Rom v. Commissioner

Harry Rom, Petitioner, v. Commissioner of Internal Revenue, Respondent
Rom v. Commissioner
Docket No. 6432
United States Tax Court
March 29, 1946, Promulgated

*249 Decision will be entered for the respondent.

Petitioner created on the same date an unfunded insurance trust, to which he transferred policies of insurance on his own life, and five so-called family trusts, one for his wife and one for each of his four children, to which he transferred income-producing securities. Under the trust agreements the income of the family trusts was to be distributed to or held for distribution to the beneficiaries. Three individuals were named as trustees for all of the trusts. In 1940 and 1941 the trustees paid all of the premiums on the insurance policies which they held under the insurance trust, utilizing for that purpose all of the net income of the five family trusts for 1940 and most of such net income for 1941. Held, that such net income is taxable to petitioner under section 167 (a) (3), Internal Revenue Code.

A. Leo Weil, Jr., Esq., for the petitioner.
Brooks Fullerton, Esq., for the respondent.
Smith, Judge.

SMITH

*615 This proceeding involves income tax deficiencies for 1940 and 1941 in the respective amounts of $ 1,562.34 and $ 2,526.81. The only question in issue is whether petitioner is taxable on the income *250 from certain trusts which he created for the benefit of his wife and children. The respondent has determined that this income is taxable to petitioner because it was applied to the payment of premiums on policies of insurance on his life.

The facts are stipulated.

FINDINGS OF FACT.

Petitioner is a resident of Pittsburgh, Pennsylvania. He filed his income tax returns for 1940 and 1941 with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh.

On December 24, 1938, petitioner created six separate irrevocable trusts for the benefit of his wife and four children. One of such trusts was an insurance trust the corpus of which consisted of policies of insurance on petitioner's life of an aggregate face amount of $ 142,500 and of a cash value at that time of $ 18,609.60. Upon the death of the grantor the trustees were to collect the proceeds of the policies and hold them in trust for the benefit jointly of the grantor's wife and four children. The trust agreement recited that the grantor was also transferring to the trustees "securities and other property" referred to as the "fund" and that the income from this fund was to be used, first, for *251 the payment of the obligations and expenses of the trust, then for the establishment of a limited fund for such purpose, and the balance, together with any dividends on the policies, was to be applied to the payment of the premiums thereon to the extent needed for that purpose. Any remaining income was to be distributed to the wife for life or held for distribution to the children when they attained their majority.

It was further provided that if the income (from the fund) and the dividends should prove insufficient to pay the premiums on the policies of insurance, the trustees were to notify the grantor and the grantor, at his election, might deliver to the trustees the amount of such deficiency *616 in cash. If he did not do so the trustees were authorized to raise the amount required to pay the premiums either by borrowing on the policies or pledging or disposing of the assets of the fund.

The securities and other property which were to comprise the "fund" of the insurance trust were never transferred to the trustees and the insurance trust remained unfunded throughout the taxable years.

The original corpus of each of the separate trusts for petitioner's wife and 4 children, *252 hereinafter sometimes referred to as the "family trusts," consisted of 50 shares of preferred stock of M. Rom & Sons Co. Fifty additional shares of the same stock were added to the corpus of each of the trusts by the grantor in each of the years 1939 and 1940, and 30 such additional shares were added in 1941.

The income of the wife's trust was to be paid to her for life and after her death the principal was to be distributed to the children equally, or transferred to their separate trusts if they were under 21 years of age.

In all of the children's trusts the income was to be accumulated and distributed to them when they respectively attained the age of 21 years. Thereafter the income of their respective trusts was to be distributed to them annually. The several trusts were to terminate after the death of the grantor and as each of the beneficiaries should attain the age of 35 years, but, at the discretion of the beneficiaries, might be terminated as they respectively became 24 years of age. Upon their termination the principal of the trusts was to be distributed to the beneficiaries.

All of the family trusts contained the following provision:

5. The Trustees shall have the following*253 rights and powers:

* * * *

(c) To purchase and loan. To purchase stocks, bonds and other securities from the Grantor, estate of the Grantor, or from any of the trusts created by the Grantor, at the fair market value thereof, over such periods of time and upon such terms and conditions as in the discretion of the Trustees shall be necessary or advisable; to loan to the executor or other personal representative of the estate of the Grantor, or to the trusts created by the Grantor, or any of them, such sums and upon such security, or without security, as may seem to the Trustees advisable in their uncontrolled discretion. In addition to the foregoing, whether before or after the death of the Grantor, the Trustees shall have the uncontrolled right and power in their sole discretion to loan, borrow against, pledge and hypothecate all or any of the securities and/or property constituting the Fund for the benefit of all or any of the beneficiaries of this trust.

The above quotation is from the wife's trust. There was a slight immaterial change in the wording of the last quoted sentence in the trusts for the children.

All of the trusts, the insurance trust and the family trusts, had*254 the same trustees, namely, Leonard Rom, Emery Rom, and Louis Nevins.

In 1939 the trustees opened a bank account in their names as trustees in which they deposited all of the income of the several family trusts. *617 They received no income from the insurance trust in either of the years 1940 or 1941. They drew checks on that account in the aggregate amount of $ 3,909.27 in 1940 and $ 3,896.06 in 1941, with which they paid the premiums on the policies of insurance held in the insurance trust. The income received from the family trusts amounted in the aggregate to $ 3,500 in 1940 and $ 5,250 in 1941. To raise the additional amount needed to pay the 1940 premiums the trustees borrowed $ 558.87 from M. Rom & Sons Co. The grantor did not make any loan to the trustees or advance them any funds with which to pay the premiums in either of the years and there is no evidence that the trustees ever called upon him to do so, as they were authorized to do under the insurance trust agreement.

The trustees opened books of account for the several trusts in 1939. There was a single cash book which currently reflected the receipts of income from the family trusts and the disbursements made*255 for all of the trusts and a single journal in which entries were made at the end of each year showing a breakdown of expenses among the several family trusts and any additional gifts made to those trusts during the year. There was a general ledger in which the accounts of the insurance trust and of the five family trusts (as a unit) were kept separately and also a subsidiary ledger showing separately the corpus and income of each of the family trusts.

On September 21, 1943, after an examination of petitioner's books and records had been made by a revenue agent, an entry was made in the trustees' journal showing loans receivable of $ 2,997.60 by each of the five family trusts and loans payable by the insurance trust of the aggregate of those amounts, $ 14,988.02.

For each of the years 1940 and 1941 the trustees filed a single fiduciary return for all six trusts under the title "Trust of Harry Rom -- Leonard Rom, Emery Rom, and Louis Nevins, Trustees." In those returns they reported all of the net income of the several family trusts for those years. When the revenue agent was examining petitioner's books and records the trustees prepared and handed to him amended returns for each *256 of the family trusts for the years 1940 and 1941. The amended returns showed for each of the trusts a net income of $ 700 for 1940 and $ 1,050 for 1941. For the three trusts whose beneficiaries had not attained the age of 21 years the income was all shown as not distributable and therefore taxable to the fiduciaries. For the other two trusts the income was shown as distributable, and taxable to the beneficiaries.

The respondent determined in his deficiency notice that petitioner is taxable individually on that portion of the income of the several family trusts for 1940 and 1941 which was used to pay the premiums on the policies of insurance on petitioner's life held in the insurance trust.

*618 OPINION.

It is the respondent's contention that the income of the family trusts which was used to pay the premiums on the policies of insurance on petitioner's (the grantor's) life held in the insurance trust is taxable to petitioner under section 167 (a) (3), Internal Revenue Code. 1

*257 Petitioner contends that the income of the family trusts belonged to and is taxable to the beneficiaries of those trusts and that the amounts thereof which were used to pay the premiums were borrowed from the family trusts and were not "applied" to the payment of the premiums within the meaning of the statute.

The evidence before us does not explain why petitioner did not carry out his declared intention of setting up a fund in the insurance trust with which to pay the premiums on the policies held in that trust. The agreement creating the trust recited that the grantor was transferring certain securities, described in an attached schedule, the income from which was to be used primarily to pay the premiums. However, no securities or other property were transferred to the insurance trust and no "fund" for that purpose was established in that trust or elsewhere. Instead petitioner transferred income-producing securities to the five family trusts which he created at the same time. Those securities consisted solely of shares of preferred stock of M. Rom & Sons Co. Whether they were the same securities that petitioner had originally intended to transfer to the insurance trust, we *258 do not know. We do not know just what was the relationship between the petitioner and M. Rom & Sons Co.

The statute says (section 167 (a) (3) above) that the income of the trust must be taxed to the grantor if it "is, * * * applied to the payment of premiums upon policies of insurance on the life of the grantor." There can be no denial of the fact that all of the income of the family trusts for 1940 and most of it for 1941 was used to pay the premiums on the policies of insurance on the grantor's life. We do not think that petitioner can avoid the consequences of the statute by seeking to establish that the trustees borrowed the income from the family trusts, or from the beneficiaries of the trusts. There was nothing given to evidence any such loans and no such book entries were made at the time. After the revenue agent had made his examination of petitioner's books and records in 1943 and called the trustees' attention to the matter, they then made entries in the accounts of the trusts purporting to show such loans.

*619 The same three individuals served as trustees of all the trusts. We do not know what relationship they have to the petitioner or the beneficiaries. Apparently*259 they felt free to use the income of the family trusts for payment of the premiums. There is no evidence that in doing so they ever obtained the consent of the beneficiaries or consulted them about the matter. The wife and those of the children who had attained their majority were entitled to receive the income of their trusts annually. The income from the trusts for the minor children was to be held by the trustees for distribution to them when they became 21.

For all that is shown, the grantor, petitioner, was fully cognizant of what the trustees were doing and approved their action. We can not find on the evidence of record that the income of the trusts was not used to pay the premiums on the insurance policies in accordance with the grantor's predetermined plan. See Burnet v. Wells, 289 U.S. 670">289 U.S. 670.

Among the cases relied upon by petitioner are Frederick K. Barbour, 39 B. T. A. 910 (reversed on other grounds, 122 Fed. (2d) 165); Commissioner v. Jergens, 127 Fed. (2d) 973 (affirming memorandum opinion of the Tax Court); Stephen Hexter, 47 B. T. A. 483;*260 and George F. Booth, 3 T.C. 605">3 T. C. 605.

The distinguishing feature of those cases (except Commissioner v. Jergens, supra) 2 is that the trust income was not only payable to beneficiaries other than the grantor, but it was actually paid to those beneficiaries and made available to them for their unrestricted use. They, not the trustees, voluntarily paid the insurance premiums. Some of the beneficiaries, as in Stephen Hexter, supra, had individual income of their own and had been paying the premiums on the policies involved before they were ever assigned to the trust.

In Frederick K. Barbour, supra,*261 we said:

The Supreme Court in Burnet v. Wells, supra, recognized the distinction between trusts for the preservation of policies of insurance and those where the trust income may be expended by the beneficiaries without restraint and without the imposition of the grantor's will upon the use of such income. * * * The facts in the present case bring it within such latter class. * * *

If those facts obtained here we would consider the cases cited controlling. However, the evidence here is that the trustees never paid or distributed the income of the family trusts to the beneficiaries and, so far as it is shown, never obtained their consent to use it for the purpose of paying the premiums. The beneficiaries never actually received the income and never had any opportunity to exercise their *620 independent control over it. They never "suggested" that it be used to pay the premiums. Cf. George F. Booth, supra.We can not assume that Congress intended, in enacting section 167 (a) (3), to make a distinction between instances where the trustees are empowered, by the trust agreement, to pay the premiums out of trust*262 income and where they are empowered to "borrow" the trust income for that same purpose without any limitation or security and without the knowledge or consent of the beneficiaries. The purpose of section 167 (a) (3) being to check tax evasion (Burnet v. Wells, supra), such an inviting loophole in the law could hardly have been intentionally offered.

The income sought to be reached by the statute is that "applied" to the payment of premiums on policies of insurance on the grantor's life. We think that it was intended to reach income which the trustees, acting within their lawful powers, used for that purpose, whether they denominate such use a loan or call it by some other name. By authorizing the trustees, acting as trustees of the insurance trust, to borrow funds to pay the premiums on the insurance policies and also authorizing them as trustees of the family trusts to lend the funds of the other trusts for that purpose, the grantor made it possible for the trustees to apply all of the income of the family trusts, if necessary, to the payment of the premiums.

Petitioner states in his brief that:

It should also be noted that in all of the foregoing*263 cases the action of the beneficiaries in paying the life insurance premiums was voluntary, and such action was uncontrolled by the grantors of the trusts. Identically the same situation exists in the instant case.

The situation here is not identical. The income was never paid to or made available to the beneficiaries. There is no evidence that the payment of the premiums was "voluntary" on the part of the beneficiaries, or that they took any action whatever in the matter.

The facts here are stronger for the Government than those in Henry A. B. Dunning, 36 B. T. A. 1222, decided against the taxpayer. There the trust income was actually paid over to the beneficiary, the grantor's wife, and at his "suggestion" she used a part of it to pay the premiums on policies of insurance on the grantor's life of which she was the beneficiary.

On the facts disclosed by the stipulation, we find no error in the respondent's determination that petitioner is taxable in 1940 and 1941 on the income of the family trusts that was used to pay the premiums on the policies of insurance on his life.

Decision will be entered for the respondent.


Footnotes

  • 1. SEC. 167. INCOME FOR BENEFIT OF GRANTOR.

    (a) Where any part of the income of a trust --

    * * * *

    (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor * * *.

  • 2. Commissioner v. Jergens is not in point here. The insurance premiums which were paid out of trust income there were not on policies of insurance on the grantor's life, but on the life of her husband. Section 167 (a) (3) therefore had no application. See W. C. Cartinhour, 3 T. C. 482.