Day v. Commissioner

JULIUS G. DAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Day v. Commissioner

Docket No. 96835.

United States Board of Tax Appeals

42 B.T.A. 109; 1940 BTA LEXIS 1046;

June 18, 1940, Promulgated

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">*1046 Petitioner created a trust for his son, the corpus consisting of a note secured by a mortgage under seal. Alleged interest payments made on the note by petitioner during the taxable year, held, not deductible, since the note was given without consideration and hence constituted an unenforceable obligation. Johnson v. Commissioner, 86 Fed.(2d) 710, followed; William Park,38 B.T.A. 1118">38 B.T.A. 1118, distinguished.

George E. H. Goodner, Esq., for the petitioner.

Davis Haskin, Esq., for the respondent.

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LEECH

">*109 This is a proceeding to redetermine a deficiency in income tax of $527.71 for the calendar year 1935. Such part of the deficiency as is in controversy arises out of respondent's determination that certain payments made by petitioner in the taxable year on a note did not constitute deductible interest.

FINDINGS OF FACT.

Petitioner is an individual, residing in New Haven, Connecticut. He kept his books and made his tax returns on the cash basis.

In 1925 petitioner desired to give $30,000 to his son, Julius G. Day, Jr., who was then a minor. He had already given a similar amount to each of his">*1047 two daughters, and he desired to treat all his children alike before his approaching remarriage.

On April 25, 1925, petitioner executed the following trust agreement with his son-in-law, Nathan Tufts, as trustee:

DEED OF TRUST.

WHEREAS Julius G. Day, of New Haven, Connecticut, has this day executed and delivered to Nathan Tufts, of Greenfield, Massachusetts, his promissory note for Thirty Thousand ($30,000) Dollars, payable on demand, with interest at the rate of six (6%) per cent per annum, payable semi-annually, Jany & July secured by a 1st mortgage upon the property No. 271 Whitney Avenue, New Haven, Connecticut, IN TRUST, however, for Julius G. Day, Jr., subject to the provisions hereof;

NOW, THEREFORE, IT IS AGREED between the parties:

1. That said Tufts shall hold said note and mortgage and such other notes, secured by said mortgage (or new mortgages substituted therefor as new notes shall be given to him), and when the interest on said note and notes is received by him, shall invest the same, less such charges, if any, as he as Trustee may be liable to pay, and hold the investments until said Julius G. Day, Jr. shall arrive at the age of twenty-one (21).

2. That">*1048 when said Julius G. Day, Jr. shall arrive at the age of twenty-one (21), said Tufts, as Trustee, shall assign said notes, mortgages and accumulations to him.

">*110 3. That in case of the death of said Julius G. Day, Jr. before he shall have arrived at the age of twenty-one (21), said Tufts, as Trustee, shall assign said notes and mortgage to his executor or administrator.

4. That in case of the death, resignation or inability to act of said Tufts, said Julius G. Day may, by an instrument in writing, appoint a new Trustee, with all of the powers herein given to said Tufts.

IN WITNESS WHEREOF, the parties have hereunto set their hands and seals at New Haven, Connecticut, this 25th day of April, A.D. 1925.

[Signed] JULIUS G. DAY (L.S.)

NATHAN TUFTS (L. S.)

In the presence of

[Signed] HELEN G. DEANE

MARY DEANE DAY

On the same day petitioner executed a promissory demand note for $30,000 to "Nathan Tufts Trustee for Julius G. Day Jr.", with interest at 6 percent and reciting on its face that it was secured by "mortgage on Whitney Ave House." This house was petitioner's residence. The note was not under seal and contained the statement "value received."

">*1049 The mortgage above referred to was also executed on April 25, 1925. It was not recorded. It reads as follows:

TO ALL PEOPLE TO WHOM THESE PRESENTS SHALL COME, GREETING:

KNOW YE, That I, Julius G. Day, of the City and County of New Haven, in the State of Connecticut, For the consideration of Thirty Thousand ($30,000) Dollars received to my full satisfaction of Nathan Tufts, of Greenfield, in the State of Massachusetts, as Trustee for Julius G. Day, Jr., of said New Haven, do give, grant, bargain, sell and confirm unto the said Nathan Tufts, and unto his successors in the Trust and assigns forever, a certain piece or parcel of land, with all the buildings and improvements thereon, situated in said City of New Haven and bounded:

* * *

TO HAVE AND TO HOLD the above granted and bargained premises, with the appurtenances thereof, unto the said grantee, as Trustee, his successors in the Trust and assigns forever, to his and their proper use and behoof. AND ALSO, I, the said grantor, do for myself, my heirs, executors and administrators, covenant with the said grantee, his successors in the Trust and assigns, that at and until the ensealing of these presents I am well seized of">*1050 the premises as a good indefeasible estate in FEE SIMPLE; and have good right to bargain and sell the same in manner and form as above written; and that the same is free from all incumbrances whatsoever.

AND FURTHERMORE, I, the said grantor, do by these presents bind myself and my heirs forever to WARRANT AND defend the above granted and bargained premises to him the said grantee, his successors in the Trust and assigns, against all claims and demands whatsoever.

In Witness Whereof, I have hereunto set my hand and seal this day of April A.D. 1925. The condition of this deed is such that, whereas I am indebted to said grantee in the sum of Thirty Thousand Dollars, as evidenced by my promissory note, dated April 27th, 1925, by which note, for value received, I promise to pay to the order of Nathan Tufts, Trustee for Julius G. Day, Jr. Thirty Thousand Dollars on demand, with interest on the principal unpaid at the rate of six (6%) per cent per annum, payable semiannually, together with all taxes assessed upon said sum against said payee or the holder of said note.

">*111 Now, if said note shall be paid in all respects according to its tenor, this deed shall be void.

">*1051 [Signed] JULIUS G. DAY (L. S.)

Signed, sealed and delivered in the presence of

[Signed] B. F. WINSLOW

H. J. TERRILL

At all times material to this proceeding the trustee held the note and the mortgage securing it. The trustee, serving without compensation, invested payments of interest received from petitioner, in securities. Julius G. Day, Jr., became of age in 1927, and the trustee then transferred to him the aforesaid securities, but retained the note, continuing to collect the interest thereon as paid by petitioner. The subsequent interest payments were turned over by the trustee to Julius G. Day, Jr., as received. No demand for payment of the note has been made by the trustee or by Julius G. Day, Jr., and the latter has never demanded the note from the trustee.

During 1933 and 1934 petitioner, because of the depression, made no interest payments; but on April 22, 1935, he gave the trustee his check for $4,950, covering the interest in arrears and the interest then due. The trustee endorsed the check over to Julius G. Day, Jr., who received payment therefor.

The principal of the note is still unpaid, but the interest is paid up to date. The mortgage is still">*1052 in effect. The value of the mortgaged property in 1935 was approximately $30,000. Foreclosure has neither been instituted nor threatened.

Petitioner has never directed or interfered in the administration of the trust. The trustee consulted with petitioner as to investment of the interest prior to 1927 "only casually and generally."

OPINION.

LEECH: Petitioner contends that inasmuch as the note given by him to the trustee is secured by an instrument under seal, it is a valid and enforceable obligation and the interest payments are consequently deductible. He states that under controlling Connecticut law (see Sterling Morton,38 B.T.A. 1270">38 B.T.A. 1270), the consideration given for an instrument under seal may not be questioned, but must be conclusively presumed to exist. Hence, he says, the instant situation is controlled by William Park,38 B.T.A. 1118">38 B.T.A. 1118, which held that, where by the law of a state the consideration for a note may not be questioned because the note is under seal, the note must be deemed evidence of an enforceable debt and the interest paid thereon must be allowed as a deduction.

">*1053 This note is not, however, under seal. But even if it were, absence of consideration could be shown under the laws of Connecticut. See St. Paul's Episcopal Church v. Fields,81 Conn. 670">81 Conn. 670; 72 A. 145. ">*112 The fact that the mortgage and the trust deed were sealed instruments, and the further fact that, in Connecticut, a seal imports consideration in such instruments as a release (Dwy v. Connecticut Co.,89 Conn. 74">89 Conn. 74; 92 A. 883), an option (Hartford-Connecticut Trust Co. v. Divine,97 Conn. 193">97 Conn. 193; 116 A. 239) or a quitclaim deed (Monski v. Likomske,118 Conn. 635">118 Conn. 635; 173 A. 897), do not foreclose our inquiry into the existence of consideration for the note here.

There is no promise to pay contained in either the mortgage or the trust instrument. The mortgage constitutes the security for the note, but it is the note itself which evidences the debt, if any. It is the general rule, moreover, that there can be no valid mortgage without a valid debt, and if the note is unenforceable, the mortgage falls with it. ">*1054 Hendrie v. Hendrie, 94 Fed.(2d) 534; Lee v. Macon County Bank,233 Ala. 522">233 Ala. 522; 172 So. 662">172 So. 662; Rogers v. Snow Bros. Hardware Co.,186 Ark. 183">186 Ark. 183; 52 S.W.(2d) 969; Western Loan & Building Co. v. Scheib,218 Cal. 386">218 Cal. 386; 23 Pac.(2d) 745; Guaranty Title & Trust Co. v. Thompson,93 Fla. 983">93 Fla. 983; 113 So. 117">113 So. 117; Thorin v. Marchi,287 Ill. App. 513; 5 N.E.(2d) 292; Hoover v. Pennington,19 La. App. 779; 141 So. 517">141 So. 517; Sanger v. Bancroft,78 Mass. 365">78 Mass. 365; Spielman v. Albinson,183 Minn. 282">183 Minn. 282; 236 N.W. 319">236 N.W. 319; Donovan v. Boeck,217 Mo. 70">217 Mo. 70; 116 S.W. 543">116 S.W. 543; Shriver v. Sims,127 Neb. 374">127 Neb. 374; 255 N.W. 60">255 N.W. 60; Pierson Co. v. Freeman,113 N.J.Eq. 268; 166 A. 121; Title Guarantee & Trust Co. v. Nessle,296 N.Y.S. 270">296 N.Y.S. 270; ">*1055 Red River National Bank v. Latimer,110 S.W.(2d) 232 (Tex. Civ. App.); Tesdahl v. Collins,97 Pac.(2d) 649 (Wash.); Doyon & Rayne Lumber Co. v. Nichols,196 Wis. 387">196 Wis. 387; 220 N.W. 181">220 N.W. 181. Consequently, we are here concerned only with the question of whether the note itself is enforceable.

Petitioner first urges that love and affection constitute valid consideration. Such is not the law. Estate of Hugo Goldsmith,36 B.T.A. 1201">36 B.T.A. 1201; Shriver v. Danby,12 Del. Ch. 84; 106 A. 122; Bainbridge v. Hoes,149 N.Y.S. 20">149 N.Y.S. 20; Shugart v. Shugart,111 Tenn. 179">111 Tenn. 179; 76 S.W. 821">76 S.W. 821; In re Smith's Estate,226 Wis. 556">226 Wis. 556; 277 N.W. 141">277 N.W. 141. Petitioner's second argument is that the trustee's agreement to accept and perform the trust was consideration for the note. But there is no evidence that the note was given in exchange for such services. In fact, there was no agreement that the trustee would receive anything for his services and no compensation was paid him. The record is also clear that petitioner intended">*1056 to give his son $30,000 and that the note, mortgage, and trust were the means adopted for that end.

We think that this case is controlled by Johnson v. Commissioner, 86 Fed.(2d) 710. That case held that where a trust was set up composed solely of a note given without consideration, payments of interest on the note were wholly gratuitous and not allowable as ">*113 deductions from gross income. See also Jamie A. Bennett,40 B.T.A. 745">40 B.T.A. 745; Sand Springs Railway Co.,21 B.T.A. 1291">21 B.T.A. 1291. The instant note was not backed by any valid consideration whatever. Our conclusion is that it constitutes an unenforceable obligation.

Petitioner contends, however, that the note is enforceable in any event to the extent of the collateral securing it, citing 38 B.T.A. 1118">William Park, supra (now on appeal, C.C.A.3d Cir.). It is true that in the Park case the Board stated that "a collateral note is enforceable, at least to the extent of the collateral, regardless of whether or not it is under seal. ">*1057 Dando's Appeal,94 Pa. 76">94 Pa. 76." However, the Park case was rested specifically on Pennsylvania law, whereas we are now concerned with Connecticut law. In the latter state it has been held that no action lies on a note and mortgage given without consideration. Kane v. Kane,120 Conn. 184">120 Conn. 184. In any event, we have been cited to no authority for, and decline to adopt, the position that a gratuitous promise is rendered enforceable by the promisor's act in giving security therefor. See Restatement of Contracts, § 75. ¹

Respondent's determination that the interest is not deductible is sustained. In view of this conclusion, it will not be necessary to pass upon the">*1058 other grounds advanced by him in support of his position.

Decision will be entered for the respondent.

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Footnotes

• 1. (1) Consideration for a promise is (a) an act other than a promise or (b) a forbearance, or the creation, modification or destruction of a legal relation, or a return promise, bargained for and given in exchange for the promise.

  (2) Consideration may be given to the promisor or to some other person. It may be given by the promisee or by some other person.

  [Implicit in this definition is the thought that the promisor can not give consideration for his own promise.] ↩