment was an advance royalty and they do not contend that any sale took place.

A deduction for depletion is proper in the year in which an advance royalty is received even though no oil is produced from the property in that year and regardless of the prospects during that year of whether or not oil will be produced in the future. Herring v. Commissioner, 293 U. S. 322. The case of Grace M. Barnett, 39 B. T. A. 864, shows that a deduction for depletion was properly allowed in 1934, the year in which a cash bonus or advance royalty was received, even though the lease was terminated in the following year without any oil or gas having been extracted from the property. The opinion holds that the amount should be restored to income for 1935, the year in which the lease was terminated, because no depletion actually took place. See to the same effect J. T. Sneed, Jr., 40 B. T. A. 1136. We hold, following the authorities above cited, that the petitioners are entitled to percentage depletion for 1935, based upon the advance royalty of $65,000 received in that year.

Issue No. If..

Petitioner Marrs McLean entered into an agreement with his wife on December 29, 1934, which provided as follows:

Whebeas, the parties hereto are possessed of a community estate and it is their mutual desire to divide a portion of said community estate, share and share alike, to the end that one-half of said entire portion of said community property herein designated shall constitute the sole separate property of each.
Now, Thereeoke, Know Aii Men by These Presents : that for and in consideration of the premises and affection Marrs McLean bears to his wife Verna Hooks McLean, and the mutual agreements herein contained, the said Marrs McLean hereby releases, quitclaims, assigns and sets over unto the said Verna Hooks McLean all of his right, title and interest, including the right of control and disposition in and to all of the following described securities to the end that the same constitutes the sole separate property of the said Verna Hooks McLean:
[Here follows a list of certificates of certain shares of stock.]
For and in consideration of the premises and of the love and affection Verna Hooks McLean bears to the said Marrs McLean, and the mutual agreements herein contained, the said Verna Hooks McLean hereby releases, quitclaims, assigns and sets over unto the said Marrs McLean all of her right, title and interest in and to all of tlie following described securities to the end that the same constitutes the sole separate property of the said Marrs McLean:
[Here follows a list of certificates of certain other shares of stock.]

The stocks listed in the foregoing agreement were a part of the petitioners’ community estate. The stock certificates stood in the name of Marrs McLean, who, contemporaneously with, the execution of the agreement, endorsed them in blank. He and his wife then delivered, each to the other, the stock certificates he or she purported to assign to the other by the agreement.

Marrs McLean and his wife, on the same day, created separate trusts with the First National Bank of Beaumont, Texas, as trustee. Each delivered to the trustee at that time the certificates of stock received by him or her under the agreement. Marrs McLean joined, 'pro forma, in the trust instrument executed by his wife. The provisions of the trust instruments were reciprocal in nature. Each instrument directed the trustee to accumulate and reinvest the income of the trust for a period of ten years, or until the death of the settlor, whichever occurred first, upon the happening of which the trustee was authorized to pay to the settlor’s spouse, for life, all, part, or none of the annual net income of the trust, at that spouse’s election. The trust corpus, plus any accumulated income, was to be distributed, upon the death of the life beneficiary, to Ruth McLean, the petitioners’ daughter, according to a certain plan, and the trust terminated. If Ruth McLean predeceased the life beneficiary without leaving issue, then the entire trust estate was to be delivered to the life beneficiary, but if she predeceased the life beneficiary leaving issue, then such issue were entitled to the remainder interest in the trust upon the death of the life beneficiary. However, if none of such issue survived the life beneficiary, or if Ruth McLean, predeceased by the life beneficiary, left no children or grandchildren surviving her, then the trust estate was to revert to the settlor, if he or she be living, unless Ruth McLean should leave a will disposing of the trust estate, in which event the trust estate was to go as her will directed. Finally, each trust instrument contained provisions, of which the following from the Marrs McLean trust is an example:

The terms and conditions of this trust can be amended by the joint action in writing by Verna Hooks McLean, the trustee and the settlor before Ruth McLean attains the age of twenty-one years, but after Ruth McLean attains the age of twenty-one years, then this trust can be amended only by the joint action in writing by Ruth McLean, the trustee, Verna Hooks McLean, if she is not deceased, and the settlor, if he is not deceased, provided, however, in no event can any amendment be made at any time that will cause any part of the funds in this trust to be paid to or revert to the use and enjoyment of the settlor, as it is the intent of the settlor and the essence of this trust that the settlor has irrevocably divested himself of all interest in this trust estate and he is. at no future time to have any interest in the trust estate or its income except the reversionary interest herein provided * * *, and provided further that no amendment prior to her attaining the age of twenty-five (25) years shall change the effect of this trust, viz., that Ruth McLean is to receive all of the principal sum or corpus of this trust regardless of any change that may be made in the disposition of the income * * *.

Two days later, on December 31, 1934, other shares of stock which constituted part of the petitioners’ community estate were delivered to the trustee by Marrs McLean and his wife, to be incorporated in his or her trust after each had first released his or her interest in the shares to the other by an agreement similar to the one executed on December 29.

None of the income received by the trustee from the corpus of each trust has been distributed to either of the petitioners or to anyone else.

The Commissioner, in determining the deficiency for the year 1935, held that the income of the trusts for that year constituted taxable 'community income of the petitioners for 1935.

The Commissioner made his determination upon the theory that the income of these trusts was taxable to the grantors under section 166 of the Revenue Act of 1934 because there was a possibility that the corpus of the trusts would revert to the grantors. The Board has held, in William E. Boeing, 37 B. T. A. 178, reversed on another issue, 106 Fed. (2d) 305, and Genevieve F. Moore, 39 B. T. A. 808, that a possibility of reverter does not make the income of a trust taxable to the grantor under section 166 or 167. The following quotation is from the Boeing case:

We do not think that the language of this section covers or was intended to cover the situation where there is no definite provision for such future distribution to the grantor, but only the bare possibility that upon certain contingencies over which the grantor has no control the corpus and accumulations may revert to him. This is what has been called a mere “possibility of reverter” in the estate tax cases (Helvering v. St. Louis Union Trust Co., 296 U. S. 39; Becker v. St. Louis Union Trust Co., 296 U. S. 48), and we do not think that where such bare possibility exists the income of the trust may be said to be “held or accumulated for future distribution to the grantor”, within the meaning of section 167. That section, being one which cuts across the usual concept of the separate entity of trusts, should not, we think, be given any broader interpretation than its terms require, (cf. Preston R. Bassett, 33 B. T. A. 182), and if article 167-1 of Regulations 86 purports to include in the scope of the statute such a trust as the one before us we think the regulation is an erroneous interpretation of the statute.

The two St. Louis Union Trust Co. cases cited in the above quotation are no longer to be followed. Helvering v. Hallock, 309 U. S. 106. However, those cases had to do with estate tax, and the Boeing, the Moore, and the present case have to do with income tax. The St. Louis Union Trust Co. cases were merely referred to and not relied upon in the Boeing case; consequently, there is no reason why the Board should fail to follow the Boeing and the Moore cases in the present case.

The respondent, anticipating that his original position will not be upheld, has advanced another argument in support of his determination. He says that the attempt by these petitioners to divide a portion of their community property into separate property was invalid under Texas law; their attempts to create trusts thus accomplished nothing; the securities remained community property; and the income from those securities is taxable to the petitioners as community income. The cases which he cites to show that the agreement of December 29,1934, was invalid fail to adequately support his argument. He has held in companion cases that these transfers were effective and resulted in taxable gifts.

Authorities on the Texas law support the proposition that a husband and wife living in Texas can not change the character of their property generally so as to convert community into separate property. The petitioners concede this. Yet there is- authority for the proposition that a husband and wife in Texas may, by gift or agreement between themselves, convert specific property from community property to the separate property of either spouse under some circumstances. Contracts of the latter kind have been enforced where it appeared that they were just, equitable and fair so that they appealed to the conscience of the court. See Speer’s Law of Marital Eights in Texas, 3d ed., secs. 56 and 341, and cases there cited. There is no suggestion that the agreement of December 29, 1934, was in any respect unjust, inequitable, or unfair. It affected only a small part of the property of this community. It referred to specific property and purported to make an equal division of that property between the two spouses. Its purpose was to permit each spouse to create a trust. The preamble of each trust recited a desire of the settlor to create a trust fund for the benefit of Ruth McLean. Ruth McLean was the only child of the petitioners.

.The respondent has failed to call our attention to any facts which would make invalid either the agreement of December 29, 1934, or the trusts created on that same day. However, even if the agreement whereby the petitioners attempted to make the property separate property was invalid, still it would not follow that the trusts themselves were invalid. Marrs McLean was a party to each agreement. No authority is cited to show that valid trusts can not be created from Texas community property or that Marrs McLean could not place community property of this community in these trusts. The argument of the respondent does not touch this latter point. We are not convinced that the trusts are invalid, and, haying considered and rejected all of the arguments advanced by the respondent on this point, we hold for the petitioners.

Decisions will Toe entered under Rule SO,


author: Tyson:

text:
    Safe Deposit and Trust Company of Baltimore, as Executor of the Last Will and Testament of Homer G. Day, Deceased, (Estate of Homer G. Day), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91601.
    Promulgated March 15, 1940.

      Bichará P. Crenshaw, Jr., Esq., for the petitioner.

      Harold F. Noneman, Esq., for the respondent.
   OPINION.

Tyson:

This proceeding involves a Federal estate tax deficiency of $1,420.42, resulting from the respondent’s determination that the value of the corpus of two trusts created by decedent inter vivos is includable in his gross estate under the provisions of section 302 (c) and (d) of the Revenue Act of 1926, as amended. ' Petitioner assigns error in such determination and alleges that the decedent’s estate is entitled to a refund of estate tax of $22.35 plus interest from November 15, 1935.

The proceeding has been submitted upon facts admitted by the pleadings, oral testimony, and a stipulation of facts embracing certain exhibits, which stipulation is included herein by reference as a part of our findings of fact.

The petitioner, a Maryland trust company, is the sole executor of the last will and testament of Homer G. Day, who was born on January 12, 1886, and died on May 27, 1935, a resident of the City, County, and State of New York.

On or about April 6, 1929, and February 1, 1930, the decedent herein transferred to petitioner, as trustee, certain property under two written trust instruments executed and delivered by decedent on those dates, respectively. Neither of those transfers in trust was made in contemplation of death.

Each of the trust instruments provided that the net income from the principal of the trust should be paid to the grantor (decedent herein) during his lifetime and that after his death the income, and eventually the principal, of the trust should be paid to designated persons in the manner therein provided. Each trust instrument further provided as follows:

The right to revoke this Deed in whole or in part or to alter or change any of its terms and provisions is hereby expressly waived by me, except only in the event I should marry, in which event the right is reserved to me from time to time to revoke the trust in whole or in part or to alter or change any of its terms or provisions, * * *

At the time of the decedent’s death he was 49 years of age and he had never married and neither of the trusts involved herein had been altered, amended, or revoked. The petitioner herein is still administering the trust property in accordance with the terms of the trust instruments.

On May 27, 1935, the date of decedent’s death, the value of the property subject to the trust instrument dated April 6, 1929, was $33,310.18 and the value of the property (other than insurance payable to the trustee) subject to the trust instrument dated February 1, 1930, was $9,154.19.

In determining the deficiency here involved, the respondent included in the decedent’s gross estate the above stated values of the properties transferred under the two trust instruments. Respondent contends, inter alia, that the decedent’s inter vivos transfers in trust were “intended to take effect in possession or enjoyment at or after his death” within the meaning of section 302 (c) of the Revenue Act of 1926, as amended by section 803 of the Revenue Act of 1932. Petitioner contends that the transfers were complete when made; that at date of his death the decedent did not have a presently existing power of revocation because his reserved power was conditioned upon the remote contingency of his marriage, which never happened, and, further, that the decedent reserved only a mere possibility of reverter of the principal of the two trusts.

In our opinion, the broad principle of Federal estate tax law announced by the Supreme Court in Helvering v. Hallock, 309 U. S. 106, is controlling here. The Court there held that section 302 (c) of the Revenue Act of 1926, as amended, relating to inter vivos transfers “intended to take effect in possession or enjoyment at or after his death”, embraces an inter vivos transfer of property where the instrument making such transfer provides for a possible return or reverter of the property to the grantor upon a contingency terminable at his death; and this irrespective of the technical form of conveyance used by the grantor to hold the ultimate disposition of Ms property in suspense until Ms death.

In the instant case we need not inquire into the character of the grantor’s (decedent’s) reserved power of revocation, i. e., whether it was a presently existing power or a power conditioned upon the happening of some future contingency. Here the interests of the beneficiaries (other than the life interest of the grantor decedent) under the two trust instruments were, by reason of the death of the grantor and not until then, freed from the possibility of a reverter of the principal of the trusts to the grantor and also not until the death of the grantor could the beneficiaries acquire dominion over the income or principal of the trusts — a dominion which they did not have prior to the grantor’s death, as was also true in the Hdllook case, supra. Here there was the possibility that a reverter of the principal of the trusts could be effectuated by the grantor’s marriage and by his revocation of the trusts thereafter. Thus, because of the effect of grantor’s death thereon his transfers in trust of the property here involved were “intended to take effect in possession or enjoyment at or after his death” within the meaning of section 302 (c) of the Revenue Act of 1926, as amended, supra, and the value of the property embraced in the two trusts is to be included in the decedent’s gross'estate.

Decision will Toe entered for the respondent.

      The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      >»*«***
      (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, * * *


author: Smith :

text:
    Jessie G. Brown, as Executrix of the Last Will and Testament of Milton Hay Brown, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91093.
    Promulgated March 19, 1940.

      Albert G. SehUpf, Esq., and Logam, Hay, Esq,, for the petitioner.

      Franklin F. KoreTl, Esq., for the respondent.
   supplemental opinion.

Smith :

The decedent herein was a son of Kate Hay Brown. In our prior opinion in this case, 40 B. T. A. 934, we said:

Prior to her death on October 28, 1923, Kate Hay Brown owned an undivided one-half interest in a number of farms and other parcels of real property inherited by her from her father. Upon her death her husband, Stuart Brown, inherited a one-third undivided interest in fee and each of their three children inherited a two-ninths interest in fee in the estate. The heirs decided that it was impracticable to set oft their interests in metes and bounds and decided that it was to the interest of all to keep their interests undivided. They therefore created a trust, evidenced by the trust instrument executed on December 24,1923. Stuart Brown contributed his undivided one-third interest and each of the three children contributed his two-ninths interest to the trust estate, * * *
* * * * * * *
Prior to the creation of the trust on December 24, 1923, Stuart Brown, had an undivided one-third interest in fee in the estate of Kate Hay Brown. Joining with his children he transferred this property to the trust on December 24,1923, with the right to receive the income for life with the further right to say who of the descendants of Kate Hay Brown should receive his share upon his death.
* * * • * * *
The simple facts are that the interest in the corpus of the trust estate owned by his father, Stuart Brown, never became a part of the decedent’s estate. He simply had a right to receive the income for life from one-third of his father’s interest in the trust estate, with a limited power of appointment with respect thereto. * * *

The above statements were based upon, our understanding of the statutes of the State of Illinois. -The respondent now contends that the courts of Illinois have interpreted the statutes differently. The point has been reargued by counsel.

The issue is whether Stuart Brown transferred to the trust on December 24, 1923, a one-third interest in fee in the property of his wife, Kate Hay Brown, or only a dower interest. If he transferred one-third, then our original opinion was correct. But, if it was only a dower interest then Milton Hay Brown, the decedent in this case, transferred to the trust a one-third interest in his mother’s estate subject only to the dower rights of his father, Stuart Brown, in that one-third. The petitioner contended and contends that the interest in the property transferred by Stuart Brown was a one-third interest in fee.

The Illinois statute in force at the time of the death of Kate Hay Brown and of also her husband, Stuart Brown, provided as follows:

Fourth — When there is a widow or surviving husband, and also a child or children or descendants of such child or children of the intestate, the widow or surviving husband shall receive, as his or her absolute personal estate, one-third of all the personal estate of the intestate; and he or she shall also receive as his or her absolute estate, in lieu of dower therein, one-third of each parcel of veal estate of which the intestate died seized and in which such widow or surviving husband shall waive his or her right of dower. Such waiver may be effected by either or both of the following methods:
(a) By filing or recording, within one year after the death of the intestate, in the manner hereinafter provided, an instrument in writing duly signed and acknowledged by the surviving widow or husband expressing his or her intention to waive dower in such real estate; and
(b) By failing to file or record within one year after the death of the intestate, in the manner hereinafter provided, an election to take dower in such real estate.
*******
No such instrument, whether electing to take or waive dower, shall be of any effect unless filed or recorded within the time, in the manner and in the office herein provided. [Smith-Hurd Illinois Revised Statutes, 1923, ch. 39, § 1, p. 744.]

In Braidwood v. Charles, 327 Ill. 500; 159 N. E. 38, the wife died intestate, leaving her husband and two children as her sole heirs at law. The husband died intestate eight days after the death of his wife and was survived by his son by a prior marriage. The son contended that his father inherited one-third of all of the real estate of which his wife died seized and that upon his death this one-third interest in fee descended to him as heir of his father. In denying this contention the court said :

Tbe waiver of tbe right of dower is a condition precedent to the right of the widow or surviving husband to claim one-third of the real estate in fee, and in order to establish her or his right to the interest in fee a waiver of dower in' a manner provided by the statute must be alleged and proved. Steinhagen v. Trull, 320 Ill. 382, 151 N. E. 250. The cross-bill in the present suit alleges no waiver by appellant’s father of his right of dower, but, on the contrary, states that by the death of Mrs. Milham her surviving husband became vested in fee, in lieu of dower, of an undivided one-third of each parcel of real estate of which she died seized. The surviving husband upon his wife’s death took only a right of dower, and not an interest in fee in his deceased wife’s real estate. The statute gave him the right to renounce his dower for an ampler estate, but until he exercised that right by either or both of the methods prescribed he merely retained his dower and did not acquire an interest in fee simple. By his death eight days after the death of his wife, without exercising his election, his right of dower, which was for life only, was extinguished, and his right of election necessarily terminated at the same time. A life estate is not inheritable, hence the appellant, so far as any interest in the real estate which Mrs. Milham owned is concerned, inherited nothing from his fattier. Appellant cannot revive an extinct life estate, convert it into a fee simple interest, and inherit the latter.

In Stelling v. Stelling, 330 Ill. 155; 161 N. E. 411, the court held that:

Waiver of widow’s right of dower by filing and recording writing expressing such intention in manner provided by Statute of Descent (Smith-Hurd Rev. St. 1927, c. 39), § 1, par. 4, cl. (a), or by failing to file or record election to take dower within year after husband’s death under clause (b), must be alleged and proved to entitle her to claim one-third of decedent’s realty in fee.

To the same effect is F. L. Wilson v. Robert Morris Hilligoss, 278 Ill. App. 564.

No claim is made by the petitioner that Stuart Brown filed any instrument of record waiving his right of dower. He died October 26, 1924, or less than one year after the death of his wife. The petitioner argues that since Stuart Brown joined his three children in the trust indenture and in the execution of the warranty deed he in effect waived his dower rights in the estate of his wife and legally made the election to receive a one-third interest in fee in lieu of dower.

Under the above decisions of the Illinois courts, which are binding upon the Board in the matter under consideration, a waiver of dower rights in real estate can be made only in the manner provided by statute, that is, by filing such a written waiver within one year after the death of the deceased spouse or by failing to do so within one year. Counsel for the petitioner has not referred us to any opinions of the Illinois courts in conflict with those above cited. In accordance therewith it must be held that at the time of the execution of the trust indenture on December 24,1923, Stuart Brown had only a dower interest in the estate of Kate Hay Brown. His dower interest is the only interest which he transferred or could have transferred to the trust. This being true, it must be held that Milton Hay Brown transferred a one-third interest in the estate of his mother, subject to the dower right of his father. There is no evidence as to the value of that dower right. We think that the respondent did not err in including in the gross estate of the decedent the value of a one-third interest in the trust estate, stipulated to be $241,808.45. The opinion of the Board, promulgated at 40 B. T. A. 934, is modified accordingly.

Reviewed by the Board.

Decision will be entered under Rule 60.


text:
    S. F. Durkheimer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95209.
    Promulgated March 19, 1940.

      Herbert L. Swett, Esq., and R. R. Morris, Esq., for the petitioner.

      Jolin H. Pigg, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for 1936 in the amount of $505.42. The petition alleges that the respondent erred in the determination of the deficiency by adding to his taxable income $2,197.49 representing income allegedly received by him in 1936 from the estate of Delia F. Durkheimer, deceased.

The petitioner is a resident of Portland, Oregon. His mother, Delia F. Durkheimer, died testate on November 5, 1935, naming the petitioner as the executor of her estate. The will was admitted to probate on November 15, 1935, the petitioner being appointed as executor. The will provided in part:

Sixth: All the rest, residue and remainder of my property, real, personal and mixed, wheresoever and whatsoever, 1 give, devise, and bequeath to my beloved son, Sylvan, to be his absolutely.

The final account of the executor was filed with, the Probate Court on July 3, 1936, and “Order on final account and closing estate” was entered by the Probate Court on August 14, 1936, whereby the court allowed and approved the final account and authorized the petitioner as executor to transfer to himself in Ms own right “all remaining assets in his possession as executor.” The estate had income during the period of administration. The amount of the income was, however, much less than the expenses- of the estate and the taxes paid. It is stipulated, however, that the estate had a net income for the period January 1 to August 13, 1936, without deducting therefrom the taxes paid, both state and Federal, and a credit of $800 paid to two annuitants, of $2,197.49. On brief the respondent admits that the $800 paid to the annuitants was at legal deduction from the gross income and that the amount which should have been added to the petitioner’s gross and net incomes upon the final settlement of the estate of his mother was only $1,397.49.

In his income tax return for 1936 the petitioner did not include in his gross income any part of the amount which he received as residuary legatee on August 14, 1936. His contention is that this was a part of the bequest received by him from his mother.

It is the respondent’s contention that $1,397.49 of the net income of the estate of Delia F. Durkheimer for the period January 1 to August 13, 1936, constitutes taxable income of the petitioner; that it represented distributable income of the estate which was paid over to the petitioner during the taxable year.

Section 162 of the Revenue Act of 1936 provides in part as follows:

Tbe net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
*******
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the bene-fieiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year;
(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

Subdivision (b) refers only to income which is “to be distributed currently by the fiduciary to the beneficiaries.” In Commissioner v. Stearns (C. C. A., 2d Cir.), 66 Fed. (2d) 371, the court said that it understood the phrase to mean “that the will or deed directs the distribution.” This subdivision clearly has no application to the proceeding at bar. The will of the decedent made no provision that any part of the income of her estate was to be distributed currently to the residuary legatee. As executor of the will the petitioner was charged with the duty of collecting income during the period of administration, paying the expenses, taxes, and legacies as required by the will, and, after obtaining an approval of his accounts by the Probate Court, to pay over the residue to the residuary legatee. This is exactly,what he did.

Subdivision (e) has reference only to cases where the income has been paid or properly credited to the legatee during the period of administration or settlement. We. think it plain that there was no payment or credit to the residuary legatee in this case prior to the completion of the administration of the estate.

At the hearing of this proceeding counsel for the respondent stated that he relied upon decisions of the Board in Robert C. Roebling, 28 B. T. A. 644, and Adolph Bernard Spreckels, 37 B. T. A. 709. Our decisions entered pursuant to the opinions in those cases were reversed by the United States Circuit Court of Appeals as follows: Roebling v. Commissioner (C. C. A., 3d Cir.), 78 Fed. (2d) 444; and Spreckels v. Commissioner (C. C. A., 9th Cir.), 101 Fed. (2d) 721. Counsel for the respondent stated that, inasmuch as there was no conflict in the opinions of the Circuit Courts, it was deemed inadvisable to' recommend an application for a writ of certiorari in either of those cases.

For reasons stated below we are of the opinion that the points in issue in those cases are not the points in issue here. Those cases involved distributions by trustees rather than by an executor, and the question was as to whether income which had accrued to the trust from, the beginning of the taxable year to the date of distribution was taxable to the trust or to the beneficiary. The courts held that the amounts in question were taxable to the trusts and not to the beneficiaries.

In In re Harvey v. Cardwell, 14 Or. 171; 12 Pac. 307, decedent left to, his wife for her use for life the residue of his estate. During administration the executors of the estate loaned money to his wife out of the estate assets. In 1880 the court ordered the estate settled and the residue delivered to the wife. Certain gifts over from the estate to the children of the decedent were made. The life tenant died. One of the children sought to collect interest on the indebtedness of the life tenant to the estate, from the estate of the life tenant. The court said:

* * * As applied to the estates of decedents, “residue” means all that property which remains after paying charges and debts, and satisfying all the devises and legacies. Blackstone defines it to be the surplus of the testator’s estate remaining after all the debts and particular legacies have been discharged. 2 Bl. Comm. 514. “The term ‘residue,’ ” said Carpenter, J., in Phelps v. Robinson, 40 Conn. 264, “as used in wills, ordinarily means that portion of an estate which is left after the payment of the charges, debts, and particular bequests.” Graves v. Howard, 3 Jones, Eq. 302. It is the proper ascertainment of these, their payment and discharge, which creates the residue, and makes it tangible as such, to be held or received by the party authorized to take it, to be enjoyed, used, or applied according to the requirements of the will; and, under our practice, what such residue is, and in what it consists, is ordinarily ascertained and determined when the final account is presented and judicially acted upon by the court.
This, then, is the point of time to be ascertained from the record), when the residue becomes an entity, and when Eloísa Harvey became entitled to the use and control of the residue of the property of whatever character. As a consequence, the note which she had personally given to the executor of the estate ceased) to be chargeable with interest at this time. It was the same as the note of any third person turned over to her as a part of such residue, the interest upon which thereafter she would have been entitled to use for the benefit of herself and children, in accordance with the objects of the will. * * *

The opinion of the court in the above cited case was approved in Brown v. Hilleary, 147 Or. 185; 32 Pac. (2d) 584, in which the court said:

In Leahy v. Cardwell [In re Harvey v. Cardwell], supra, this court said|: “As applied to the estates of decedents, ‘residue’ means all that property which remains after paying charges and debts, and satisfying the devises and legacies.”
In Meyerovitz v. Jacobovitz, supra [263 Mass. 74; 160 N. E. 331], the court said:
“It is the general rule, now, that all property belonging to the testator at the time of his death, not otherwise disposed of by the will, passes under a true residuary clause, whether owned by him at the time the will was- executed, or whether consisting of estates changed as to form of investment from real to personal or from personal to real after the execution of the will, or whether depleted by gifts or losses or increased by profits or acquisitions subsequent to the execution of the will. That general rule governs the case at bar.”

In a decision of a Connecticut court, Stanley v. Stanley, 142 Atl. 851, the decedent’s will directed his executors to divide the residue of his estate into two parts. One part was given absolutely to Alix Stanley, the other to trustees to pay the income thereof to the beneficiaries for life with gifts over. The executors sought instructions as to the disposition to be made of the residue and the income thereon accumulated during the administration which would remain after the payment of all debts, legacies, and expenses. The court said:

A general legatee is entitled to no part of the income earned by the estate in the course of its settlement and no interest upon his legacy.
* * * * * * *
The residue is that portion of an estate that remains after the payment of debts, legacies, and administration charges. Into it, and forming a part of it, must go all legacies which are void or have lapsed, * * * and also the income and accretions of the estate which are undisposed of. The residue includes every part of the estate not otherwise disposed of by the will.
We are asked, in view of the conclusion reached as to the disposition of the undisposed of income, whether it became principal or income. The answer is necessarily involved in preceding answers. It became a part of the residue, and hence principal.

In In re Lord's Estate, 236 N. Y. S. 137; affd., 239 N. Y. S. 851, the will involved divided the residue into three equal parts, one of which was given to the decedent’s husband while the other two were given to trustees. Considering the disposition of the net income earned by the residuary estate during the administration, the court said:

Primary rule is that all income not otherwise disposed of by will, and which accumulates during administrative year, becomes principal and must be added to tentative residue to ascertain true residue.

We think it very clear that in the proceeding at bar no payment was made by the executor of the estate to the residuary legatee during the period of administration or settlement. The payment was made after the administration had been completed. What the petitioner received was his legacy. It was exempt from income tax. This does not mean that the income of the estate during the period of administration was not taxable to any one. It clearly was taxable to the estate, as provided in section 161 of the Eevenue Act of 1936 as follows:

SEO. 161. IMPOSITION OF TAX.
(a) Appiioamom- op Tax. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including —
*******
. (3) Income received by estates of deceased persons during the period of administration or settlement of the estate; * * *

The action of the respondent in including in the petitioner’s gross and net incomes any portion of the income of the estate of Delia F. DurMieimer is reversed.

Decision will l)& entered wnder Bule 50.