*1443 1. TRUSTS - TAXABLE INCOME. Where settlors of a trust conveyed to a trustee oil lands, corporation stocks, promissory notes, and other property, with power to manage and control, to lease and sell, to invest and reinvest, and with duty to distribute income and proceeds of property sold each year thereafter to certain beneficiaries named in the trust deed, after the payment of certain obligations specified under the title "Burdens and Obligations of the Trust," held, it was mandatory on the trustee under the language of the trust deed to accumulate sufficient funds, either out of income or proceeds from the sale of property, to pay these burdens and obligations, and the trustee having in the taxable year accumulated out of income a sufficient sum with which to pay them, such income, to the extent necessary to pay these burdens and obligations, was not distributable to the beneficiaries and petitioner is not entitled to take same as an additional deduction from gross income under section 219(b), Revenue Act of 1924. John D. Rogers,16 B.T.A. 368">16 B.T.A. 368. Held, further, that the balance of income for 1924, not needed to pay and discharge these burdens and obligations*1444 of the trust, was, under the provisions of the trust deed, income which was to be distributed currently by the fiduciary to the beneficiaries and petitioner is entitled to take same as an additional deduction under section 219(b), Revenue Act of 1924, and this is true whether such income was actually distributed within the taxable year to the beneficiaries or not. William E. Scripps,1 B.T.A. 491">1 B.T.A. 491; Estate of Henry Mayer,16 B.T.A. 1164">16 B.T.A. 1164; Willcuts v. Ordway, 19 Fed.(2d) 917.
2. Id. DEPLETION. Petitioner is not entitled to deduct depletion on a discovery basis except as to one item stipulated to be $1,743.07, because he may not base depletion on discovery value established before he as donee under a trust deed acquired oil and gas properties from which the oil royalties were received. Magdaline McKinney,16 B.T.A. 804">16 B.T.A. 804; Darby-Lynde Co.,20 B.T.A. 522">20 B.T.A. 522; affd., 51 Fed.(2d) 32.
3. Id. CAPITAL GAIN. Petitioner is not entitled to treat, as capital gains, profits from bonuses received from the sale of oil leases during the taxable year, because petitioner had not held the lands*1445 for more than two years prior to the sale of such leases. Under the 1924 Act, petitioner could not add to his period of holding, the period of holding by the settlors of the trust. William Kempton Johnson,17 B.T.A. 611">17 B.T.A. 611; affd., 52 Fed.(2d) 727; sydney Shoenberg et al.,19 B.T.A. 399">19 B.T.A. 399; affirmed by Court of Appeals, D.C., Dec. 28, 1931 (par. 9002 C.C.H.).
*995 This proceeding is for the redetermination of a deficiency in income taxes amounting to $235,057.79 for the period June 1, 1924, to December 31, 1924, the said deficiency being asserted against the fiduciary under and by virtue of a certain trust instrument hereinafter referred to. Petitioner contends that no deficiency is due.
The following allegations of error represent a combination of the eight errors alleged in the petition, which are restated as far as possible in the language used therein:
1. The respondent has erroneously held that the income received by the trustee and the proceeds of the sale of trust property*1446 sold by the trustee, from and after June 10, 1924, to December 31, 1924, were not taxable to the 27 beneficiaries named in the trust deed, but were taxable to the fiduciary;
2. The respondent has erroneously construed and interpreted the trust deed executed June 10, 1924, for the benefit of the 27 beneficiaries, in that he has refused and disallowed as additional deductions *996 in computing the net income of the trust, as required by the Revenue Act of 1924, the amount of the income of the trust for the taxable year 1924 and the proceeds of the sale of the trust property sold by the trustees during the year 1924, which were required to be distributed currently by the trustees to the 27 beneficiaries on or before December 31st of that year, but has erroneously included such income and such proceeds, so required to be distributed by the trustees to the beneficiaries, as income of the fiduciary;
3. The respondent has erroneously held that the income to which the beneficiaries were entitled during the calendar year 1924 and the proceeds from the sale of the trust property during the calendar year 1924 were not properly credited to each of such beneficiaries during the year*1447 1924, and for that reason disallowed the same as additional deductions in computing the net income of the trust;
4. The respondent has erroneously refused and disallowed as an additional deduction in computing the net income of the trust, depletion in the sum of $264,334.92;
5. The respondent has erroneously disallowed the benefits of the capital gain provisions of the Revenue Act of 1924, section 208(a), et seq., to the trustee in the sale of oil and gas leases, and the sale of oil and gas royalties, and the sale of oil and gas in place, amounting to more than the sum of $78,000 during the calendar year 1924.
FINDINGS OF FACT.
The petitioner is the trustee under a certain trust instrument executed on June 10, 1924, by Luke F. Wilson and his wife, Nellie M. Wilson, whereby certain properties were conveyed to Luke W. McCrory, trustee, for the benefit of named beneficiaries.
For many years prior to the creation of the trust, Wilson and his wife had lived in Kansas City, Missouri, where he had been vice president of the National Bank of Commerce of Kansas City. During those years he had accumulated a large amount of real and personal property, including approximately*1448 40,000 acres of land in Archer County, Texas, which was used for ranching and farming.
In 1917 and 1918 oil was discovered on the Archer County acreage, but the pool had only a few producing wells and its boundaries were soon limited by the dry holes that were drilled in. However, during 1923 and the early part of 1924, a new oil boom developed, resulting in feverish activity on the ranch property, which continued for two or three years and resulted in the establishment of three distinct fields having approximately 200 producing oil wells. Prior to the creation of the trust, Wilson had individually leased approximately one-half of the Archer County lands for oil and gas, but thereafter the leasing was handled by McCrory as trustee.
*997 The leases entered into by Wilson, and later by the trustee, were made on what was generally referred to as the "Texas 88 Form," a standard lease form providing for a five-year lease, a rental charge for deferment of drilling, usually amounting to $1 per acre, and a consideration to be paid the lessor of one-eighth of the oil and gas produced. However, in a number of the leases executed by Wilson and the petitioner, the lessees paid*1449 an additional consideration, or bonus to secure the lease, while in others they agreed that an additional sum would be paid the lessor out of seven-sixteenths of the oil, if any oil were in fact produced from the lease, but if no oil were produced, then no additional consideration was to be paid.
For a year or more prior to June 10, 1924, Wilson had been considering plans and details for distributing a large portion of his estate among his nearest of kin and the nearest of kin of his wife. When the trust was created Wilson was 82 years of age, having survived both his parents and all his brothers save one, B. M. Wilson, who was then 75 years of age. No issue had been born to his marriage, and his nearest of kin, aside from his brother, were 15 nieces and nephews and one grandnephew, all of whom, except the grandnephew, were between the ages of 35 and 67 and some of whom were in poor, if not necessitious, circumstances. Nellie M. Wilson, wife of Luke F. Wilson, was 79 years of age at June 10, 1924, having survived both her parents and all of her brothers and sisters. Her nearest of kin at said date were 11 nieces and nephews, some of whom were in poor, if not necessitous, circumstances*1450 and all of whom were between the ages of 35 and 50. At June 10, 1924, at least three of the donors' nephews were indebted to Wilson because of loans made to them or because of endorsements which he had had to make good.
On or about May 18, 1924, Wilson created a special trust fund, which is not in controversy in this proceeding, consisting of a series of notes, all but one maturing in 1924 and amounting to approximately $240,000. Luke McCrory was named as trustee of said trust, which was created for the benefit of Luke F. Wilson's nearest of kin and the nearest of kin of his wife, being the 27 persons aforementioned. By the terms of the special trust McCrory was to make distribution every 60 days as said notes were collected. During 1924 McCrory collected all of said notes and distributed to each of the 27 beneficiaries during that year the sum of $11,093.06, the first distribution being made on or about July 15, 1924.
After creating the special trust and on June 10, 1924, Luke F. Wilson and his wife executed the trust instrument here in question, and on the same date the trustee duly accepted the trust duties imposed upon him by said instrument.
*998 By this instrument*1451 the grantors conveyed to the petitioner, as trustee, approximately 40,000 acres of ranch and farm land in Archer County, Texas, on which there were a number of producing oil wells, 482 1/2 acres of similar land in Cree County, Oklahoma, a residence property in Wichita Falls, Texas, some cattle, a large amount of notes receivable, and other miscellaneous items of personal property. There was also included in the conveyance "all oil runs, whether as royalties, purchase money or otherwise," from and after the first day of June, 1924. The trust was to terminate 10 years from and after the death of Luke F. Wilson, with power in the trustee in his discretion at any time after the expiration of 5 years from the death of said Luke F. Wilson to terminate the trust by distribution among the respective beneficiaries. The "beneficiaries" named and defined in the trust instrument were the 27 nephews and nieces and grandnephew of the grantors, with provision that, in the case of the death of any of them prior to the termination of the trust leaving issue, such issue should take the part theretofore held and owned by the deceased parent, but if there should be no such issue, then such part should*1452 pass to and vest in the other beneficiaries so named, share and share alike. The trust instrument is a lengthy document and, except as to the portion headed "Burdens and Obligations of the Trust," it is not believed necessary to set it out in full in these findings of fact.
Subdivision III, subsection I, under the section headed "Powers," sets forth fully and completely the powers of the trustee in respect of the "full, complete and exclusive possession, control, management, and ownership" of all the foregoing property. The portion of said subdivision headed "Burdens and Obligations of the Trust" reads as follows:
The said Trustee, or his successor, shall take and receive, hold, manage, control, and dispose of the trust estate subject to the following burdens and conditions, to wit:
(a) The Trustee shall from the income and revenue of the trust estate, and from the sale of any portion of the trust property pay all and every expense incident to the handling and management of the trust herein imposed and including as full compensation to the Trustee hereunder for all services of every character performed by him an annual salary of Six Thousand ($6,000.00) Dollars, payable in*1453 monthly installments, and in addition thereto shall have the full and free use of Lot Two (2) of Luke Wilson Addition to Wichita Falls, Texas, for residential purposes during the term of this trust. Should it be found that the compensation above provided is inadequate to compensate the trustee for his services hereunder, then upon agreement in writing of at least a majority in interest of the beneficiaries, then said compensation may be increased by such majority to such adequate compensation as they may determine.
(b) The said Trustee, or his successor, shall take said property subject to any and all burdens, charges and liens thereon, (if any), and subject to any *999 and all state, county or other ad valorem taxes thereon, for the year 1924, and for any and all prior or subsequent years, and subject to any other general or special taxes thereon, and shall pay off and satisfy all such taxes or other charges thereon from trust funds received hereunder.
(c) Said Trustee shall make due returns for all Gift Taxes, Estate Taxes, Inheritance or other Taxes which may be due by the trust estate or by the grantors and each and both of them under the laws of the United States, *1454 the State of Texas, or any other State, so far as he may be required by law to do, and said Trustee, so far as said taxes shall be payable by the fiduciary, shall be paid from said trust estate, and as to said taxes which are or may be properly payable by the beneficiaries, said Trustee is authorized to make such payments from the trust estate and to charge the same against the respective beneficiaries for whom he shall pay the same, in the distribution of the income of said trust estate, or from the sale of the trust estate or any part thereof; provided, however, that all such taxes whether payable by the Trustee or the beneficiaries hereunder, shall so far as the grantors are concerned, be payable from the trust estate, and so that any remaining property of the grantors or either of them shall not be charged with the payment of any such taxes, but shall be and remain free therefrom.
(d) Said Trustee shall also from the trust estate pay all and singular all of the income taxes of the grantors, the said Luke F. Wilson and Nellie M. Wilson, each and both, for the year 1924, from all sources, including not only the income from the trust property heretofore received by them or either*1455 of them during that part of the year 1924 which has heretofore expiredBut all other income to them or either of them from all other sources during the entire year 1924, and said Trustee shall set aside sufficient funds for that purpose.
(e) All other income, after setting aside a sufficient amount of the revenues and income, and proceeds of the sale of all or any part of the trust estate which may be necessary to pay off and satisfy all of the expenses and taxes set out in paragraphs "(a), (b), (c), and (d)" next above, together with a reasonable surplus necessary or proper in the performance of the duties hereunder, shall be distributed to the beneficiaries hereunder each and every year hereafter, on or before December 31st, of each year.
It being declared, furthermore, to be the intention hereof that not only the income and revenues derived from said property shall be distributed, but likewise the proceeds of the sale of the property of the trust estate, and that each of the beneficiaries hereunder shall be liable for his or her own income taxes on all such distributions, and if the same shall be required to be paid by the fiduciary hereunder that the same shall be charged*1456 to the respective beneficiaries.
In addition to the properties conveyed to the trustee under the above instrument, Wilson and his wife owned the following properties from which they derived income: An 8-story office building at Eighth and Walnut Streets in Kansas City, Missouri, known as the Gumbel Building, which was clear of indebtedness and which brought in $18,000 to $20,000 annually; a small flour-milling property in Kansas City, Kansas; and their residence in Kansas City, Missouri.
During the taxable period June 1 to December 31, 1924, the trustee received income from the following sources, each and every item of *1000 which was reported as gross income by him on the fiduciary return of income on Form 1041 on or before March 15, 1925:
| Bonus | $51,939.92 |
| Rentals | 12,418.02 |
| Royalty | 528,669.84 |
| Sale of royalty | 26,101.70 |
| Income from dairy | 3,449.09 |
| Income from ranch | 403.84 |
| Interest received | 5,045.34 |
| Total | 628,027.75 |
The item of "bonus" income was derived from leases executed by petitioner during the taxable period, or was received under agreements entered into between Wilson and his lessees, whereby Wilson was to receive additional consideration*1457 if oil were discovered on their leases. The item of "rentals" income was derived primarily from sums paid by lessees to defer or delay the development of their leases, the usual rate being $1 per year per acre, although in a few cases it was $2. The item of "royalty" income represented the receipts from oil-producing leases in which the trustee or Wilson had reserved a one-eighth interest, and covered the period June 1, 1924, to December 31, 1924. Ordinarily the oil companies paid for the oil twice a month, payments being made on the 10th for oil run in the last 15 days of the preceding month, while payments on the 25th covered oil run in the first 15 days of each month. The oil royalty for the 10-day period June 1, 1924, to June 10, 1924, inclusive, amounting to $29,949.60, which was prior to the date of the trust deed but which was included therein, was estimated by taking ten-thirtieths of the total oil royalty received for the month of June, 1924.
The "sale of royalty" income was derived from a so-called "mineral deed" executed by Wilson to G. W. Peckham on or about March 8, 1924. By the terms of said deed Wilson, after acknowledging the receipt of one dollar and other*1458 valuable consideration from Peckham, "granted, sold, conveyed, assigned and delivered" to the latter "an undivided one [eighth] (1/8) interest in and to all of the oil, gas and other minerals in and under, and that may be produced from * * *" certain described lands in Archer County. The deed further recites that said lands were under lease and that "this sale is made subject to the terms of said lease and covers and includes all of the oil royalty and gas rental or royalty due and to be paid under the terms of said lease. As a further consideration hereof, the grantee [Peckham] agrees to pay the grantor [Wilson] the further sum of Fifty Thousand ($50,000.00) Dollars to be paid out of onehalf of the oil conveyed by this mineral deed." The deed also provided that "on March 1, 1939, the interest hereby conveyed shall revert *1001 and reinvest in the grantor, his heirs or assigns," and that Peckham should "receive the oil conveyed under this assignment, beginning March 1, 1924." During the taxable period the trustee received $26,101.70 of the $50,000 additional consideration which Peckham agreed to pay under the aforesaid mineral deed.
The other items of income reported*1459 by the trustee were income from dairy and ranch operations and the interest which was received on notes receivable and certificates of deposit.
During the taxable period the trustee paid every and all obligations known in name and amount that constituted a liability on the trust corpus and matured in 1924. Upon his fiduciary return he claimed as deductions expenses aggregating $74,092.26 (including taxes - state, county and city - $25,637.08) which had been sustained and paid in administering the trust. Of this amount respondent has disallowed the item of $25,637.08 for taxes.
In addition to the above items, the petitioner claimed a deduction of $2,145.09 representing depreciation. Of this amount respondent has disallowed $893.79 on the ground that the trust only owned the property during seven-twelfths of the year. Petitiover also claimed a deduction for depletion on oil royalties of $264,334.92, which is 50 per cent of the income reported from oil royalties on said return. The above claimed deductions totaled $342,072.27, and the trustee reported a net income for the trust for the taxable period of $285,955.48, claiming the distributive share of each of the 27 beneficiaries, *1460 $10,590.94.
The trustee's books of account commenced on June 1, 1924, and consisted of a cash book, a ledger, a production record, a lease record, a check register, and supplementary records thereto. The books were kept on the cash receipts and disbursements basis, and daily trial balances were taken off by the bookkeeper each business day that changes occurred in the ledger accounts. On December 31, 1924, two trial balances were taken off, one before closing the books, but after posting entries relating to business transacted on December 31, and one after the books were closed. In order to close his books on December 31, instead of the next business day, the trustee had, upon the advice of counsel, made special arrangements to obtain statements and canceled checks on that day from the banks in which trust funds were deposited. After posting the transactions of December 31, the trustee closed his books of account, which was accomplished by clearing his receipts and disbursements through an "undivided profits" ac(ount by means of journal vouchers, each of which was signed and approved by Luke W. McCrory, trustee. After closing his books on said date, the balance of the undivided*1461 profits account, that is, the balance after debiting said account with $77,737.35 *1002 representing the expenses, depreciation, etc., hereinbefore mentioned, was credited to the beneficiaries of the trust by journal voucher, No. 16, dated December 31, 1924, as follows:
| Debit | Credit | ||
| Account | Amount | Account | Amount |
| Undivided profits | $550,290.40 | Account of 27 beneficiaries | |
| - share and share alike | $550,290.40 |
The foregoing credit entry was posted to a newly opened ledger account as follows:
Name Beneficiaries - Twenty-seven, share and share alike.
| 1924 | Debits | Credits | Balance |
| 12-31, J.V. No. 16 | $550,290.40 | $550,290.40 |
This ledger account shows disbursements in 1925 as follows:
| 1925 | |||
| 3- 3 | First installment L. F. Wilson Inc. tax | ||
| 1924 to Col. I.R | $25,000.00 | ||
| 9 | L. F. Wilson gift tax to Col. Int. Rev | 122,243.68 | |
| J.V. #17 Lia | 24,295.00 | ||
| 5- 5 | Fred J. Dwyer Co., Col. State Income | ||
| Tax L. F. Wilson | 6,257.96 | ||
| 6-12 | Second installment L. F. Wilson Inc. | ||
| tax 1924 to Col. I.R | 25,000.00 | ||
| 7- 2 | Disbursements to 27 beneficiaries, | ||
| named in trust deed at $5,000 each | 135,000.00 | ||
| 9- 1 | Col. Internal Revenue, 3rd installment | ||
| L. F. W | 25,000.00 | ||
| 11-30 | Col. Int. Rev. last installment, | ||
| L. F. W | 24,535.38 | ||
| $387,332.02 | |||
| Balance, December 31, 1925 | $162,958.38 |
*1462 On or about January 9, 1925, the trustee mailed each of the beneficiaries a circular letter giving a detailed account of his administration of the trust. Attached to said communication was a financial statement showing the trustee's receipts and disbursements, together with a computation of the profit of each of the 27 beneficiaries for the period June 1, 1924, to December 31, 1924. The statement was the same as was attached to petitioner's fiduciary return on Form 1041, already referred to. The last three paragraphs of the circular letter explain the statement attached thereto and the failure to actually distribute the $550,290.40 credit, as follows:
The statement for income tax purposes is to be used in connection with other income which you may have. The money paid you from the Special Trust *1003 amounting to $11,093.06 was all principal gift, except $176.42, and only $176.42 of this amount is to be included in your statement of income, with the $10,590.94 as shown. Any income tax due by you as shown by your return should be paid to the Collector of Internal Revenue, located in your state. It is suggested that you have your banker assist in making your return, *1463 or someone who makes it a business whom your banker will recommend.
Your return must be filed by March 15, 1925.
The earnings since June 1, 1924, shown on the statement, are being held by your Trustee to pay the gift tax and income tax of Aunt Nell Wilson and Uncle Luke Wilson, as provided in paragraphs C and D under "Burdens and Obligations of the Trust" of the Trust Deed. The income under the Trust Deed has been credited to the twenty-seven beneficiaries on our books in this office. Payment of the taxes will be made and this account will be charged, each one with 1/27th of the amount thus paid. There will be no distribution whatever from your Trustee of any funds until settlement of income and gift tax has been completed with the Federal Government. This settlement may require a year, more or less, and is one which your Trustee can not hasten as it is strictly a Federal Government transaction, and many delays may be anticipated. In the meanwhile, all revenue will be accumulating for the twenty-seven heirs.
In August or September, 1924, the trustee retained the services of James P. Waggener and his associates in Wichita Falls to assist him in preparing the gift-tax return*1464 and the income-tax returns, State and Federal, of the donors (the payment of the taxes due thereon being some of the "Burdens and Obligations of the Trust"), and the fiduciary return for the trustee. The preparation of Wilson's gift-tax return involved the valuation of various lands and properties, and at December 31 the data necessary for such valuation was so incomplete that it was impossible to even approximate the amount of the tax. The gift-tax return was prepared and filed on or about March 8, 1925, the return being accompanied by a check for $122,243.68, the amount of tax shown by said return. The ineome-tax return for the donors and the fiduciary return were prepared and filed on or before their due date, namely, March 15, 1925. Wilson's return showed a tax of approximately $100,000, and was accompanied by a check for $25,000 for the first quarterly installment of said tax, while the fiduciary return showed net income of the trust and the share of each beneficiary as hereinabove set forth, but claimed there was no tax due by the trust because it was a distributable trust. In addition to the Federal income taxes and gift taxes, the fiduciary paid Missouri State income taxes*1465 for the donors amounting to $6,257.96. At December 31, 1924, the amount of these taxes was unknown.
In a letter dated May 29, 1925, addressed to H. G. Collier, Division Chief, Internal Revenue Service, Wichita Falls, Texas, petitioner explained his handling of the funds of the trust estate which came into his hands in 1924, as follows:
*1004 This will acknowledge receipt of your letter of May 28th requesting certain information concerning the fiduciary return filed by me as Trustee for the Luke F. Wilson Estate for the seven months ending December 31, 1924.
Your particular questions are as follows:
1. For what reason was the income of the Trust Estate for the seven months ending December 31, 1924, withheld instead of being distributed to the beneficiaries?
2. Was the income shown to be distributable to the beneficiaries on the Fiduciary Return (Form 1041) filed by you as Trustee for the seven months ending December 31, 1924, subject to the demands of said beneficiaries as of December 31, 1924, in that they could obtain actual possession of these funds on that date?
I believe the answer to both of these questions can be readily found in the trust deed, a copy*1466 of which has been furnished your office. However, in order to comply with your request, I have to advise as follows:
1. The net income of the trust estate for the seven months ending December 31, 1924, was withheld by me as Trustee and not actually distributed to the beneficiaries for the reason that, in my opinion, the burdens and obligations of the trust necessitated the handling of the funds in this manner. Reference is made to page 9 of the trust deed and to paragraphs (a), (b), (c), (d) and (e), under the heading "Burdens and Obligations of the Trust." It will be noted that there are certain obligations to be met by the Trustee on behalf of the beneficiaries, such as the payment of Federal income and gift taxes of Luke F. Wilson and Nellie M. Wilson. In view of the fact that at December 31, 1924, these obligations were unknown as to amount, it was impossible to calculate the funds necessary to meet the said obligations of the trust. Therefore, acting in my own discretion, under the terms of the trust deed, I believe it my duty as Trustee, on behalf of the beneficiaries, to hold in readiness the funds that were in my possession in order that the liabilities and obligations*1467 could be met when they became definitely known. It is my opinion and belief that this is a fair interpretation of the requirements of the trust deed and that the handling of the funds in this manner in no way changed the nature of the trust, which is specifically a distributable trust in that it is required of me as Trustee to distribute the funds after said obligations of the trust are met.
In this connection, reference is made to Section 219(a), paragraph 3, of the 1924 Income Tax Law, "Estates and Trusts", which reads as follows: "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 amount of the legatee, heir or beneficiary.
*1468 I believe that the return filed by me as fiduciary on Form 1041, on behalf of the beneficiaries of the Wilson Trust Estate, comes squarely under the provision of law just quoted for the reason that it was in the discretion of myself as Trustee either (1) to distribute the earnings pro rata to the beneficiaries and call on said beneficiaries pro rata for the payment of the obligations of the trust, or (2) to hold the funds, crediting same pro rata to the beneficiaries, and on behalf of said beneficiaries pay the obligations of the trust from said funds.
*1005 As I have already informed you, my records will show that the earnings of the trust have been properly credited to the beneficiaries, share and share alike.
2. With reference to your second question as quoted above, I have to advise that the income shown to be distributable to the beneficiaries on fiduciary return, Form 1041, for the fractional year 1924, was not subject to the demands of said beneficiaries as of December 31, 1924, and they could not have obtained at that time actual possession of these funds. However, as already stated, the matter has been handled in accordance with the provisions of Section 219(a), *1469 Estates and Trusts, 1924 Income tax law, in that it was within my discretion either to distribute this income or to credit same pro rata to the individual beneficiaries.
If there are any other questions that you wish to ask concerning this matter I shall be glad to answer same to the best of my ability.
Respectfully,
LUKE W. MCCRORY, Trustee.
Three of the beneficiaries named in the trust and both of the donors have departed this life since the trust was created. Nellie M. Wilson died in September, 1927; Luke F. Wilson in May, 1928; Belle Wilson in November, 1927; Daisy Churchman in February, 1928; and William McCrory Neal in May, 1930. Daisy Churchman left surviving her two sons, both of age, while William McCrory left one child, a minor.
At the hearing it was stipulated that the petitioner is entitled to a deduction for discovery depletion in the amount of $1,743.07 on account of a discovery of oil made by one of petitioner's lessees on July 14, 1924, after the creation of the trust.
It was further stipulated that the oil properties acquired by the petitioner June 10, 1924, under the trust instrument, had been acquired by Luke F. Wilson at such a time that he*1470 (Luke F. Wilson) was entitled to no cost on its mineral content; that before the trust was created various discoveries of oil had been made upon the ranch so that as long as the property was held by Luke F. Wilson he had what it known as a discovery value for the basis of depletion; that if the Board holds as a matter of law that the petitioner as trustee is entitled to discovery depletion based upon the discovery value used by the donor, then the amount of such discovery depletion (including the amount of $1,743.07 mentioned above) would be one of two figures as follows:
If the oil runs from June 1 to June 10, 1924, should be taken into consideration, the amount would be $262,831.29; if it is not proper to take into consideration the oil runs from June 1 to June 10, 1924, the figure would be $247,856.49; leaving for determination by the Board the question as to whether the trustee is entitled to use the donor's discovery value as a basis for depletion under the provisions of the Revenue Act of 1924.
*1006 It was further stipulated that the land in Archer County, Texas, which was acquired by petitioner on June 10, 1924, had been owned and held by the donor, Luke F. Wilson, *1471 for more than two years immediately preceding June 10, 1924, and had been used by him for farming, ranching, and the production of oil under leases. There was evidence that a portion of the income of the trust was received from lessees of the petitioner by way of additional consideration other than the one-eight royalty interest specified in the leases. The various leases were introduced in evidence as part of Exhibit 11, under which it was testified that these various amounts had been received. This portion of the income amounts to $51,939.92. Included in the income of the trust was an item of $26,101.70 representing amounts collected by the petitioner after June 10, 1924, under and pursuant to a deed of a royalty interest executed by the donor prior to the creation of the trust. The petitioner contends that these two sums of $51,939.92 and $26,101.70 represented capital net gain under the provisions of the Revenue Act of 1924.
The respondent's methods of computing the deficiency involved in this proceeding was given in a statement attached to the deficiency notice as follows:
| Net income reported on Form 1041 | $285,955.48 | |
| Add: | ||
| 1. Taxes not allowable | $25,637.08 | |
| 2. Excessive depreciation | $893.79 | |
| 3. Depletion disallowed | $264,334.92 | |
| $290,865.79 | ||
| Adjusted net income | $576,821.27 |
*1472 EXPLANATION OF CHANGES
* * *
Relative to your contention that the income from this Trust Estate is taxable to the beneficiaries, you are advised that they have received careful consideration. It appears from your statements that the credit of the income to the beneficiaries was merely a book entry and did not permanently set aside this income nor was it available to the beneficiaries on or before December 31, 1924. In I.T. 1733, Cumulative Bulletin II-2, page 169, it states in part that "It seems * * * that in order to be taxable to the beneficiary the income must be in fact distributable to him, it must be his for the mere asking; that is, the income must be at least constructively received by him. It is not believed that the courts would look with favor upon an attempt to tax as income to the beneficiary any income of a trust of which he could not, by any act of his own, obtain possession."
This office has held that the crediting of income to a beneficiary of an estate, which is referred to in the statute, is more than the making of a mere bookkeeping entry, the recording of an existing fact. It is in itself an act which separates the income of the beneficiary from the*1473 income of the estate, and from the standpoint of the beneficiary affects a realization of income y him. *1007 There must be a transfer of income to the control of the beneficiary, if there is to be a crediting of income within the meaning of the statute.
In the instant case the trust instrument gave the trustee the right to retain amounts necessary to meet obligations referred to herein, and a reasonable surplus. As stated in your letter to the Deputy Collector, due to the fact that at December 31, 1924, these obligations were unknown as to amount, you were unable to calculate the funds necessary to meet the obligations of the trust. You did not see fit to distribute the income in question as of December 31, 1924, nor did you properly credit it to the beneficiaries within the meaning of the law. The income was clearly not subject to the demands of the beneficiaries and they could not have enforced a demand therefor.
Therefore, this office is of the opinion after thorough consideration of the facts involved, the evidence of record, and the arguments presented by your representative, that the income in question for the period ended December 31, 1924, should be taxed*1474 to the Trust Estate.
OPINION.
BLACK: The principal issue presented by this proceeding is whether the income of the trust is taxable to the fiduciary, who brings this proceeding, or whether it is taxable to the beneficiaries. The applicable statute is section 219 of the Revenue Act of 1924.
A correct decision of the issues in this proceeding depends upon a proper construction of the provisions of the trust deed itself. We do not think it is ambiguous. As we shall later point out, we think paragraph (e) of that part of the trust instrument labeled "Burdens and Obligations of the Trust" is decisive of the main issue before us.
Before entering upon a discussion of this particular provision of the trust deed, however, we desire to consider and pass upon a contention made by petitioner in his brief, though not specifically set out in his petition. This contention is that the conveyance in the trust deed by the grantors, Luke F. Wilson and wife, to petitioner as trustee for the benefit of the designated beneficiaries, with power to lease, sell, invest, reinvest, and to ultimately distribute the trust corpus and income, was a mere irrevocable power of attorney such as we held*1475 we had before us in Trudie T. Munger,16 B.T.A. 168">16 B.T.A. 168, and that no separate taxable entity was created by the trust deed. Of course, if this contention is correct, then clearly the effort of the Commissioner to tax the fiduciary as a separate legal entity was wrong.
But we do not think it is correct. The trust deed contains on page 10 a provision which, we think, serves to distinguish it from the mere agency forms of trusts. The language referred to is as follows:
Said trustee shall at all times during the term hereof be entirely free from interference or molestation by each and all of the beneficiaries hereunder, and no beneficiary hereunder shall instigate or prosecute any suit in any of the *1008 courts of the county against the trustee or his successor, except for acts constituting fraud, embezzlement or willful breach of trust and no receiver of the trust estate shall in that event be appointed by any of the courts of the country, but should said trustee be found guilty of any such acts constituting fraud, embezzlement or willful breach of trust in any such suit, he shall be removed from said trust by any court having jurisdiction and the successor*1476 next provided for in the paragraph hereafter referring to successor or substitute trustee, shall thereupon succeed to such trust, but in the event the plaintiff should not prevail in said suit, then such beneficiary or beneficiaries so filing said suit, shall be charged with all of the attorney's fees and expenses of the trustee in defending said suit, plus the sum of five thousand ($5,000) dollars, all of which shall be chargeable to such beneficiary or beneficiaries and deducted from the distributions next thereafter made, and the aforesaid $5,000 shall be distributed among the remaining beneficiaries hereunder, share and share alike.
Such a provision as we have quoted above and other provisions in the trust instrument are clearly inconsistent with a mere agency trust such as we held we had before us in Trudie T. Munger, supra, cf. N. H. Boynton,11 B.T.A. 1352">11 B.T.A. 1352; Cleveland Trust Co., Executor,24 B.T.A. 132">24 B.T.A. 132; Stoddard v. Eaton, 22 Fed.(2d) 184. Petitioner's contention on this point is denied.
Petitioner's main contention is that the trust deed created a mandatory distributable trust; that all income for each*1477 and every year after the creation of the trust, including the year 1924, the year of the execution of the trust deed, was distributable by its very terms and that therefore the income was taxable to the beneficiaries and not to the fiduciary. Petitioner contends that, if he is wrong in the above contention, then the trust was a discretionary trust where the trustee might either accumulate income or pay or credit it to the beneficiaries within the taxable year and that the facts show that in the instant case the trustee credited to the beneficiaries, on December 31, 1924, all of the income of the trust for the taxable period and that therefore the income is, by reason of section 219(b)(3), taxable to the beneficiaries and not to the trustee. We will now consider these respective contentions.
If the income was to be distributed currently by the fiduciary to the beneficiaries, then, under (b)(2) of section 219 of the Revenue Act of 1924, the fiduciary would be entitled to take as an additional deduction all of the income so to be distributed and there would be nothing left in the hands of the fiduciary to tax. And this would be true whether the income was actually distributed or*1478 not. William E. Scripps,1 B.T.A. 491">1 B.T.A. 491; Estate of Henry Mayer,16 B.T.A. 1164">16 B.T.A. 1164; Florence M. Smith, Executrix,5 B.T.A. 225">5 B.T.A. 225; Willcuts v. Ordway, 19 Fed.(2d) 917. On the other hand, if the income for the taxable period now before us was not to be distributed currently to the beneficiaries, there is no additional deduction udner (b)(2) of section *1009 219 and the tax must be paid by the fiduciary. John D. Rogers,16 B.T.A. 368">16 B.T.A. 368; Anna M. Chambers,17 B.T.A. 820">17 B.T.A. 820.
In determining just what the situation is which we have before us, it is necessary to examine those provisions of the trust deed which are found under the heading "Burdens and Obligations of the Trust." These have been set out in full in our findings of fact. An examination of them will show that there were certain obligations enumerated in paragraphs (a)(b)(c) and (d) thereof which the trustee was to assume and pay. How he was to pay them and what he was to do with the remainder of the trust corpus and income was set out in paragraph (e) thereof.
It seems clear to us that the provisions of paragraph (e), above*1479 referred to, made it mandatory upon the trustee to accumulated and set aside a fund sufficient to pay all the expenses and taxes enumerated in paragraphs (a)(b)(c) and (d). It is true that by the provisions of paragraph (e) the trustee was given the discretion to accumulate the fund from which these expenses were to be paid out of either income or proceeds of the sale of the trust corpus, or both. But his duty to accumulate the fund was not discretionary, but mandatory. If the trustee, in the exercise of his discretion, had sold enough of the trust corpus to pay these expenses and had paid or credited all the income to the beneficiaries, we think no one could have complained and the income so paid or credited would have been taxable to the beneficiaries and not to the trust.
After the payment of the burdens and obligations enumerated in paragraphs (a)(b)(c) and (d) thereof, the trust ivstrument undoubtedly required the trustee to make annual distribution of income. And this duty was not merely discretionary, it was mandatory. That fact is shown by the last clause of paragraph (e), which reads:
It being declared furthermore, to be the intention hereof that not only the income*1480 and revenues derived from said property shall be distributed, but likewise the proceeds of the sale of the property of the trust estate, and that each of the beneficiaries hereunder shall be liable for his or her own income taxes on all such distributions, and if the same shall be required to be paid by the fiduciary hereunder that the same shall be charged to the respective beneficiaries.
But the trustee, in the exercise of his discretion, did not sell enough of the corpus of the estate to pay these burdens and obligations of the trust enumerated in paragraphs (a)(b)(c) and (d), as he might have done. Manifestly he decided to pay them out of the income of the estate received in his hands between the period of June 10, 1924, and December 31, 1924.
True, he went through the form of crediting the 27 named beneficiaries of the estate on December 31, 1924, with all the net income *1010 of the estate after certain deductions had been taken. It is the contention of the petitioner (fiduciary that this crediting was a credit within the meaning of (b)(3), section 219 of the Revenue Act of 1924, and hence represents an additional deduction to which petitioner is entitled within*1481 the meaning of said statute. We think this contention is correct in part and wrong in part.
It is wrong as to the part of the funds required to pay the burdens and obligations of the trust. Evidently there was no intention on the part of the trustee to ever distribute this part of the funds to the beneficiaries. As we said in John D. Rogers, Trustee, supra, concerning certain sums which the trustee had retained to operate the plantation during the following year, "It is in no sense income of the beneficiaries. They are not entitled to it, and it is not distributable to them as such, nor was it actually so distributed."
Of the $550,290.40 credited to the beneficiaries on December 31, 1924, $252,332.02 was actually used by the trustee in 1925 to pay burdens and obligations described in paragraphs (a)(b)(c) and (d) of the trust deed, such as the income tax of Luke F. Wilson, the gift tax due by Luke F. Wilson and wife, grantors in the trust deed, the income tax of Luke F. Wilson to the State of Missouri, etc. These amounts, as we have already endeavored to point out, were in no sense distributable to the beneficiaries, but were part of the burdens and obligations*1482 of the trust.
Petitioner is not entitled to take any part of this $252,332.02 as a deduction under (b)(3) of section 219 or any other section of the statute. He is entitled to take the remainder of the $550,290.40 credited to the beneficiaries on December 31, 1924, as an additional deduction under paragraph (b) of section 219 of the Revenue Act of 1924.
As was said in Willcuts v. Ordway, supra (speaking of a similar statute), "Distributions as there used, does not necessarily mean passing into the uncontrolled possession and disposition of the beneficiary. It means separation and segregation from the trust estate, so that it no longer forms any part or parcel thereof. The test set up by the statute is whether the income passes from the trust estate which produced it and ceases to be subject to the terms and control of that trust. If this trust instrument authorizes such income to be so separated and segregated and they were so treated in fact, the Commissioner was in error and the trial court properly overruled the demurrer to this petition and entered judgment for the refund." The remainder of the $550,290.40, after the deduction of the $252,332.02 used*1483 in paying the burdens and obligations described in paragraphs (a)(b)(c) and (d) of the trust deed, was not actually distributed to the beneficiaries until 1925 and 1926. One hundred and thirty-five thousand dollars thereof was distributed *1011 in 1925 and the balance in 1926. But even so, we think it was separated and segregated from the trust estate when credited to the beneficiaries on December 31, 1924, sufficiently that petitioner is entitled to take such sum as an additional deduction under the provision of the statute already referred to, and respondent should so treat it in recomputing the deficiency.
We sustain respondent in his disallowance of $25,637.08 taxes, state, county and municipal, paid by the trustee. These were not taxes which accrued against the property while in the hands of the trustee, but were taxes which had accrued prior to the conveyance to the trustee and were not proper deductions from income by the taxpayer. Grand Hotel Co.,21 B.T.A. 890">21 B.T.A. 890; John Hancock Mutual Life Insurance Co.,10 B.T.A. 736">10 B.T.A. 736.
Respondent's disallowance of $893.79 as excessive depreciation is also sustained. If fact we do not understand*1484 petitioner to contest the two last named adjustments in the event the trust income is held to be taxable.
Petitioner's contention that he is entitled to deduct depletion a discovery basis is denied except as to the one discovery made by the taxpayer after the creation of the trust. That amount has been stipulated to be $1,743.07. Magdaline McKinney,16 B.T.A. 804">16 B.T.A. 804; Darby-Lynde Co.,20 B.T.A. 522">20 B.T.A. 522; affd., 51 Fed.(2d) 32.
Petitioner's contention that he should be allowed the benefits of the capital gain provisions of the Revenue Act of 1924 is denied on the authority of William Kempton Johnson,17 B.T.A. 611">17 B.T.A. 611; affirmed in 52 Fed.(2d) 727; Sydney Shoenberg et al.,19 B.T.A. 399">19 B.T.A. 399; affirmed by the Court of Appeals, D.C., Dec. 28, 1931 (par. 9002 C.C.H.).
Petitioner had not held the land upon which the leases were sold during the taxable year for a period of more than two years. He could not add to the period of his own holding the period of holding of the grantors.
Reviewed by the Board.
Decision will be entered under Rule 50.
MURDOCK, dissenting: I dissent*1485 from the prevailing opinion in so far as it holds that the income for 1924 not needed to pay and discharge burdens and obligations of the trust mentioned in paragraphs (a), (b), (c), and (d) of the subdivision headed "Burdens and Obligations of the Trust" was, under the provisions of the trust deed, income which was to be distributed currently by the fiduciary to the beneficiaries and, therefore, deductible under section 219(b)(2) in determining the income taxable to the fiduciary. Any amount deductible in computing the net income of the trust must be included *1012 in computing the net income of the beneficiaries whether distributed to them or not. The phrase "to be distributed currently" appeared for the first time in the Revenue Act of 1924. The reports of the various committees do not mention the new words, but say only that section 219 has been rewritten for the sake of clarity and to prevent evasion of tax on the income of estates and trusts. The 1921 Act spoke of income of the taxable year "to be distributed to the beneficiaries periodically, whether or not at regular intervals." It was taxable to the estate or trust except where, under the instrument, it was distributable*1486 during the taxable year. I do not believe the 1924 Act made any change in the taxability of such income as is here involved. The intention in both acts was to prevent those interested from arbitrarily or otherwise shifting or reducing tax burdens through their control over the time and amount of actual payments. "Currently" must relate to the current year or some part thereof, and not to the indefinite future when for the first time the amount of the 1924 income to be distributed can be determined. Cf. Elizabeth S. Sprague,8 B.T.A. 173">8 B.T.A. 173. The present decision is contrary to the general scheme of the income-tax acts requiring income to be reported by annual periods on the basis of events fixed on or before the end of the year. In the case of John D. Rogers, Trustee, cited in the prevailing opinion, the trustee had the right, in his discretion, to set aside a fund sufficient to meet some anticipated obligations of the succeeding year. We held that the amount so set aside was taxable to the trust rather than to the beneficiaries, without considering whether the amount retained was more or less than the amount actually used in the succeeding year to meet the anticipated*1487 needs. The case, therefore, proves too much for the prevailing opinion and supports the view which I take. In Elizabeth S. Sprague, supra, we said: "Unquestionably the duty to determine whether the retention of surplus income was necessary or unnecessary for that purpose rested upon the trustees, and until that duty was performed there was no distributable income."
It is apparent that this trustee, acting with the advice of counsel, did everything in his power, before the end of the year 1924, to minimize the income-tax liability of the trust and of the beneficiaries under the trust for that year. Yet, he was unable to determine or even approximate within the year the amount of Federal gift tax due or the amount of taxes due to the State of Missouri. Furthermore, it does not appear that he was able to determine or approximate the amount of Wilson's income-tax liability. No one suggests that he acted beyond his powers in retaining the full amount of the income for the year 1924 under the terms of the trust instrument. In his letter of May 29, 1925, he admitted that the burdens and *1013 obligations of the trust necessitated retention of the funds by him*1488 because it was impossible within the year to calculate the funds necessary to meet the obligations of the trust. He further stated that under the terms of the trust he believed it was within his discretion, and, indeed, his duty, to hold the funds in his possession in order that the liabilities and obligations could be met when they became definitely known. I agree that his interpretation, acquiesced in by the beneficiaries, was a fair one of the requirements of the trust. He further stated that the income of the trust for the fraction of the year 1924 was not subject to the demand of the beneficiaries as of December 31, 1924, and they could not have obtained at that time actual possession of these funds. This situation, it seems to me, was within the fair intendment of the trust instrument so far as the income for that particular year is concerned. Other years might be quite different, because some large obligations were nonrecurring. I, therefore, agree with the Commissioner that the credit of the entire income to the beneficiaries did not permanently set aside any of this income for or make it available to the beneficiaries on or before December 31, 1924. To say that this*1489 particular income was "to be distributed currently" to them so as to render them liable for income tax upon it is a misuse of the quoted words. There was not within the year a separation or segregation of the income of the beneficiaries from the income of the trust so that the former no longer formed any part or portion of the trust property and ceased to be subject to the terms and control of that trust. Although under the terms of the trust instrument some income might have been so separated and segregated, none was in fact so treated. Therefore, under the decision in Willcuts v. Ordway, cited in the prevailing opinion, all of the income was taxable to the trust and none of it was taxable to the beneficiaries. Furthermore, the amount is not deductible under section 219(b)(3), for the fiduciary exercised whatever discretion he had by retaining control over all of the income, and his so-called crediting was not a proper or true crediting, but a meaningless entry on the books which he never intended should be binding upon him nor effect a segregation of the funds from those of the trust.