*1006 1. Petitioner's wife loaned him $53,000 and a large amount of corporate stock, in order to satisfy calls made by his broker for margin. At a time when the situation as to the brokerage account appeared critical, petitioner and his wife consulted her father and the president of a bank, and placed themselves in their hands. At the request of the banker, the wife took out insurance on petitioner's life, and he executed a note in her favor and transferred corporate bonds to her. The wife then transferred the bonds, note, and insurance policies in trust for petitioner, the trust instrument giving petitioner the income of the trust after payment of premiums on the insurance, broad powers of management, and control and disposition of corpus. Petitioner and his wife throughout the transactions acted under instructions from the banker and her father. Held, no error in Commissioner's treatment of petitioner as settlor of the trust and in including all trust income in computing petitioner's net income, under sections 166 and 167 of the Revenue Act of 1932.
2. The petitioner executed a trust for the benefit of each of his four children. The income of the trusts was payable to the*1007 grantor, as ordered by him, during the minority of the beneficiaries, to be used for their support, maintenance, education and enjoyment and thereafter the beneficiaries were to receive the income at such times as the grantor directed the trustee to make distribution. Held, that the income of the trusts is taxable to the petitioner, the grantor. J. S. Pyeatt,39 B.T.A. 774">39 B.T.A. 774; Henry A. Loeb,40 B.T.A. 517">40 B.T.A. 517.
*402 These proceedings were consolidated for hearing and report and involve the redetermination of deficiencies in income taxes for 1933, 1934, and 1935 in the amounts of $2,775.54, $4,718.97, and $6,302.78, respectively. The issues are whether there should be taxed to petitioner the income from (a) a trust created by petitioner's wife and (b) trusts created by petitioner for the benefit of his children.
FINDINGS OF FACT.
Issue 1.
The petitioner and his wife, Purdon Smith Whiteley, are residents of Pennsylvania and the transaction involved*1008 herein occurred in that state.
*403 Prior to the taxable years petitioner opened, and at all times important thereafter maintained, a marginal stock account. The account was with E. W. Clark & Co. until about 1937, when the account, including the indebtedness and security therefor, was transferred to Reynolds & Co. Prior to the transfer considerable sums were paid to the broker in cash by the petitioner in reduction of his indebtedness. The debit balances in the stock trading account were, in round numbers, as follows on the dates specified:
| Nov. 30, 1931 | $296,000 |
| Dec. 31, 1931 | 263,000 |
| Jan. 31, 1932 | 269,000 |
| Feb. 28, 1932 | 270,000 |
| Mar. 31, 1932 | $270,000 |
| Apr. 30, 1932 | 251,000 |
| May 31, 1932 | 216,000 |
| Sept. 30, 1939 | 194,000 |
At various times between May 25, 1930, and April 9, 1932, Purdon Smith Whiteley, as the owner thereof, loaned to petitioner 7,500 shares of preferred stock of the Commonwealth & Southern Corporation, and petitioner deposited it with his broker as additional margin on his account. Thereafter some of the shares of stock were withdrawn from time to time. On April 9, 1932, 5,200 shares of the stock were still on pledge in the*1009 account. On or prior to May 26, 1932, Purdon Smith Whiteley withdrew from a trust created on May 19, 1932, by her brother, Beauchamp E. Smith, in which she was beneficiary, 6,000 shares of preferred stock of the Commonwealth & Southern Corporation and thereafter loaned the stock to petitioner to replace the 5,200 shares. The 6,000 shares were delivered to the broker on May 26, 1932, and 2,100 shares are still pledged in the account. Of the 5,200 shares surrendered by the broker in the exchange, 5,000 shares were placed by Purdon Smith Whiteley in a trust created by her on May 21, 1932, for the benefit of Beauchamp E. Smith, and the remaining 200 shares were transferred and delivered to Purdon Smith Whiteley. The value on May 31, 1932, of 5,200 shares of preferred stock of the Commonwealth & Southern Corporation was about $375,000.
Petitioner's wife also loaned petitioner $8,000 in December 1931 and amounts aggregating $45,000 in May 1932, a total of $53,000, which amount petitioner used to pay obligations to the Western National Bank of York, Pennsylvania, and the broker, resulting from requests of the latter for additional margin on his brokerage account. At those times petitioner*1010 had on deposit with the broker as collateral for his account everything he had that was acceptable to them.
Petitioner owned valuable shares of stock of the Dentists' Supply Co., a closely held corporation. The stock was unlisted and was unacceptable to E. W. Clark & Co. as collateral on petitioner's account. Petitioner deposited the stock with the Western National *404 Bank of York, Pennsylvania, as additional collateral for the payment of money borrowed from it and to secure payment of amounts owed his wife. The stock will be returned to petitioner when the 2,100 shares of preferred stock of the Commonwealth & Southern Corporation still in the account (which shares had a value of about $140,000 in October 1939) are released by the stockbroker and returned to the Beauchamp E. Smith trust, from which the shares were withdrawn by petitioner's wife.
In May 1932 and for some time prior thereto, particularly in December 1931, petitioner's finances were in a critical condition. He was willing to do anything to relieve the situation and gave assurances that his wife would receive anything he could get, including property from the estate of his father, who died in January*1011 1932. On May 26, 1932, he received from his father's estate and delivered to his wife coupon bonds of various corporations of a face value of $126,000 and market value of about $64,220. Petitioner's wife clipped the coupons due June 1, 1932, on a portion of the bonds and deposited the proceeds in her personal checking account. The amount of the coupons, $192.50, was returned by her in her income tax return for 1932. Petitioner's wife was aware of his financial predicament and in December 1931 informed him that she desired to, and with petitioner's consent did, consult her father, C. Elmer Smith, a director of the Western National Bank of York, Pennsylvania, about the matter. Petitioner advised Smith and George T. Livingstone, president of the bank, of his financial affairs' and placed himself in their hands. In December 1931 Smith, in the presence of petitioner and his wife, requested Livingstone to protect properly his daughter's estate and informed Livingstone that he would cooperate with him whenever necessary to accomplish the desired result. After December 1931, Smith and Livingstone took care of petitioner's wife's financial transactions with petitioner relating to his*1012 stock brokerage account, and all of her acts in respect thereto were performed under their instructions. Smith, Livingstone, and petitioner's wife after December 1931 discussed the subject a number of times. In May 1932, when the broker made another call for margin, Smith and Livingstone concluded that some definite action should be taken to correct the situation. Livingstone alone conceived the idea of having petitioner's life insured, with petitioner's wife as beneficiary, and Smith decided that petitioner should execute a note in favor of petitioner's wife. A note for $200,000 was prepared and Smith and Livingstone requested petitioner's wife to have her husband sign it.
On May 25, 1932, petitioner, at the request of his wife, executed under seal, and delivered to her, a demand note in her favor for $200,000, with interest, no rate of interest being specified. The petitioner *405 signed the note without objection. The note was assigned by the wife on the same day to the Western National Bank, "Trustee of Purdon Smith Whiteley." He would have signed a note for a larger amount if his wife had requested him to sign one. Petitioner's wife would have given petitioner*1013 everything she had to help him out of his financial difficulties and did not intend the note for $200,000 and corporate bonds as a charge for the financial assistance that she had given him. Petitioner owed nothing to his wife other than $8,000 borrowed from her in December 1931 and $45,000 from May 16 to May 24, 1932, and 6,000 shares of preferred stock of the Commonwealth & Southern Corporation. Petitioner paid his wife interest on the money loan of $53,000 and has repaid the same in full by payments made in 1934, 1936, and 1937.
The note and bonds were not a charge against petitioner for the financial assistance his wife had given him.
Petitioner desired to protect his wife's interests under all circumstances. When she first discussed with him the question of additional insurance on his life, he objected upon the ground that he already had an adequate amount, but he gave his consent and signed the applications for insurance with her on May 24, 1932, the day upon which a $175,000 policy was issued, to show his consent to the policy being issued on his life, and in answer to questions as to health. On May 24 and June 3, 1932, pursuant to the applications, two policies of*1014 insurance in the aggregate amount of $200,000 were issued on the life of petitioner. Petitioner's wife, or her executors, administrators, or assigns, was named beneficiary in each policy and she on May 31 and June 8, respectively, assigned all of her "right, title and interest" in the two policies to the Western National Bank, trustee under a deed of trust of May 31, 1932. Petitioner's wife paid the initial premiums of $8,904 on the policies. The insurance was decided upon by Livingstone and Smith after they decided to obtain the note and bonds from petitioner. It was not intended ad additional protection to the wife on account of her loans of stock and cash to petitioner. They believed the loans would be adequately protected without the insurance.
On May 31, 1932, petitioner's wife executed an instrument transferring to the Western National Bank of York, Pennsylvania, in trust, the aforementioned corporate bonds of a par value of $126,000, the note of petitioner for $200,000, and the life insurance policies in the aggregate amount of $200,000, as the corpus of the trust. The income of the trust, after payment of expenses of the trust, including the premiums on the policies*1015 of insurance, was made payable to the petitioner for life, and in addition thereto the trustee was directed to pay and deliver to him from time to time, subject to the written *406 consent of the wife, if living, and if deceased, the trustee, "such further amounts from the principal of this Trust as he shall deem proper and necessary, for his maintenance, support, comfort and enjoyment." Subject to the control and written directions of the wife and/or the petitioner, the trustee was authorized to:
1. Vote and exchange securities in the trust.
2. Consent to reorganizations, consolidations, etc.
3. Pay assessments, etc., to protect its interests as holder of the securities.
4. Exercise options and stock rights, and
5. Generally to exercise all rights lawfully exercisable by any person owning similar property.
Upon the death of petitioner all or any part of the net income and principal of the trust was payable to such of his children and in such proportions as petitioner should by his last will appoint. In case of failure of petitioner to exercise the power of appointment the net income and corpus of the trust, or any balance not appointed, was to go in equal*1016 part to petitioner's children in a specified manner. Any part or all of the principal of the trust was payable at any time to any beneficiary upon his written application accompanied by the written consent of the wife, if living, and if not, the trustee.
The petitioner was authorized to direct the trustee in writing to hypothecate, sell, exchange, or loan the property in the trust to such person, firm, or corporation as he should designate and upon such terms as he should designate. The petitioner was appointed cotrustee of the trust, with power, as such, limited to the direction of investments. The trustee had no authority to lease, sell, transfer, invest, reinvest, mortgage, or encumber the property of the trust without the written consent of the cotrustee. The wife expressly surrendered all power to amend, modify, or revoke the trust, and provided in the trust deed that "she shall have no power over the disposition or the distribution of the principal or the income thereof." The idea to create the trust originated with Livingstone. His consulations on the terms of the trust were with petitioner's wife and her father; never with petitioner. Petitioner was not aware of his*1017 wife's intention to form the trust until a short time prior to May 24, 1932. He objected to the creation of the trust.
All of the action taken by petitioner's wife in connection with the matter in controversy was taken pursuant to instructions received from Livingstone and/or Smith. On June 1, 1932, the petitioner requested the trustee in writing to withdraw the bonds from the and pledge them as security for a loan from one of the banking correspondents of the trustee. Pursuant to this request, on or about June 3, 1932, the trustee withdrew the corporate bonds from the trust and deposited them with E. W. Clark & Co. as guaranty for *407 the stock trading account of petitioner. Prior to October 1938 all of the bonds were removed from the brokerage account and returned to the trust. Some of them were redeposited with the broker in about October 1938 as additional collateral. About $20,000 of the bonds are still on deposit with the broker. Excepting the 2,100 shares of preferred stock of the Commonwealth & Southern Corporation, no other property of the trust or of petitioner's wife is on deposit in petitioner's brokerage account at the present time.
During 1932 petitioner*1018 paid no interest, and in each of the years 1933 to 1939, inclusive, he paid $8,000 not later than June 20 of each year as interest on his note for $200,000 held by the trustee, being at the rate of 4 percent per annum. Nothing has been paid on the principal of the note. The interest was claimed as a deduction in income tax returns filed by the petitioner for the years in which the interest was paid and was reported by the trust in income tax returns for the years involved. The trust also reported in income tax returns filed for 1933, 1934, and 1935, interest received on the $126,000 face amount of bonds.
The trust paid no premiums on the life insurance policies in 1932, but paid the premiums during the years 1933, 1934, and 1935, out of income of the trust estate. The trustee paid an income tax on the amount used to pay insurance premiums and not distributed to any beneficiary. The remainder of the income of the trust (less certain minor deductions) was paid to petitioner, who paid an income tax upon it.
In his determination of the deficiencies the respondent taxed all of the income of the trust to petitioner upon the ground that the corpus of the trust was owned by him*1019 prior to the creation of the trust, and that he received all the benefits and controls the distribution of the principal thereunder.
Issue 2.
On June 12, 1935, the petitioner created an irrevocable trust for each one of his four children, naming the First National Bank of York, Pennsylvania, trustee. The terms of the trusts were identical. The one created for the benefit of his minor daughter, Virginia, provided for the payment of the income of the trust "to the Donor, as, if and when ordered in writing by him to do so, during the minority of his daughter, Virginia Whiteley, to be used solely and entirely by him for her support, maintenance, education, and enjoyment." Any income not distributed was to be invested in securities "if ordered and approved by the Donor." After the beneficiary attained the age of 21, she was entitled to receive income and corpus *408 "in such amounts and at such times as the Donor in writing orders such distribution or distributions to be made."
During 1935 the income of the four trusts was $5,878, all of which, except $450, was invested and became a part of the corpus of the trust. The $450 was paid to the petitioner and was invested*1020 by him for the children in 40 shares of preferred stock of the Empire Power Co. Ten shares of the stock were issued to and registered in the name of each child.
OPINION.
Issue 1.
DISNEY: The major difference between the parties here is whether the form or the substance of the transaction should prevail; that is, whether petitioner or his wife should be treated here as the grantor of the trust. The gist of the petitioner's argument is that his wife was the grantor both in substance and form, upon the ground that she received the bonds and note from him unconditionally. He contends that the situation here is no different from what it would be if the trust had been created by his wife out of property which had never belonged to him. Respondent insists upon brief that, with the exception of the insurance policies, the value of which, he says, was negligible, the property transferred in trust belonged to the petitioner, and that it was mutually understood that the transfer was made to secure the wife against loss of her property then at risk in his stock trading account and not to pass ownership. Respondent relies upon sections 166 and 167 of the 1932 Act. 1 He makes no*1021 contention that the question is governed by section 22(a).
*1022 *409 Petitioner's wife, at the request of Livingstone and Smith, applied for, paid the initial premiums on, and was made the beneficiary of, the insurance policies. The insurance was not taken out as protection to her for the loans of stock and cash she had made to petitioner. They were secured in other ways. It does not appear that the insurance had a cash surrender value at the time of its transfer to the trustee. It was an expense of the trust, not an income-producing asset thereof. The presence in the trust of this insurance does not, in our opinion, demonstrate that petitioner is not the real grantor of the trust, as the respondent contends him to be.
It is clear that the statutory provisions relied upon by the respondent are not controlling if petitioner's wife is to be regarded as the grantor of the trust, for sections 166 and 167 relate only to grantors of trusts. In determining whether petitioner or his wife should be regarded as the grantor of the trust we are not limited to the bare terms of the instrument. Numerous cases hold that transactions between husband and wife must be closely scrutinized to determine their real character. In a case involving*1023 the deductibility of a loss resulting from the sale of property to a corporation wholly owned by the taxpayer, the court, in , said:
* * * The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.
In , affirming , involving the deductibility of interest on an amount borrowed by the taxpayer from a trust created by his wife with funds furnished by the taxpayer, the court said that: "Despite such purpose [to avoid or minimize taxes], the question is always whether the transaction under scrutiny is in reality what it appears to be in form."
In *1024 , the collector contended that certain shares of stock transferred by Richardson to his wife and by her shortly thereafter set up in trust continued to belong to the husband. In ordering a new trial to determine additional facts, the court remarked:
* * * So in this case the transfer may in fact have been intended only to deceive the taxing authorities. It is not necessary that such a mutual understanding shall be explicit or verbal; it may be gathered from the conduct of the parties in a series of transactions, or in any other way. . All that need appear is that the donor did not intend to divest himself of control over the res, that the donee knew *410 of the donor's intent and assented to it, and that the donor knew of the donee's assent. If all this is fairly inferable from the relations, the gift, however formal, is a sham; but the donor's belief, though well founded, that he can prevail upon the donee to comply with his demands, is alone not enough; it does not put the donee's will under any constraint, and the property becomes unconditionally*1025 his. ; smith v. ; ; .
In ; certiorari denied, , a case involving reciprocal trusts, the court said that "The law searches out the reality and is not concerned with the form" and recognized that one who furnishes the consideration for a trust is a settlor.
Under the general contention of petitioner that his wife was the unconditional owner of the property transferred by her in trust, he argues that the bonds and note "were given outright to the wife" because of the existence of a very large obligation to her for loans of stock and cash. While upon brief he used terms synonymous with the word "gift", he does not specifically contend that the bonds and note were conveyed by way of gift. Such argument would be contrary to a statement made by his counsel at the hearing that he would show a consideration for the transfers. He merely refers to testimony*1026 regarding protection to his wife for the financial assistance she had given him as the motive for the transfers. He argues that the facts are unusual, if not unique, and asserts that there is no occasion here to decide the precise character of the transfers, alleging that it is sufficient that the named settlor of the trust was the absolute owner of the property transferred under the instrument.
A brief statement of the facts at this point will be of assistance. The petitioner operated a stock trading account in which there was a debit balance of about $260,000 at the close of 1931 and May 1932. He had on deposit as collateral in the account all of his own stock acceptable to the broker and 6,000 shares of preferred stock of the Commonwealth & Southern Corporation which he had borrowed from his wife. In addition he owed his wife $53,000 for cash borrowed to help carry the account. Petitioner was able with some difficulty to meet calls made at various times by the broker for more collateral. In and after December 1931 petitioner and his wife were alarmed about the condition of the account. Petitioner characterized the situation as "critical" and his wife testified that he*1027 was "desperate." In their dilemma, petitioner consulted Smith, his father-in-law, and Livingstone, a banker, and "put myself in their hands," and petitioner's wife turned to her father for guidance. Smith had no faith in the ability of petitioner and his wife to solve *411 their financial difficulties. Smith and Livingstone consulted with each other about the matter and at times with petitioner's wife, and in May the former concluded that some definite action should be taken to correct the situation. A trust was thought of by Livingstone as early as December 1931; in May 1932 the one in controversy was executed.
The evidence clearly shows a willingness on the part of the petitioner and his wife to conform their acts under the circumstances to the wishes of Livingstone and Smith. Petitioner testified: "I was in a very humble frame of mind, and I was willing to do anything." He informed Livingstone that "* * * I wanted him to - anything that I had which I could put up to show my good faith and my willingness to repay my wife and settle my affairs I was perfectly glad and willing to do." Petitioner also testified that he would have executed a note in favor of his wife for*1028 a larger amount if she had requested it. The wife testified that she "would have given him [petitioner] everything I had to help him," and, upon being questioned as to whether the bonds and note constituted a charge against petitioner for the help she had given him, she testified: "I was not charging him anything, was I? You see, this is very vague to me." Her lack of understanding of what was being done appears well founded. Livingstone, who alone conceived the idea of having petitioner take out more life insurance, and with Smith requested the execution of the note, in response to a question of whether the note was a charge for the financial assistance the wife had given the husband, testified: "Mrs. Whiteley hasn't anything to do with it. She never thought of $200,000 or twenty-five cents. Mrs. Whiteley was entirely instructed by Mr. Smith and myself." We conclude that the bonds and note were no such charge.
Petitioner also testified that he never consulted his wife about the formation of the trust. However, at least as early as May 24, 1932, when he submitted to a physical examination for life insurance for transfer as part of the corpus of the trust, he was aware of*1029 what was being done on his and his wife's behalf, for his wife testified that, when she consulted him about the insurance and creation of the trust, he objected to it. Petitioner became familiar with the terms of the trust about the time he was called to go to the doctor for an examination for insurance. For some time Livingstone, Smith, and petitioner's wife urged him to take insurance, and he objected and refused to go to the doctor for examination, but finally agreed, and took the examinations and on May 24 signed the usual applications. Other testimony is that Livingstone never consulted the petitioner about the trust. The reason is obvious. Petitioner had expressed to Livingstone and Smith a desire to do whatever *412 they deemed best under the circumstances and the evidence of record clearly shows that under this delegation of authority the whole plan was conceived and carried out. At all times petitioner's wife acted according to and as she received instructions from Livingstone and her father.
Petitioner contends that the execution of the note under seal imports a consideration. He cites *1030 , now on appeal, involving the deductibility of interest paid on a sealed note executed and delivered in Pennsylvania as a gift. The question there turned upon whether an indebtedness had been created within the meaning of section 23(b) of the Revenue Acts of 1932 and 1934. The issue here is entirely different, and the principle of that case is not controlling.
The record contains no definite proof as to the reason for obtaining the note or why the amount was $200,000. Though there is some evidence that it was regarded by Livingstone and Smith as protection to petitioner's wife, yet Livingstone also testified that the corporate bonds had nothing to do with fixing the amount of the note at $200,000, that the shares of stock of the Commonwealth & Southern Corporation at risk in petitioner's trading account or the greater part of them were secured by petitioner's Dentists' Supply Co. stock, and that the $126,000 par value bonds and the Dentists' Supply Co. stock were ample security for the wife. He testified further:
A My understanding of the $200,000 is absolutely vague. The only thing I know of is those were hectic times. Mr. Smith*1031 and myself and possibly Mr. Whiteley agreed that that was probably - in case of - in fact, I don't know actually, except we thought at that time that was the best thing to do, that was the best arrangement we could make.
Q. Well, was that the only -A. I don't think that those bonds and that sort of thing came in as any differential or difference between what she had loaned and so forth. I don't think - I don't know but I don't believe that was the pertinent point there.
Q. Well, what did you mean by "differential"?A. The note itself probably would be considered the settlement at that point of the difference of Mr. and Mrs. Whiteley, so that if either one had died at that point, and the note would have been paid off, I think that is approximately what it was. I can't say definitely. I am sorry. ,
The note provided for interest without specifying the rate. Interest at the rate of 4 percent per annum was paid by petitioner in the face of a legal rate of 6 percent prevailing in the State of Pennsylvania. The failure of the trustee to collect the legal rate is not explained in the record. We are unable to find from the evidence of record unconditional transfer of*1032 the bonds and unqualified execution and delivery of the note by petitioner to his wife as alleged by him.
*413 The respondent alleges that the whole arrangement was put into effect as a pledge to secure petitioner's wife against loss on account of the money and stock she had at risk in petitioner's stock account. There is evidence to support such view. But other evidence, the terms of the trust, and the acts of the nominal grantor and beneficiary under it, tend to leave the matter in confusion. Petitioner's wife testified as to protection intended for her; but plainly her view is not to be given great weight, for she also testified when asked the purpose of the trust: "I think you had better ask Mr. Livingstone that question, because - I am sorry; the trusts are quite beyond my comprehension"; also, asked whether she considered the $200,000 note as interest or charge for the help she was giving her husband: "It was arranged for, everything, by the Western National Bank, and you will have to ask them those questions, because everything is too complicated for me." Livingstone, too, is inconsistent in his account, for he also refers to protection for the wife, yet is positive*1033 that the insurance was not necessary for her protection, because she had the Dentists' Supply Co. stock for her protection. He says also that they could not figure on the bonds as a base of their plan. The bonds under the trust arrangement were obviously no protection for the wife, for the husband could, under the trust, and did on June 1, the day after the trust agreement was signed, authorize all of the bonds to be withdrawn from the trust and pledged to secure a loan for him, he expressing his desire to secure the proceeds of the loan as soon as possible. The entire corpus of the trust was, in the same way, subject to the command of the petitioner. We conclude that a theory of protection of the wife does not explain the reason for the trust.
We do find evidence strongly indicating that the whole plan was conceived and put into effect for the purpose of forming a taxable entity charged with the duty of paying insurance on the life of petitioner. This is shown by the testimony of Livingstone. He testified that the insurance did not result from the wife's loans of stock to petitioner; also that it was decided upon at a time other than when the conclusion was reached to obtain*1034 a note from petitioner for $200,000; and that the wife's loans of stock and cash were adequately protected without the insurance. Other testimony of Livingstone, quoted above, acknowledges inability to give a reason for obtaining the note. Livingstone could not rely upon the bonds as corpus for the trust because they were in the estate of petitioner's father and it was not known at the time the trust was being prepared when they would be distributed, and they were not, in fact, received by petitioner until May 26, the day after the wife had assigned his note to the trustee, and the second day after the insurance was applied for and in large *414 part issued. It thus appears that if the bonds had not been available for transfer to the trustee the corpus of the trust would have consisted of merely petitioner's note, an income-producing asset, and life insurance, an expense item, with the plain effect of a life insurance carrying trust. That the bonds were in fact added would not change the situation. Petitioner was to receive any income in excess of premiums. Though unable to figure the bonds as base of the plan, the parties did figure the note as the base. Though nothing*1035 was ever paid upon the principal of the note, the interest was paid regularly each year, within 30 days of the due date of the interest and the insurance premiums. The effect of the arrangement has been the carrying, by the note, of insurance. Admittedly, the insurance was not necessary to protect against the wife's advances or loans. The remainder of the trust corpus, the bonds, was immediately used by the petitioner, and only a small part is now on deposit with the trustee. The $53,000 has been paid. Yet the note remains in trust, wholly unpaid, producing interest annually at the time when the insurance premiums are due. We conclude and hold that the real object of the trust was to carry insurance on petitioner's life.
In addition, we believe that there was mutual understanding and agreement between husband and wife that the trust, of his note and property, was for his benefit. There was evidence that Livingstone never consulted petitioner in regard to the formation of the trust, but petitioner knew that a trust was under consideration some time before May 24, 1932, on which date he submitted to a medical examination for the insurance policies. There is evidence that he*1036 objected to it, but at what stage of the matter is not shown, and it is apparent that the objection was later waived or withdrawn, since on May 24 he joined his wife in signing the insurance applications, executed and delivered to her on May 25 without objection the note which she the same day assigned to the trustee, and thereafter, on May 26, delivered the bonds to her. He had then at least known of the trust for some time. It has not been shown that he did not know the terms under which his wife would place the bonds and note in trust. Asked whether at delivery of the note on May 25 there was understanding as to its being placed in trust, petitioner's answer was not a denial, but only: "Not that I remember." Livingstone consulted petitioner's wife on the terms of the trust and although she testified that the subject was vague to her, nothing of record is opposed to a conclusion that she did have advance knowledge of at least the general terms of the trust, such as that petitioner would have broad powers of control over the property after it had been transferred in trust, and that her control would be of no significance. She testified: "Mr. Livingstone and I had been talking*1037 about this trust for some *415 time." The fact of petitioner's objection and her insistence, and later acquiescence, shows mutual understanding. He was "willing to do anything."
The bankers arranged the trust. There is nothing to indicate that petitioner did not know the terms of the trust when he delivered the note and the bonds, and he acted under it by authorizing withdrawal of the bonds to secure a loan the next day after the trust instrument was signed. In any event, petitioner and his wife were at all times acting through common agents authorized to act for them, and knowledge and acts of the agents were those of the petitioner. Taxpayers who voluntarily authorize others to rearrange their property rights and then comply with requests made upon them as the petitioner and his wife did here, are in no position to assert that they were not aware of the consequences of their acts and in agreement thereon. We think a meeting of the minds of petitioner and his wife has not been negatived. Not only their words but their conduct may, and we think did, prove their understanding that petitioner did not intend to divest himself of control of his property, that the wife knew*1038 of, and assented to, petitioner's intent, and that he knew of her assent. See also Livingstone, asked whether he was conversant with the effect of the trust on income tax matters, answered indecisively, but said: "I have - Our lawyer has sort of guided us on that." The respondent determined that the trust corpus belonged to the petitioner and that he was taxable upon trust income. No evidence sufficient to overcome the presumption of correctness of the determination has been adduced. The respondent committed no error in regarding the petitioner as the grantor of the trust. Section 166 therefore applies. As the designated beneficiary of the trust, petitioner (a) was entitled to all of the net income of the trust; (b) could, with the consent of the nominal settlor, require the trustee to distribute to him amounts of principal for his maintenance, support, comfort and enjoyment and any other purpose; (c) could vote and exchange the stock and otherwise exercise rights attached to ownership; (d) exercise power of appointment on the corpus by will; and (e) hypothecate, sell, exchange*1039 or loan the property of the trust to any person, firm or corporation he should designate and specify the terms thereof. These powers are sufficient to make the income of the trust taxable to petitioner under section 166. . Petitioner's wife had no substantially adverse interest in the corpus or income.
The trustee was directed to use income of the trust to pay insurance on the life of the petitioner. The amount so used is also taxable to petitioner under the provisions of section 167(a)(3).
*416 Issue 2.
In his determination of the deficiency for 1935 the respondent taxed the petitioner on all of the income of the four trusts created for the benefit of his children upon the ground that as the settlor of the trusts he reserved the right to direct the trustee as to the use of the income during his life.
The petitioner contends that since no part of the income of the trusts was used for the support and maintenance of his children or in discharge of any of his own obligations, the income of the trusts is not taxable to him. He relies upon *1040 , and other cases in which it was followed. In the Black case and like cases, the discretion to use the income of the trusts for maintenance, support, and education of the settlor's children was vested in the trustee or trustees. Here the petitioner, as settlor, reserved power to receive and apply the income of the trusts for the support, maintenance, education, and enjoyment of his children. Where such a right exists the income of the trust is taxable to the settlor. . Even if the Pyeatt case is not applicable, the income of this trust is nevertheless taxable to petitioner. The income of each trust herein was payable "to the Donor, as, if and when ordered in writing by him to do so, during the minority of (his daughter, Virginia Whiteley), to be used solely and entirely by him for her support, maintenance, education and enjoyment." The Henry A. Loeb case, , holds, following strictly section 167(a)(2), that if the trust income "may in the discretion of the grantor * * * be distributed to the grantor", then such part thereof shall be included in computing*1041 net income of the grantor, regardless of whether any part of the income actually was distributed to the grantor. In fact, in the taxable year, Carl Loeb, Jr., received none of the income and Henry Loeb received $5,000 out of approximately $50,000, the remainder going to their mother and sister.
Since under the language of the instant trust the income "may * * * be distributed to the grantor," is the rule of the Loeb case prevented from applying merely because the trustor, if he should receive the income, must use it "solely and entirely * * * for * * * support, maintenance, education and enjoyment" of his minor children, whom he has a duty to support? We think that such restriction, entailing only what would cause grantor's taxability under , can not logically prevent the application of the rule in the Loeb case. Moreover, since the income might be spent for the "enjoyment" of the minors, an element which is beyond the legal obligation of the father and under which it would appear that he might spend the income almost at his will, there is in such respect no essential difference or distinction *417 from a mere*1042 distribution to the grantor. The respondent did not err in taxing the income of the trusts to the petitioner.
Reviewed by the Board.
Decision will be entered for the respondent.
MURDOCK and MELLOTT dissent.
LEECH, dissenting: This decision must rest, of course, upon the record in this proceeding alone. Since that record does not include any part of the record in any other proceeding, I have grave doubt as to the correctness of the conclusion of the majority on the first issue.
The conclusion on the second issue is, I think, not only wrong but clearly inconsistent with a long line of Board decisions.
The income of the irrevocable trusts was to be paid to the grantor if and when requested by him during the minority of each beneficiary and was thereupon to be used solely for the support, maintenance, education, and enjoyment of the minor beneficiary. However, no part of the trust income was paid to the grantor during the taxable year. Nevertheless, the grantor is held taxable on all of this trust income, under section 167(a)(2), because he could have obtained and used it to meet his legal obligation to support, maintain, and educate his children. *1043 That result requires a linkage of the rationale of , with the language of the cited section, which, I think, is unjustifiable and barred by that section itself. See dissent in .
Moreover, the Board, in a number of cases, including such recent promulgations as , and , has refused to apply this rationale in construing that statutory provision where a trustee had the power to distribute such income to the grantor. See ; ;; ; ; . These cases hold that a grantor, in a situation like the present, is taxable only on such trust income as was actually received and used to discharge his legal obligation. The majority attempt to distinguish those cases on the ground that the discretion*1044 to distribute the trust income was there vested in a trustee while here it was reposed in the grantor himself. This distinction is clearly untenable. A mere trustee has no interest substantially adverse to that of the grantor, , and, therefore, under the explicit terms of section 167(a)(2), the possibility of the existence of any such distinction is wholly eliminated. See Randolph E. Paul, "Five years with Douglas v. Willcuts," *418 53 Harvard Law Review 8, note. Furthermore, this attempted distinction is implicitly rejected in the recent case of . It is true that , is consistent with the result in this proceeding, but it is, I think, wholly inconsistent with the line of cases cited above, and should be overruled on this point.
, upon which the majority alternatively rest their conclusion, is obviously distinguishable. In that case the trust income was payable to the grantors, in the discretion of the trustee, without restriction as to its use, and was thus expressly*1045 taxable to the grantors under section 167(a)(2). Here, the use of the income was restricted to that of meeting the legal obligation of the grantor. If that use had been limited to any other than that of paying a legal obligation of the grantor or directly benefiting him, such income, even if paid and so used, would not have been taxable to the grantor. See ; ; ; ; . Thus, the only possible basis, constitutionally and otherwise, for taxing the contested trust income to the grantor here, is under section 167(a)(2) on the ground, implicitly barred by that section itself and inconsistent with decided cases, that he could have secured and used it to meet his legal obligation.
It is argued that the added prescribed use of the income for the "enjoyment" of the beneficiary nullified the effect of any prior limitation and lift the income, when received by the grantor, without substantial restriction as to its use.
*1046 But, the "enjoyment" has to be the enjoyment of the beneficiary and not the grantor. That those uses are certainly not synonymous contradicts any nullification of the earlier restrictions - particularly here where "enjoyment" is coupled conjunctively with the "support, maintenance, [and] education" of the beneficiary. And if disjunctively construed, "enjoyment" of the beneficiary, since it was no obligation of the grantor, would have relieved the grantor of tax. See , reversed on another ground, .
At all events, I think the restrictions here on the use of the trust income were undoubtedly substantial. Cf. . And, since none of this income was received by or used to meet a legal obligation of the grantor, under every decision of the Board of which I know, except , it is not taxable to him.
SMITH, VAN FOSSAN and TYSON agree with this dissent.
Footnotes
1. SEC. 166. REVOCABLE TRUSTS.
Where at any time during the taxable year the power to revest in the grantor title to any part of the corpus of the trust is vested -
(1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
(2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.
SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
(a) Where any part of the income of a trust -
* * *
(3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23(n), relating to the so-called "charitable contribution" deduction);
then such part of the income of the trust shall be included in computing the net income of the grantor. ↩