*1270 1. Petitioner in writing conveyed to his wife and children a four-fifths interest in a royalty contract he had with a corporation, reserving to himself (1) the right to modify the contract and reduce the royalty, (2) to pay four fifths of his debts, in unascertained amount, and (3) to pay four fifths of the living expenses of his dependent family; and in the exercise of the reserved rights, petitioner, with the consent of his wife and children, received and disbursed the royalty funds. Held, the royalty fund so received is income taxable to petitioner.
2. Payments made by petitioner in gratitude for services rendered in former years by payee to a corporation of which petitioner was a stockholder are not ordinary and necessary expenses of petitioner deductible from petitioner's gross income.
*788 This proceeding involves the redetermination of income tax of petitioner in the years and for the amounts following: 1925, $38,908.30; 1926, $42,629.32; 1927, $45,412.78. The asserted deficiencies are the result of (1) the addition to the income*1271 of petitioner by respondent of certain royalties alleged to have been disbursed by the G. Washington Coffee Refining Co. to petitioner's wife and three children, and (2) the disallowance by respondent of a deduction from gross income of $24,000 for each taxable year, paid by petitioner to one W. J. Arkell.
FINDINGS OF FACT.
1. The petitioner is an individual, residing at Mendham, New Jersey. In 1910 he was the inventor and sole owner of a secret process for manufacturing certain products from desiccated soluble substances of roasted coffee, tea, cocoa, etc. In that year petitioner caused the G. Washington Coffee Refining Co. (hereinafter called the corporation) to be organized, with $500,000 common and $100,000 preferred capital stock. Petitioner became the owner of $300,000 of the common stock and all of the preferred stock. The $200,000 balance of the common stock was sold to outsiders. During the years here involved, petitioner was the owner of all the preferred stock and he and his wife and children held practically all of the common stock. The common stock had been increased to an amount in excess of $500,000 during the taxable years. Petitioner was president of*1272 the corporation at all times. During 1918 petitioner and the corporation entered into an agreement, hereinafter called the corporation *789 contract (which took the place of a preceding agreement between them), whereby the corporation was granted the sole right to sell the products manufactured under petitioner's secret process, and the corporation was to pay to petitioner a certain royalty, payable monthly, based upon net receipts from such sales.
On or about December 30, 1918, petitioner wrote a letter (hereinafter called the letter) to his wife and children as follows:
To my dear wife, Lina, to my dear children, Louise, Irene and George:
Pursuant to our conversations on the subject, in consideration of the devoted care and valuable assistance you have given me, in the past, and other valuable consideration, I, hereby, sell and assign to each of you a one-fifth interest in all my real and personal property, except my shares of the Capital Stock of the G. Washington Coffee Refining Company of New York, but, including the contract I have with said Company by virtue of which they pay me a royalty. However, in view of your inexperience in business matters, I want it distinctly*1273 understood that I reserve, for myself, the exclusive right to alter or modify said contract, as well as the amount of Royalties payable thereunder, from time to time, as in my judgment may best serve the interests of the business.
Providing, first: That any financial obligations I now have shall be liquidated out of the herewith assigned assets to the extent of one-fifth by each of you; the balance to be used absolutely.
Secondly: That while we live together and as long as we do so, we shall each equally share in the general expense of doing so.
For your convenience, I will inform the company of your interest in my contract and authorize them to pay to each of you, directly, your share of the Royalties upon your request to them to do so.
Realizing that this may not be the best form of an Assignment I will, in the near future, cause a formal document to be prepared and executed.
Lovingly yours,
[Signed] G. WASHINGTON.
Notice of this letter was given to the corporation.
On March 3, 1919, pursuant to the last paragraph of the letter, the petitioner executed four separate instruments (hereinafter sometimes referred to as the family contracts), one to his wife and*1274 one to each of his three children, in words as follows:
In consideration of the sum of one dollar, lawful money of the United States, and other good and valuable considerations to me in hand paid by my son, GEORGE WASHINGTON, the receipt of which is hereby acknowledged, I have sold, assigned, transferred and set over, and by these presents do sell, assign, transfer and set over unto my said son, his executors, administrators or assigns, an undivided one-fifth part or share of all my right, title and interest in and to any and all royalties or other sums of money which may, at any time hereafter become due and payable to me by the G. WASHINGTON COFFEE REFINING COMPANY, its successors or assigns, pursuant to the terms of a certain written agreement between myself and the said G. WASHINGTON COFFEE REFINING COMPANY, executed the 6th day of November, 1918, or pursuant to the terms of any modification of said agreement, as hereinafter provided.
*790 This assignment is made upon the express condition, which the said GEORGE WASHINGTON, by accepting it, does hereby for himself, his executor, administrators and assigns, covenant and agree with me and with my executors, administrators*1275 and assigns shall always remain in full force and effect, viz: that the aforesaid agreement between myself and the said G. WASHINGTON COFFEE REFINING COMPANY, may be cancelled, waived or modified in any respect whatsoever, at any time and from time to time, upon the written consent of myself and the said G. WASHINGTON COFFEE REFINING COMPANY, its successors or assigns, and such cancellation, waiver or modification shall be binding upon the said GEORGE WASHINGTON, his executors, administrators and assigns.
IN WITNESS WHEREOF, I have hereunto set my hand and seal this 3rd day of March, 1919.
G. WASHINGTON (L.S.)A certain fund called the "trustee fund" or "trust account" was set up by the petitioner in the Corn Exchange Bank at a time not definitely fixed, but apparently shortly after the date of the letter and in 1919.
The corporation, after the trust account was set up, gave checks to petitioner in payment for all the royalties due under the corporation contract, which checks were placed by petitioner in the "trust account." Petitioner had the right to draw personally on this account and did draw upon it to pay household and living expenses of the family, to improve and*1276 repair the town house and country house of petitioner, and for other purposes indicated in the letter, including payment of personal obligations and debts of petitioner. During the taxable years all members of petitioner's family were dependent upon him for support, except one of his daughters after her marriage in 1927, and except as the assignment of interests in the royalties may have relieved the situation.
Upon the audit of petitioner's returns for the taxable years, respondent added to petitioner's income the following amounts, representing a four-fifths interest in royalties disbursed under the corporation contract:
| 1925 | $159,037.36 |
| 1926 | 173,248.08 |
| 1927 | 183,856.48 |
In their respective income tax returns for the years indicated, petitioner's wife and three children each returned one fourth of said amounts. Respondent's counsel stated at the hearing that certificates of overassessment have been drawn up by the respondent, wherein it is proposed to refund to each beneficiary (the wife and children) the tax paid by them on the royalties received in said years. These certificates are held in the Bureau pending the decision of the Board in the instant case, *1277 it was stipulated by respondent's counsel on the hearing.
*791 2. In 1910 W. J. Arkell was instrumental in securing the organization of the corporation and in acting as promoter and in selling its common stock, and thereafter acted as a director and vice president of the corporation. There is no evidence of the compensation, if any, paid him for these services, but petitioner thereafter agreed to and did pay him 35 cents per gross of cans of the refined coffee manufactured and sold, which varied in amount. In 1918 Arkell, who was getting old, resigned his positions with the corporation, retired from active business, and moved to Los Angeles, Calif., to reside. He suggested to petitioner some kind of settlement and petitioner agreed orally to pay him $2,000 per month during his life. This amount was paid during 1925 and 1926 from the "trust account"; in 1927 the payments were sent directly to him by the corporation for the account of the petitioner. Arkell died sometime after 1927 and before December 1932. Petitioner claims that the payments to Arkell were a business expense to him, deductible from gross income.
OPINION.
SEAWELL: 1. With respect to the first*1278 issue, petitioner contends that by his letter of December 30, 1918, he gave to his wife and three children not only a four-fifths interest in the royalties to become due and payable to him, but a four-fifths interest in the contract with the G. Washington Coffee Refining Co., from which the income was to be derived. Respondent says and contends that the letter was a temporary expression of intention of petitioner expressly limited in duration until petitioner should "in the near future, cause a formal document to be prepared and executed," and that when the formal documents were prepared and executed on March 3, 1919, the letter's purpose and intent was at an end. There was no suggestion in the letter or in the oral evidence that the letter was to be temporary or to be replaced by the family contracts, except as the quotation copied might import. The letter was in force, certainly, until a more formal conveyance of the property it conveyed was delivered. While the letter purports to convey a four-fifths interest in the contract of petitioner with the corporation to his wife and children, the formal family contracts purport to convey only a four-fifths "interest in and to any and*1279 all royalties or other sums of money which may, at any time hereafter become due and payable" to petitioner under said contract. If, as the letter purports, an interest in the contract was conveyed, income accruing from that interest - their own property - would be taxable to the wife and children and not to petitioner; but if, as the family contracts purport, only interest in the income from the contract is conveyed, the income would first belong to the petitioner - as the *792 owner of the property from which the income is derived - and would be taxable to him and not to the wife and children. . So we have as a preliminary question to decide whether the letter or the family contracts control the income in controversy. The four instruments of March 3, 1919, were made pursuant to the last sentence of the letter of December 30, 1918, which reads: "Realizing that this may not be the best form of an Assignment I will, in the near future, cause a formal document to be prepared and executed." It will be observed that the promised "formal documents", the contracts of March 3, 1919, nowhere purport to annul the previous letter. *1280 It would require very express terms unequivocally assented to and accepted by the grantees to do so. If the letter makes a conveyance of property not mentioned in the contract, the contract would not, by that circumstance, reconvey such property to the original owner. Title vested in the wife and children by operation of the letter required a conveyance by them to place the title back in the writer of that letter. .
The property or property right conveyed by the letter, which is not conveyed by the family contracts, is the corpus from which the income sought to be taxed to petitioner is derived. The letter, therefore, is the all important document and controlling here. Separated into its parts we find: (1) The letter conveys a four-fifths interest in the corporation contract; but (2) it reserves the right to the grantor - petitioner - (a) to alter or modify the contract with the corporation; (b) to change the amount of royalties payable thereunder; (c) to use the income from the four-fifths interest in the corporation contract assigned to liquidate the grantor's financial obligations; (d) to use the income from the four-fifths*1281 interest in the assigned corporation contract in paying the family expenses so long as they lived together; and (3) only that part of the proceeds of the four-fifths interest in the contract assigned, or of any modified contract, which remained after paying grantor's obligations and said family expenses was to become the property of and subject "absolutely" to the use of the beneficiaries - the wife and children.
The provision of the letter which purports to "sell and assign" an interest in real estate falls short of the requirements of the common law or of any modification thereof in regard to modern conveyances of land. There is, in the first place, no description of the land, the instrument is not under seal, and there are no words of conveyance or of inheritance. None of the income in controversy was derived from the land, and whether the letter could be construed as a deed sufficient to convey title would be immaterial, except for the fact that care, upkeep, and improvement of the town house and country house were considered by the parties at the time as part *793 of the family expense and much of the income in controversy was used for that purpose. We conclude for*1282 the purposes of this phase of the case that title to the real estate was not conveyed by the letter, and remained the property of the petitioner, and the expenses for its repair and upkeep inured directly to petitioner's personal benefit. Further visualizing the picture of this matter created by the testimony of the witness - the petitioner was the only witness - we note that at about the time the letter and the family contracts were executed or shortly thereafter, a "trust account" or "trust fund" was established by petitioner with the Corn Exchange Bank, into which all the royalty payments of the corporation to petitioner under his contract with it, including the four-fifths interest assigned to his wife and three children as well as his own reserved one fifth, were placed. In his brief petitioner denies that this fund was a trust except in name only. It does not contain all the earmarks of the usual deed of trust, but no express words are necessary to create a trust. . Considering all the circumstances surrounding the establishment of the "trust fund" in the Corn Exchange Bank, the conclusion seems inescapable that*1283 the letter formed a trust for the specific purposes therein set forth and that the bank account was set up in pursuance of the plan of the trust. Petitioner was, in effect, and apparently by tacit consent, the trustee. A trust, however, does not fail because there is no trustee named. All the funds which went into the account were from the royalties; all disbursements from the account were by petitioner's checks, and apparently no other had the right to check on the account; the funds were used, as provided in the letter, to pay petitioner's liabilities and the family expenses. How much were petitioner's financial obligations at the time and what part of them, if any, had been discharged before the taxable years here involved, and what part, if any, were discharged during said years, or thereafter, the evidence failed to disclose. Most of the evidence had reference to years prior to 1925, but the situation created and existing before that year was not shown by petitioner, on whom the burden rested, to have been changed at any time before or during the taxable years. In 1918 petitioner estimated his expenses for one child in school and keeping up the home to have been $25,000*1284 or $30,000 per year, all of which was borne out of said fund. The improvements on the two residences, petitioner stated without reference to time, were quite extensive and quite expensive, and all paid out of the trust fund. It appears from his position as president and in charge of the corporation, his large ownership of its stock, and the acquiescent attitude of his wife and children, the other stockholders, as well as by reason of his reserved rights and powers with reference to the income to be derived from the corporate contract, *794 that the petitioner was effectually in charge and able to handle the royalty contract in practically any manner he desired.
The situation, in short, seems to be that petitioner assigned to his wife and children an interest in his contract with the G. Washington Coffee Refining Co., the income from which, with their acquiesence, he placed in a fund to be used in paying his family expenses, his debts, and the improvement of his real estate. It does not appear that these benefits to himself personally might not have absorbed the entire income from the four-fifths interest in the royalty contract. He had power to so modify and change the*1285 corpus of the trust that a part, if not the whole thereof, might be revested in himself. Under such circumstances the income of the trust is taxable to the trustor. Section 219(g) of the Reqenue Acts of 1924 and 1926. . We sustain the Commissioner on this issue.
2. Petitioner contends that the payments of $2,000 per month to W. J. Arkell are deductible expenses under section 214(a) of the Revenue Act of 1926, which provides that "In computing net income there shall be allowed as deductions: (1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."
During the taxable years petitioner appears not to have been engaged in business. The services rendered by Arkell were in years before the taxable years; and the services were not for petitioner, but for the G. Washington Coffee Refining Co. Moreover, even if these things were not true, there is no attempt to show that the expense for the services were ordinary and reasonable as provided by the statute. On this issue we also find for the respondent.
Reviewed by the Board.
Judgment will be entered for the*1286 respondent.
MARQUETTE, SMITH, MCMAHON, MATTHEWS, LEECH, and ADAMS concur in the result.