*1060 1. Amounts transferred to an irrevocable trust by a cemetery association in 1928 and 1929 for perpetual care of the lots are not deductible from gross income.
2. The portion of the sales price on lots sold during the taxable years which the association was obligated to set aside for perpetual care was not income to the association.
*882 The respondent has determined a deficiency for the calendar year 1929 in the amount of $17,746.88. The petitioner alleges error on the part of the respondent in disallowing a net loss incurred in 1928 and in disallowing the deduction of amounts transferred to a trustee in 1928 and 1929 for additions to a perpetual care fund.
FINDINGS OF FACT.
The petitioner is a cemetery association, organized under the laws of the State of Michigan in 1895. Its business is the development and care of the Woodlawn Cemetery and the sale of burial lots therein. In 1928, the cemetery tract comprised 160 acres, of which 64 acres had been developed so as to require perpetual care.
The petitioner has always represented to*1061 purchasers of burial lots that it would make provision for perpetual care of the lots and cemetery grounds. Its printed rules and regulations, promulgated in 1919, provided that:
The Association guarantees the present and future general care of all lots and a portion of the price of each lot is set aside for perpetual care, the income of which will be ample for that purpose.
In the preamble to the regulations reference is made to a "Perpetual Care Fund" which was to be set aside out of the moneys received from sales of lots and administered according to the laws of the State of Michigan. The regulations also quoted section 9411 of Howell's Michigan Statutes, which provides for the creation and administration of perpetual care funds. Neither the sale contract nor the petitioner's rules and regulations specified that a definite percentage or portion of the sale price of lots would be set aside for the perpetual care fund.
At the beginning of 1928, the petitioner had a perpetual care fund of $133,500, of which $128,500 was invested in municipal bonds, This fund was in the petitioner's control and possession.
*883 At or about the beginning of 1928, a number of other*1062 cemetery associations in the vicinity of Detroit, some of them newly organized, put on extensive sale campaigns, representing that some of the old companies, of which the petitioner was one, were not making adequate provisions for perpetual care. As a result the petitioner, in 1928, had a survey made of the operations of the preceding four years to determine just how much it had expended for care in those years and what additions should be made to the perpetual care fund so that the income therefrom would be adequate. The survey disclosed the following expenditures for care and income from the perpetual care fund:
| Year | Expenditures | Income from |
| for care | fund | |
| 1924 | $18,985.62 | $5,738.00 |
| 1925 | 20,418.91 | 4,928.13 |
| 1926 | 22,777.28 | 5,773.13 |
| 1927 | 25,084.13 | 6,059.59 |
Following completion of the report on the survey, a meeting of the board of directors was held on January 9, 1928, at which the following action took place:
The matter of increasing the Perpetual Care Fund was discussed, and it was shown to the satisfaction of the Board that $286.500.00 should be added to our present Perpetual Care Fund of $133,500.00 in order to bring this fund up to a*1063 sufficient amount, so that it will serve its purpose in caring for the lots that have been sold since the inception of the Cemetery to January 1, 1927.
It was then moved and supported $100that,000.00 of the funds on hand in the Woodward Subdivision account be invested in municipal bonds, and added to the present Perpetual Care Fund, and that the proper officers of the Association be hereby authorized to enter into an irrevocable trust agreement with the Union Trust Company of Detroit, who shall be the future Trustees of the Perpetual Care Fund, in accordance with the terms of a special trust agreement which is now being prepared. Carried.
It was moved and supported that the selling price of cemetery lots from date until such a time when new prices are made, shall be at the minimum rate of $1.50 per square foot, and at a maximum rate of $2.50 per square foot, and that the proper officers be authorized to set aside twenty-five cents per square foot on all future lot sales, the proceeds of which shall be added to the Perpetual Care Fund at the end of each year. Carried.
Pursuant to the above resolution, the petitioner, on May 14, 1928, entered into an irrevocable trust agreement*1064 as of December 31, 1927, with the Union Trust Co. of Detroit, trustee, whereby the trust company was to receive and hold certain funds to be transferred to it by the petitioner in trust irrevocably and in perpetuity, the income therefrom to be paid to the petitioner and used "solely for the purpose *884 of providing Perpetual Care in respect to Cemetery lots heretofore or hereafter sold under the Agreement hereinbefore referred to." During the calendar year 1928, pursuant to the above resolution and trust agreement, the petitioner turned over to the Union Trust Co., as trustee, $384,000 par value of Michigan municipal bonds. The petitioner charged off $100,000 of this amount in its 1927 income tax return and the balance, $284,000, in its 1928 return. The respondent allowed the deductions for both years, with the result that the petitioner's return for 1928 showed a net loss of $92,864.18.
At or about the time that it entered into the aforesaid trust agreement, the petitioner changed the form of its sale contract to contain the following provision:
The Association agrees to turn over to its Trustee, either monthly, quarterly, semi-annually or at least annually, the*1065 sums hereinbefore specified as being paid as deposits for perpetual care, which deposits are approximately the equivalent of twenty-five cents per square foot for every square foot of land sold for burial purposes. This amount is to be deposited in either bonds or cash with the Trustee, and the income therefrom used solely for perpetual care as provided in the Trust Agreement and in the rules of the Company.
This form of sale contract was used for the balance of the year 1928 and for 1929.
The petitioner received income from the perpetual care fund in the hands of the trustee of $6,975.85 in 1928, and $19,700.22 in 1929. It paid out in those years for care of the lots and cemetery grounds a total of $22,533.93 in 1928, and $25,110.91 in 1929.
During the calendar year 1929, the petitioner transferred to the Union Trust Co., as trustee, for addition to the perpetual care fund a total of $71,000, which it claimed as a deduction in its return for that year. Of that amount the respondent allowed the deduction of $13,959.37, representing 25 cents per square foot for the lots sold during the taxable year. Also in its return for 1929, the petitioner claimed a net loss deduction*1066 for 1928 of $92,864.18, all of which the respondent disallowed, and claimed a deduction of the amount of $25,110.91 representing the total amount expended for care in that year, but did not include in its income the $19,700.22 received in that year from the perpetual care fund. In his computation the respondent restored to income the $19,700.22 received from the perpetual care fund.
OPINION.
SMITH: The petitioner's principal contention is that it is entitled to deduct either as an ordinary and necessary business expense or as a loss in the years 1928 and 1929, the amounts paid over in those years to the Union Trust Co. as trustee for the perpetual care fund. The argument is made that the petitioner was under a binding *885 obligation to the purchasers of lots already sold to provide an adequate fund for perpetual care and also that the establishment of the fund was necessary as a means of meeting competition in the sale of other lots.
Prior to 1928, the petitioner's sale contract contained no specific provision for a fund for perpetual care. All sales of lots were made subject to the petitioner's rules and regulations, which guaranteed the present and future general*1067 care of all lots and stated that a portion (no specific portion) of the sale price would be set aside for that purpose. In 1928, after the trust fund had been created, a new sale contract was adopted which provided that approximately 25 cents per square foot of the purchase price of each lot sold would be paid into a perpetual care fund. As to the sales made under the new contract the specified amount of 25 cents per square foot on the lots sold was impressed with a trust upon its receipt and was therefore not income to the petitioner. Portland Cremation Assn. v. Commissioner, 31 Fed.(2d) 843; Los Angeles Cemetery Assn.,2 B.T.A. 495">2 B.T.A. 495; Troost Ave. Cemetery Assn.,4 B.T.A. 1169">4 B.T.A. 1169; affd., 21 Fed.(2d) 194; New York & New Jersey Mausoleum Co.,26 B.T.A. 128">26 B.T.A. 128.
However, as to the prior sales made under the old contract the petitioner was not obligated, either contractually or by law, to set aside any specific portion of the sales price for perpetual care and no part of such income was impressed with the trust. Cf. *1068 Portland Cremation Assn. v. Commissioner, supra.
The amount of $384,000 transferred to the perpetual care fund in 1928 included the $133,500 which the petitioner had in a reserve for perpetual care at the beginning of 1928. We do not know from what source these funds were derived or what percentage of sales, if any, they represented. Presumably the amounts, except the $133,500 already held in reserve, were taken out of general surplus. The question here raised, however, is not whether the amount of $384,000 is includable in gross income as in the years of its receipt by the petitioner, but whether it is deductible from gross income in 1928 because of its transfer irrevocably to the trustee for the perpetual care fund in that year. This question was raised in Evergreen Cemetery Assn.,25 B.T.A. 544">25 B.T.A. 544, but was not there decided, the facts proved in that case having been found insufficient to support a conclusion upon the question of law. A similar question was considered in New York & New Jersey Mausoleum Co., supra, where we said:
* * * The cost of the mausoleum up to the years here involved was something over $200,000, and*1069 under the requirements of the law there should have been a trust fund in existence in excess of $20,000. How could this in any way reduce income in subsequent years? The statement in the sales *886 agreement to the effect that the purchase price would provide a perpetual care fund did not obligate petitioner to set aside any ascertainable sum which a purchaser could require to be administered as a trust. As a matter of fact the petitioner never treated any part of the receipts from sales as having been received by it as a trustee. The record is entirely bare of evidence that petitioner created a trust fund with the $15,000 it borrowed in 1921 and left on deposit with the bank as a "special interest fund." Even conceding that the borrowed money could somehow be regarded as a trust fund, it does not appear that there was any relation between that sum and petitioner's income for the year 1921. It is obvious, we think, that the existence of a trust fund does not necessarily affect income one way or another. Such a fund may be created out of donations, surplus, or capital, with no effect whatever on current income. It is only in cases where sums that would otherwise be reflected*1070 in income are diverted from the use of the taxpayer, as in the cases above cited, that income is affected. When in 1924 the taxpayer paid off $10,000 of the loan it was merely liquidating a liability, which plainly could not serve to reduce income.
Inasmuch as the State law applicable to petitioner's operations required the maintenance of a trust fund based on cost, and no connection whatever is shown between cost and sales, we are of the opinion that petitioner is not entitled to reduce income from sales by reason of its so-called trust fund. * * *
We are of the opinion that the amounts transferred to the perpetual care fund in 1928 and 1929 in excess of 25 cents per square foot on the lots sold during those years are not deductible either as ordinary and necessary business expenses of those years or as losses. The petitioner is entitled to deduct in each year as a business expense the amount actually paid out by it during such year for the care of the lots, but to the extent that the amounts paid into the trust fund in 1928 and 1929 represented a capital reserve or trust fund for future care of the lots they were in no sense an expense of the taxable years before us. There*1071 is no authorization at law for the deduction of the amounts set aside out of its earnings of prior years, or out of its current earnings, in excess of its contractual obligation, for the care of lots in future years. Income must be computed upon an annual basis and the tax liability of each year must be determined with reference to the receipts and expenditures of that year. Burnet v. Sanford & Brooks Co.,282 U.S. 359">282 U.S. 359.
There was no element of a loss in the transaction by which the amounts in dispute were transferred to the trust fund. The entire net income from the fund was to be used in the care of the lots. This was an annual expense which the petitioner was obligated to meet in some manner. If there had been no trust fund established for that purpose, then the petitioner would have been required to pay the cost each year out of its own funds.
The petitioner in his brief refers to section 11166, Michigan Compiled Laws, 1915, which reads as follows:
*887 Sec. 7. It shall be the duty of such board of directors to preserve good order in the grounds of such cemetery; to provide for the laying out and embellishing of the same, and to see that*1072 they are well kept and in good condition. When the payments for lands purchased shall have been fully made, to reserve at least two-thirds of all the receipts of such corporation which shall be derived from the sale of burial rights after the payment of the current expenses for interest, improvements, and embellishing, until the aggregate amount thereof shall, in the opinion of said board, be sufficient to constitute a permanent fund which, when invested, shall produce an income large enough to meet the expense of keeping the grounds of such cemeteries perpetually in good condition after the same shall have once been properly laid out, improved, and embellished according to the plan thereof; to invest the receipts to be reserved as aforesaid in the bonds of the United States, or of the state of Michigan, or of municipal corporations of this state, and to use the income thereof only for the purposes aforesaid; to cause to be issued scrip or certificates to each subscriber to the articles of the association, which certificates shall specify the amount paid into the capital stock by such subscriber. Such script shall be personal property and transferable by the holder thereof, under*1073 such regulations as the board of directors may adopt; to make a report to the annual meeting of the condition of the association, and its receipts and disbursements for the previous year.
The evidence does not indicate, however, that the petitioner set aside the amounts in question in compliance with this provision of the Michigan law. The same law was in effect in prior years. Its effect, if any, on the petitioner's taxable income was to impress a trust upon a portion of the receipts from the sale of lots in those years, removing such amounts from petitioner's taxable income. See cases cited above.
Since the disallowance of the deduction of the $284,000 item in 1928 offsets the claimed net loss of that year of $92,864.18, there is no net loss which may be carried forward in 1929.
The petitioner claimed the deduction in its 1929 return of $71,000 represented the total of additional amounts transferred to the perpetual care fund in that year. The respondent allowed the deduction of $13,959.37 representing 25 cents per square foot on the lots sold during the year, which amount the petitioner was obligated under the sales contracts to pay into the perpetual care fund. The*1074 balance, $57,040.63, was disallowed as a deduction. This adjustment was correctly made. Of course, as shown by the deficiency notice, the amount of $13,959.37 was not deductible as a business expense but was excluded from gross income because received by the petitioner in trust for the benefit of the lot owners.
The petitioner also alleges error on the part of the respondent "in including in taxable income interest from tax-exempt municipal bonds in the amount of $19,700.22." During 1929, the petitioner expended in caring for the lots $25,110.91 which it claimed as a deduction in its return for that year, but it did not report in its *888 return the above amount of $19,700.22 received from the perpetual care fund. What the respondent actually did, as shown by the deficiency notice, was to charge back to income, or disallow as a deduction, $19,700.22 of the amount of $25,110.91 claimed in the return. The deficiency notice states:
5. Since the income received by the trustee from the perpetual care fund was turned over to the Cemetery Company to take care of expenses of maintenance and upkeep of the cemetery and does not constitute income to the corporation such portion*1075 of the expenses is thereby offset and does not constitute an allowable deduction from income.
It is not material whether the income received by the petitioner from the perpetual care fund is exempt as income from tax-free securities or not. The petitioner is entitled to deduct from gross income for perpetual care only the expense borne by it. To the extent that the cost of perpetual care was reimbursed to it by an amount received from the perpetual care fund the expense was not borne by it. And if the amount thus received is not reflected in petitioner's gross income, the cost of perpetual care must be reduced pro tanto. See Glendinning, McLeish & Co. v. Commissioner, 61 Fed.(2d) 950, in which the Circuit Court of Appeals for the Second Circuit held that deductions claimed in 1922 to 1926 as ordinary and necessary expenses should be disallowed because the contract under which the payments represented by the deductions were made provided for repayment to the plaintiff of such amounts. The respondent's action on this point is sustained.
Judgment will be entered for the respondent.