*1034 Where the income of a trust was used in partial liquidation of a legal obligation of the grantors of the trust, held that such income is taxable to the grantors. Helvering v. Blumenthal,296 U.S. 552">296 U.S. 552, and Douglas v. Willcuts,296 U.S. 1">296 U.S. 1, followed.
*436 These consolidated proceedings involve deficiencies in income tax for the calendar year 1935 as follows:
Petitioner | Docket No. | Deficiency |
James L. Knight | 91357 | $1,457.88 |
Clara I. Knight | 91358 | 3,132.99 |
John S. Knight | 91359 | 4,701.27 |
*437 A single and similar issue is involved in each of these proceedings. The petitioners each assign error in the respondent's action in increasing the reported income of each petitioner by one-third of the income realized during 1935 from certain stocks held by a trustee under a trust created by the petitioners.
In Docket No. 91358, the petitioner, Clara I. Knight, admits a deficiency of $11.33 arising from the respondent's inclusion in her income of an item of interest in the sum of $53.31, *1035 which is not in dispute.
These proceedings have been submitted upon a stipulation of facts which, together with the exhibit attached thereto, is included herein by reference as a part of our findings of fact. There will be set forth herein only those facts deemed essential to consideration of the issue presented.
FINDINGS OF FACT.
The petitioners, all of whom are adult citizens of the United States and residents of Akron, Ohio, are the only heirs at law, in equal shares, of the estate of Charles L. Knight who died intestate on September 26, 1933, while a resident of the same city.
At the time of his death the decedent owned 3,306 shares of the capital stock of the Beacon Journal Co. (hereinafter referred to as Beacon), an Ohio corporation engaged in the publication of a news-paper in Akron. The remainder of the total of 4,985 outstanding shares of Beacon stock was owned almost entirely by members of the decedent's family. For Federal estate tax purposes the decedent's gross estate was valued at $1,169,305.19, including the amount of $876,090 as the value of the 3,306 shares of Beacon stock, at $265 each, and the amount of $293,215.19 as the value of other assets. The*1036 decedent's estate had liabilities totaling $424,513.57, not including the Federal estate taxes determined to be $76,746.15. The principal liabilities consisted of the amount of $108,974.97 due the Beacon Journal Co. on open account for moneys advanced by that company to the decedent, or for his benefit, during his lifetime and of notes totaling $119,366.68 held by the First Central Trust Co. of Akron after the application, as a credit on such notes, of the decedent's checking balance of $106,637.52. That trust company was in process of liquidation and was holding 1,100 shares of the Beacon stock owned by decedent as collateral for the payment of his notes.
On October 10, 1933, the Summit County Probate Court appointed John H. Barry, of Akron, administrator of the estate of the decedent. He subsequently qualified and acted in that capacity until he was discharged on July 11, 1934, upon approval of his final account filed in the Probate Court on June 19, 1934.
To avoid a sale of the 3,306 shares of Beacon stock and in order to close the decedent's estate as quickly as possible, the heirs (petitioners *438 herein) entered into negotiations with Beacon and, as a result*1037 thereof, secured from that company on June 30, 1934, a loan of $119,366.68, with which the debt due the First Central Trust Co. was liquidated. That sum was charged on Beacon's books to an account designated as "C. L. Knight Account, Notes Payable (assumed by heirs of Estate), Clara I., James L., and J. S. Knight", and such account then showed the following debits:
1934 | |
May 10 (C.L.K. notes) | $108,974.97 |
June 30 (First Central notes) | 119,366.68 |
228,341.65 |
As security for the total indebtedness of $228,341.65 to Beacon and for Beacon's advances for taxes already determined and possible future taxes to be assessed, the heirs agreed to pledge to that company the 3,306 shares of Beacon stock as collateral. In addition thereto, the heirs jointly and severally agreed to assume liability for the entire amount and gave their individual notes as follows: Clara I. Knight, $76,113.89; James L. Knight, $76,113.88; and John S. Knight, $76,113.88, representing the above total amount of $228,341.65.
On July 31, 1934, a petition was filed in the Probate Court, seeking distribution in kind of the assets of the decedent's estate. The petition was granted and on or about*1038 August 20, 1934, the certificates representing the 3,306 shares originally issued to the decedent were surrendered to Beacon and on August 21, 1934, new certificates were issued to each, Clara I., James L., and John S. Knight, for 1,102 shares of Beacon stock, respectively. Those individuals deposited all of the new certificates with Beacon as collateral security, prusuant to their agreement with that company.
The above mentioned account designated on Beacon's books as "C. L. Knight Account, Notes Payable (assumed by heirs of Estate), Clara I., James L., and J. S. Knight" was closed out on or about February 8, 1935, by credit entries showing transfer of the debit balance of $228,341.65 to three new accounts opened on the same date on Beacon's books under the names of "Clara I. Knight Note", "James L. Knight Note", and "John S. Knight Note", respectively. On those new accounts the sum of $76,113.88 was charged to the Clara I. Knight Note account and the sum of $76,113.88 was charged to each of the other such accounts.
On December 15 and December 18, 1934, Beacon advanced additional sums of $7,816.52 and $210.72, respectively, which were used for the payment in part of inheritance*1039 taxes, additional income taxes, and interest. Such advances were charged to a new account, opened at that time on Beacon's books as the "C. L. Knight Estate Account (Inheritance Taxes)." That account was also charged with a further *439 advance, by Beacon, of $30,673.79 on May 21, 1935, for additional Federal estate taxes as agreed to by the administrator, John H. Barry. On July 16, 1935, a payment of $7,164.39 made to Beacon by the heirs was credited to that account, leaving a debit balance of $31,536.64.
On February 12, 1935, Clara I., James L., and John S. Knight jointly and severally entered into a trust agreement which, inter alia, set forth that they as his sole and only heirs at law were "each entitled to an undivided one-third interest in and to all the estate, both real and personal, of Charles L. Knight, deceased", including the decedent's 3,306 shares of Beacon stock, which stock they mutually desired to be held in trust for a period of 10 years; that certificates had been theretofore issued and were then outstanding in the individual name of each of them for 1,102 shares of such Beacon stock; and that:
2. * * * said heirs have mutually agreed to, and*1040 by these presents do, sell, assign and transfer all their right, title and interest in and to said certificate or certificates of stock to the Trustee hereinafter named for the following uses and purposes:
(a) To vote said stock at all meetings of the stockholders of The Beacon Journal Company in such manner and by such method as the said Trustee in his sole discretion shall deem advisable, just and proper;
(b) To collect and receive the dividends due and payable on said stock;
(c) To pay any and all taxes levied and assessed on account of said dividends, and also the expenses incurred in the administration of said trust, if any; and
(d) As it may be mutually and unanimously agreed by and between said heirs, to pay and/or apply any part or all of the balance remaining on the indebtedness of said heirs to The Beacon Journal Company until said indebtedness is fully paid and discharged, and thereafter, during the continuance of this agreement, said balance remaining to be paid in equal one-third parts, share and share alike, to said heirs or their legal representatives.
The trust agreement irrevocably appointed John S. Knight as the heirs' trustee and proxy, except that a successor*1041 trustee could be appointed by mutual and unanimous agreement of the heirs or their legal representatives in the event that John S. Knight should become unable to discharge his duties as trustee.
The trust agreement also provided that if during the life of the agreement any party thereto desired to sell his shares of such stock he would first offer to sell to one or more of the other parties thereto and that if the offer was not accepted a sale might be made to a person not a party to the agreement, but such sale would be subject to all the terms and provisions of the trust agreement, which also provided that its terms and provisions were binding upon the administrators, executors, heirs, and assigns of the parties thereto.
On or about July 15, 1935, the stock certificates representing a total of 3,306 shares of Beacon stock, previously issued to and owned by *440 Clara I., James L., and John S. Knight, each in the amount of 1,102 shares, were canceled and a new certificate for 3,306 shares was issued to John S. Knight, trustee. The latter then held the same as collateral security in place of the surrendered certificates theretofore deposited with Beacon as collateral*1042 for the payment of the indebtedness to it.
On October 31, 1935, the account in the name of "C. L. Knight Estate Account (Inheritance Taxes)", hereinbefore mentioned, was closed by transferring the debit balance of $31,536.64 to a new account then opened on Beacon's books in the name of "John S. Knight, Trustee." To that latter account was charged an additional amount of $41,575.77, advanced by Beacon on December 10, 1935, for the final payment of additional inheritance taxes and interest thereon, leaving a debit balance of $73,112.41 in the account on December 31, 1935.
During the year 1935 and on or about February 8, April 15, July 16, and October 17, certain dividends were received by the petitioners as individuals or by the trustee upon the above mentioned 3,306 shares of Beacon stock. From these dividends total payments of $8,797.05 were made by the trustee to Beacon and on the latter's books such payments were credited as follows:
Account | Amount credited | Debit balance on Dec. 31, 1935 |
Clara I. Knight account | $3,067.07 | $73,047.02 |
John S. Knight account | 2,943.13 | 73,070.75 |
James L. Knight account | 2,786.25 | 73,327.63 |
During 1936 the above mentioned*1043 "John S. Knight, Trustee" account, representing certain advances for the payment of taxes, was paid in full with the dividends received on the shares of Beacon stock held by the trustee.
In his return for the calendar year 1935, John S. Knight, trustee, reported dividends in the amount of $41,325 received upon the stock in question, a net income in the amount of $38,100.52, and paid a tax thereon in the sum of $4,451.11, for which taxes a refund is proposed for allowance. None of the dividends so reported by the trustees were reported by the three petitioners in their respective individual income tax returns for the year 1935. In determining the deficiencies in controversy the respondent increased each petitioner's income by one-third of the net income so reported by the trustee.
OPINION.
TYSON: Petitioners contend that, while in form the 3,306 shares of Beacon stock owned by the decedent at the date of his death were transferred first to the heirs through distribution of decedent's estate, and thereafter by the heirs to the trustee, in substance the creation of the trust on February 12, 1935, was a valid substitute *441 for a long term administration of the decedent's*1044 estate and the trustee became a de facto administrator of the estate; that consequently the decedent's estate had not been settled and the income in question is taxable to the trustee under section 161 of the Revenue Act of 1934; 1 that the trust agreement gave the petitioners no present right in or to the corpus of the trust or the income derived therefrom until the entire indebtedness to Beacon had been fully liquidated; that sections 166 and 167 of the Revenue Act of 1934 2 are not applicable because the trust was irrevocable and the grantors derived no direct benefit from the income therefrom; and that there is no section of the 1934 Act which places upon the petitioners any tax liability for the income here in question.
*1045 The numerous cases cited in the petitioners' brief and the excerpts quoted therefrom do not sustain the petitioners' contentions. The respondent filed no brief and has cited no authorities.
*442 The facts in the case at bar clearly establish that to avoid a sale of the 3,306 shares of Beacon stock and to close the decedent's estate as quickly as possible, the heirs, in about June 1934, personally assumed the entire indebtedness as set out in the findings of fact to Beacon; that the administrator of the decedent's estate was discharged on July 11, 1934, after approval of his final accounting; that the assets of decedent's estate were distributed in kind; and that through such distribution and on August 21, 1934, new certificates were issued to each of the petitioners for one-third of the decedent's 3,306 shares of Beacon stock. In substance as well as in form, each petitioner thereupon became the individual owner of such shares, which were then pledged by him as collateral security for his personal legal liability to Beacon. If such individual ownership had continued throughout the taxable year 1935 without the creation of the trust here involved, there would be no grounds*1046 for a contention that the dividends on such stock did not constitute income realized by petitioners.
In our opinion, the petitioners' declaration of trust of February 12, 1935, made no substantive change in their right to the benefit of the income derived from the 3,306 shares of Beacon stock transferred by them, as the grantors of the trust, to the trustee to whom a new certificate for an identical number of like shares was issued on July 15, 1935. The trustee was directed in the declaration of trust to collect the dividends payable on such stock, to pay taxes and expenses, if any, and then "as it may be mutually and unanimously agreed by and between said heirs, (the grantors in the trust and the petitioners herein) to pay and/or apply any part or all of the balance remaining on the indebtedness of said heirs to The Beacon Journal Company until said indebtedness is fully paid and discharged", and thereafter, during the continuance of the trust, to pay the remaining balance in equal shares of one-third each to the petitioners or their legal representatives. (Italics supplied.) In *1047 Helvering v. Blumenthal,296 U.S. 552">296 U.S. 552, the Supreme Court, in reversing per curiam,76 Fed.(2d) 507, held that the grantor of a trust was taxable upon the trust income used under the terms of the trust indenture to liquidate the grantor's indebtedness to a bank. That case was decided upon authority of Douglas v. Willcuts,296 U.S. 1">296 U.S. 1, and Helvering v. Schweitzer,296 U.S. 551">296 U.S. 551. In the Willcuts case the grantor of a trust was held taxable upon the trust income used to pay alimony to the grantor's divorced wife because such payment was in discharge of a legal obligation of the grantor and the trust income stood substantially on the same footing as though the grantor had received it personally and had been required by a decree to make the payment directly to his divorced wife.
*443 In its opinion the Court said:
We do not regard the provisions of the statutes as to the taxation of trusts, fiduciaries and beneficiaries (Revenue Act 1926, §§ 2, 219, 26 USCA §§ 1696 and note, 161-167 note; Revenue Act 1928, §§ 161, 162, 26 USCA §§ 161, 162) as intended*1048 to apply to cases where the income of the trust would otherwise remain, by virtue of the nature and purpose of the trust, attributable to the creator of the trust and accordingly taxable to him. These provisions have appropriate reference to cases where the income of the trust is no longer to be regarded as that of the settlor, and we find no warrant for a construction which would preclude the laying of the tax against the one who through the discharge of his obligation enjoys the benefit of the income as though he had personally received it.
The decision in Helvering v. Butterworth,290 U.S. 365">290 U.S. 365, 54 S. Ct. 221">54 S.Ct. 221, 222, 78 L. Ed. 365">78 L.Ed. 365, is not opposed. There the trust was testamentary and the only question was with respect to the liability for the tax as between the trustee and the beneficiary. The Court observed that "the evident general purpose of the statute was to tax in some way the whole income of all trust estates." The decision has no application to a case where the income is still taxable to the grantor. Nor are the provisions of the statutes (Revenue Act 1926, § 219(h), 26 USCA § 167 note; Revenue Act 1928, § 167, 26 USCA § 167*1049 note) defining instances in which the grantor remains taxable, as in case of certain reservations for his benefit or provisions for the payment of premiums upon policies of insurance on his life, to be regarded as excluding instances not specified, where in contemplation of law the income remains in substance that of the grantor. No such exclusion is expressed and we see no ground for implying it.
The sections of the prior acts referred to in the above quotation correspond to sections 161, 166, and 167 of the Revenue Act of 1934, supra. Upon authority of the above cited cases, we hold that the trust income here in question used in discharging the legal obligations to Beacon of each of the petitioners, the grantors of such trust, is taxable to each of the petitioners to the same extent and as though they each had personally received such income during the taxable year. See also, Helvering v. Schweitzer, supra, reversing 75 Fed.(2d) 702; Helvering v. Stokes,296 U.S. 551">296 U.S. 551, reversing *1050 79 Fed.(2d) 256; and Helvering v. Coxey,297 U.S. 694">297 U.S. 694, reversing 79 Fed.(2d) 661, involving the use of trust incomes to satisfy legal obligations of the grantors of the trusts.
The instant proceedings have been presented upon the respondent's theory that all of the net income of the trust in the amount of $38,100.52 should be included in the respective individual incomes of the petitioners in the proportion of one-third to each, and upon petitioners' theory that no part thereof should be so included. Consequently, upon the stipulation of facts and for the purposes of this opinion we must assume that all of the dividend income received by the trustee during 1935 (which is not clearly established in contradistinction to such dividends as may have been received by petitioners during that year as individuals) was used in partially liquidating the petitioners' legal obligation to the Beacon Journal Co.
*444 However, if, to the contrary, only a portion of the dividend income received by the trustee was used in partial liquidation of the petitioners' obligation to Beacon, "as mutually and unanimously agreed to by and between said*1051 heirs", and the remaining balance of such income was distributed to the grantors or accumulated for future distribution to them, then, clearly, such income would be taxable to the petitioners within the express language of section 167 (a)(1) and (2), supra, since all such distributions or accumulations would have been made within the discretion of the grantors.
The determination of the respondent is apporved.
Decision will be entered for the respondent.
Footnotes
1. SEC. 161. IMPOSITION OF TAX.
(a) APPLICATION OF TAX. - The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including -
(1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;
(3) Income received by estates of deceased persons during the period of administration or settlement of the estate; and
(4) Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated.
(b) COMPUTATIONS AND PAYMENT. - The tax shall be computed upon the net income of the estate or trust, and shall be paid by the fiduciary, except as provided in section 166 (relating to revocable trusts) and section 167↩ (relating to income for benefit of the grantor). For teturn made by beneficiary, see section 142.
2. SEC. 166. REVOCABLE TRUSTS.
Where at any time 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 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 -
(1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
(2) may, 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, be distributed to the grantor; or
(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(o), 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.
(b) As used in this section, the term "in the discretion of the grantor" means "in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question". ↩