*2993 1. Where the settlor of a trust who had reserved to himself the net income for life makes a valid enforcible transfer or conveyance of his interest in the estate or the income therefrom, except an annuity of $20,000, to trustees for the benefit of certain beneficiaries named in the original trust instrument, it is held that such distributable income is taxable to the beneficiaries and should not be included as income to the settlor.
2. An unauthorized reserve for depreciation maintained by trustees held to be income distributable and taxable to the beneficiaries. Estate of Virginia I. Stern,7 B.T.A. 853">7 B.T.A. 853.
*1040 The respondent has asserted deficiencies in income taxes as follows:
| F. C. Hubbell | ||
| Year | Docket No. | Amount |
| 1922 | 25953 | $3,944.29 |
| 1923 | 30514 | 2,760.62 |
| Beulah C. Wachtmeister | ||
| Year | Docket No. | Amount |
| 1922 | 25955 | $3,375.47 |
| 1923 | 30515 | 3,440.66 |
| Grover C. Hubbell | ||
| Year | Docket No. | Amount |
| 1922 | 25946 | $5,255.87 |
| 1923 | 30516 | 1,514.92 |
| Frederick M. Hubbell | ||
| Year | Docket No. | Amount |
| 1922 | 25944 | $1,338.44 |
| 1923 | 30517 | 512.49 |
*2994 *1041 By amendment at the hearing, the respondent asserted additional deficiencies as to the petitioner Frederick M. Hubbell in the following amounts:
| 1922 | $62,133.56 |
| 1923 | 65,486.37 |
The issues are presented for determination - (1) Whether the entire net income of a trust fund, which was reserved to the settlor for life and later transferred in an instrument directing the trustees to pay the net income in excess of $20,000 a year to certain beneficiaries named in the original trust agreement, is taxable to the settlor even though the trustees distributed the net income according to the provisions of the later instrument; and (2) Whether amounts retained by trustees as depreciation sustained on trust property should be included as income distributable to the cestuis que trust who, under the provisions of the trust agreement, are to receive the "net income" from the property for life.
At the hearing these appeals were consolidated, the issues involved being common to all. The material facts are stipulated.
FINDINGS OF FACT.
The petitioners F. C. Hubbell, Grover C. Hubbell, and Frederick M. Hubbell, are residents of the City of Des Moines, Polk*2995 County, Iowa. Beulah C. Wachtmeister is a resident of Paris, France, for whom Frederick M. Hubbell, a resident of Des Moines, Iowa, is the duly appointed agent.
On December 31, 1903, Frederick M. Hubbell and his wife, Frances E. Hubbell, made, executed and delivered a trust agreement to certain trustees, conveying real estate and personal property for the uses and purposes therein stated. The material portions of the instrument, which was duly recorded, follow:
ARTICLE I. "The trust period," above referred to, is described and designated as follows. It shall commence upon the execution of these presents, and shall continue and exist during the lives of the following named persons, who are each and all now living, viz., Frederick M. Hubbell and Frances E. Hubbell, his wife - hereinafter called "trustors" - Frederick C. Hubbell, Beulah C. Wachtmeister and Grover C. Hubbell - children of the said Frederick M. Hubbell - and Frederick W. Hubbell and James W. Hubbell - sons of the said Frederick C. Hubbell - and during the life of the survivor of said persons, and for twenty-one (21) years thereafter.
ARTICLE II. During the whole of "the trust period" aforesaid, said "trustees" *2996 shall have full power and authority to demand, sue and receipt for, take and enter into possession of and hold the property listed and described in the schedules hereto attached, under the heading "Schedule A. Real Property; not to be sold," and each and every lot, part and parcel thereof.
They shall have power to lease said property, and to demand, collect, sue and receipt for the rents, issues and profits arising and which may be had therefrom; to bring, maintain and defend actions, both at law and in equity, *1042 involving, growing out of, or in any wise affecting said property; to maintain, improve and insure, and to plat and subdivide the same, and to vacate the plats and subdivisions thereof, as to them may seem to the best advantage of the trust estate. * * *
ARTICLE III. * * * Further, said trustees shall have power to contract debts on the faith and credit of said property listed and described in said schedules "B" and "C"; to mortgage, bond, or otherwise encumber the same, or any part thereof, should be exigencies of the trust so require, and to charge said property with all necessary, proper and reasonable expenses of maintenance, and of administration of*2997 the trust hereby created, including reasonable compensation to the trustees while actively engaged in attending to the business and management of the trust.
In short, during the whole of the trust period aforesaid, said trustees shall have full power and authority to manage and control said property in such manner as to them may seem advisable, and shall have, enjoy and exercise all powers and rights over and concerning said property, and the proceeds thereof, as fully and amply as though they were the absolute and unqualified owners of it, excepting only that the net rents, issues, profits and proceeds of sales thereof shall be invested by them only in such real estate and in such manner as is above set forth.
ARTICLE VI. For and during the natural life of the said Frederick M. Hubbell, the net income of and from the trust property and estate above described shall be paid by said trustees to him, the said Frederick M. Hubbell, either annually, semi-annually, quarterly or monthly, as he may desire and request.
ARTICLE VIII. At and after the death of said Frederick M. Hubbell, the net income of and from the trust property and estate aforesaid, after the payment of the annuity, *2998 above raised and provided, to the said Frances E. Hubbell, shall, during the remainder of the trust period aforesaid, be paid by said trustees, either annually, semi-annually, quarterly or monthly, as to said trustees may seem best as follows: One-third (1/3) to the said Frederick C. Hubbell, and to the heirs of his body; one-third (1/3) to the said Beulah C. Wachtmeister, and to the heirs of her body, and one-third (1/3) to the said Grover C. Hubbell, and to the heirs of his body. And, should any of said children of the trustors, viz., Frederick C. Hubbell, Beulah C. Wachtmeister or Grover C. Hubbell, die without leaving heirs of the body, him or her surviving, the one-third (1/3) share payable to such child so dying without heirs of his or her body, shall thereafter be paid by said trustees to the surviving children or child of the trustors, and to the heirs of their respective bodies; the intention of this article being that said three children of the trustors and their lineal descendants, and no one else, shall, after the death of the said Frederick M. Hubbell, and subject to the provisions of Article VII hereof, take, have and enjoy the net income of and from the trust property*2999 and estate aforesaid, and that such lineal descendants shall take per stirpes and not per capita.
ARTICLE XV. At the expiration of the trust period hereby created said trustees shall account for, pay over, distribute among and convey to the lineal descendants of the said Frederick C. Hubbell, beulah C. Wachtmeister, and Grover C. Hubbell, then living, the trust property and estate then remaining in the hands and under the control of said trustees; said lineal descendants to take per stirpes and not per capita.
On January 2, 1919, Frederick M. Hubbell executed an agreement with the trustees concerning the distribution of net income of the *1043 trust property therein referred to and conveyed in trust by the trust instrument of 1903. This instrument was duly executed, acknowledged, and recorded, the material provisions being as follows:
SUPPLEMENTAL AGREEMENT IN RELATION TO DISPOSING OF NET INCOME OF TRUST ESTATE UNDER TRUST CONVEYANCE AND CONVENTION OF FREDERICK M. HUBBELL, ET UX, TO AND WITH FREDERICK M. HUBBELL, FREDERICK C. HUBBELL AND GROVER C. HUBBELL, TRUSTEES OF THE FREDERICK M. HUBBELL ESTATE, DURING THE REMAINDER OF THE NATURAL LIFE OF FREDERICK*3000 M. HUBBELL.
THIS AGREEMENT, made and entered into this 2d day of January, 1919, by and between Frederick M. Hubbell and Frederick M. Hubbell, Frederick C. Hubbell, Frederick W. Hubbell, and James W. Hubbell, Trustees of the Frederick M. Hubbell Estate, WITNESSETH, that,
WHEREAS, on or about the 31st day of December, A.D. 1903, Frederick M. Hubbell and Frances E. Hubbell, his wife, made and entered into a certain trust conveyance and convention to and with Frederick M. Hubbell, Frederick C. Hubbell, and Grover C. Hubbell, Trustees of the Frederick M. Hubbell Estate, which said instrument was thereafter, on or about the 22nd day of January, A.D. 1904, filed for record in the office of the Recorder of Deeds of Polk County, Iowa, and duly recorded in Book 473 at page 58 et seq. of the records in said office, and,
WHEREAS, said Trust Conveyance and Convention, since its execution and delivery, has been inforce and effect and is now being observed and followed by the parties hereto in respect of the property and rights affected thereby, and,
WHEREAS, Frederick M. Hubbell, Frederick C. Hubbell, Frederick W. Hubbell, and James W. Hubbell, as Trustees of said Trust Estate, are now*3001 actively engaged in the discharge of the duties devolving upon the Trustees of said estate under said Trust Conveyance and Convention, and,
WHEREAS, Article VI of said Trust Conveyance and Convention provides as follows:
* * *
WHEREAS, Article VIII of said Trust Conveyance and Convention provides as follows:
* * *
WHEREAS, the said Frederick M. Hubbell desires to release and relinquish all the income from said trust estate during the remainder of the term of his natural life except the sum of Twenty Thousand Dollars ($20,000.00) each year, from and after January 1st, A.D. 1919, and
WHEREAS, it is the desire of the said Frederick M. Hubbell that all of the net income from said trust estate so released and relinquished by him, being the net income from said trust estate in excess of Twenty Thousand Dollars ($20,000.00) each year, shall, during the remainder of the period of his natural life, go to the children of himself and the said Frances E. Hubbell, his wife.
Now, THEREFORE, in consideration of One Dollar ($1.00) and other good and valuable consideration in hand paid, the receipt of which is hereby acknowledged, the said Frederick M. Hubbell hereby releases and relinquishes*3002 all claim and right to the net income derived or to be derived from said trust estate during the residue and remainder of the period of his natural life, except the sum of Twenty Thousand Dollars ($20,000.00) each year, which said sum of Twenty Thousand Dollars ($20,000.00) each year shall be paid to him by said Trustees at the times and in the manner provided in said Trust Conveyance and Convention *1044 for the payment of the net income from said estate, during the residue and remainder of the period of his natural life.
It is further agreed by and between the parties hereto that all of the net income from said trust estate in excess of said sum of Twenty Thousand Dollars ($20,000.00) and which, but for this instrument and the agreements herein contained, would, under the terms and provisions of said Trust Conveyance and Convention, be paid to the said Frederick M. Hubbell, shall hereafter, during the remainder of the period of the natural life of the said Frederick M. Hubbell, be paid to the children of the said Frederick M. Hubbell and Frances E. Hubbell, his wife, namely; Frederick C. Hubbell, Beulah C. Wachtmeister, and Grover C. Hubbell, share and share alike, or to*3003 their heirs, as provided in such Trust Conveyance and Convention with respect to income from said trust estate, to be paid to such persons.
* * *
Frederick M. Hubbell
FREDERICK M. HUBBELL,
FREDERICK C. HUBBELL,
FREDERICK W. HUBBELL,
JAMES W. HUBBELL,
Trustees of the Frederick M. Hubbell Estate.
During the calendar year 1922 the trustees under the said trust agreement set aside upon the books of account of the trust estate for the year 1922 the sum of $34,978.59 as a charge for depreciation upon depreciable property held by them. The trustees also set aside upon the books of account of the said trust estate for the year 1923 the sum of $38,511.78 as a charge for depreciation upon depreciable property held by them. These amounts represent fair and proper charges for depreciation sustained on the property during such years.
The income of the trust estate remaining after the deductions for depreciation set aside on the accounts of the trust estate for each of the years herein involved, and after the deduction of certain other items of expense not here in question, was then distributed by the trustees as follows:
| In the year 1922 to F. C. Hubbell | $28,111.57 |
| In the year 1923 to F. C. Hubbell | 34,816.49 |
| In the year 1922 to Beulah C. Wachtmeister | 28,111.58 |
| In the year 1923 to Beulah C. Wachtmeister | 34,816.48 |
| In the year 1922 to Grover C. Hubbell | 28,111.57 |
| In the year 1923 to Grover C. Hubbell | 34,816.48 |
| In the year 1922 to Frederick M. Hubbell | 12,739.38 |
| In the year 1923 to Frederick M. Hubbell | 9,881.45 |
*3004 In each of the said years there was distributed by the trustees of the trust estate proceeds of dividends on stock of domestic corporations in the following amounts:
| In the year 1922 to F. C. Hubbell | $14,950.89 |
| In the year 1923 to F. C. Hubbell | 27,080.97 |
| In the year 1922 to Beulah C. Wachtmeister | 14,950.88 |
| In the year 1923 to Beulah C. Wachtmeister | 27,080.98 |
| In the year 1922 to Grover C. Hubbell | $14,950.89 |
| In the year 1923 to Grover C. Hubbell | 27,080.98 |
| In the year 1922 to Frederick M. Hubbell | 6,696.80 |
| In the year 1923 to Frederick M. Hubbell | 7,331.99 |
*1045 There was also distributed to Frederick M. Hubbell by the trustees in the year 1922, $563.22 interest from tax-free securities and in the year 1923, $2,786.56 interest from tax-free securities.
The amount set aside by the trustees in each of the years 1922 and 1923 for and on account of the depreciation sustained was held by them and was not distributed to any of the beneficiaries of the trust.
Each of the petitioners in the years 1922 and 1923 reported and paid taxes upon the amounts received by them as hereinbefore stated.
OPINION.
*3005 LANSDON: The respondent alleges that the entire income of the trust estate is taxable to the petitioner, Frederick M. Hubbell, as life tenant, inasmuch as the instrument of January 2, 1919, being an agreement between the settlor and the trustees, and the cestuis que trust as such not being parties thereto, has no effect to alter or modify the trust instrument of December 31, 1903, and can operate as nothing more than an assignment of the right to receive income. It is well settled, as contended by the respondent, that after an express trust has been perfectly and completely created and the rights of the beneficiaries have become vested, the trust can not be changed, altered or modified by the settlor except with the consent of all the beneficiaries. ; ; ; ; 39 Cyc. 92, and cases there cited. It is also well settled, as the respondent contends, that an assignment of the right to receive income constitutes merely an executory agreement to transfer that income as and when it may arise in the future and*3006 the amount becomes income taxable to the assignor before the assignee receives any interest therein. ; ; ; ; certiorari denied, ; ; ; ; ; ; ; .
The facts of the instant case, however, present a situation different from that involved in the cases cited above. Here the petitioner, Frederick M. Hubbell, conveyed in 1903 certain real and personal property in trust, reserving to himself the income for life. By deed executed January 2, 1919, he conveyed his interest in the estate, *1046 except an annuity of $20,000, to trustees, directing them to pay such income to beneficiaries designated*3007 in the trust instrument of 1903 who were to have received the income after his death. The instrument of January 2, 1919, was in writing, properly executed, acknowledged, and recorded. Section 9440 of the Code of Iowa, 1924, provides:
All contracts in writing, signed by the party to be bound or by his authorized agent or attorney, shall import a consideration.
The later instrument is not an alternation or modification of the earlier trust conveyance, nor is it merely an assignment of the right to receive income; it is a new trust agreement conveying petitioner's life estate to trustees for the benefit of persons named in the instrument of 1903. The Board has recognized that the conveyance of a life estate or the income therefrom is a different matter than the assignment of income or the right to receive income. In (approved ) the Board stated:
That the taxpayer gave his share of the income from the trust to his daughter can not affect his taxability. He had a life interest. He made no transfer of that interest. When income was distributable to him, he, as trustee, paid it to his daughter, *3008 but it became his income as a beneficiary under the trust before it could be given to his daughter either by himself as an individual or as trustee. * * * What the result might be if there had been a valid, enforcible transfer or conveyance to the daughter of the taxpayer's interest in the life estate or the income therefrom it is not necessary for us to decide, since no such fact appeared in the present appeal.
It can not be questioned that Frederick M. Hubbell had a life estate as distinguished from a mere right to receive the income. In , the Supreme Court said:
* * * But if it were material, a gift of the income of a fund ordinarily is treated by equity as creating an interest in the fund. Apart from technicalities we can perceive no distinction relevant to the question before us between a gift of the fund for life and a gift of the income from it. The fund is appropriated to the production of the same result, whichever form the gift takes.
The petitioner, Frederick M. Hubbell, has divested himself of the life estate by which he had the right to receive the income in excess of $20,000 per year. He has relinquished all*3009 control over the estate and the beneficiaries now have vested rights therein. It follows that the income, except the annuity of $20,000, is taxable to the beneficiaries and not to the petitioner, Frederick M. Hubbell. ; ; ; .
As to the second issue, the respondent contends that the reserve for depreciation maintained by the trustees during each of the years *1047 herein involved was unauthorized and constitutes distributable income within the meaning of section 219 of the Revenue Act of 1921, which provides, in part, as follows:
(a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including -
* * *
(4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals, and the income collected by a guardian of an infant to be held or distributed as the court may direct.
* * *
(d) In cases under paragraph (4) of subdivision (a), *3010 * * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary that part of the income of the estate or trust for its taxable year which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not * * *
The petitioners, then, are taxable on "that part of the income * * * which, pursuant to the instrument or order governing the distribution, is distributable to each beneficiary, whether distributed or not," and that amount having been determined, it is well settled that no deduction can be allowed for depreciation sustained upon trust property. ; ; ; certiorari denied, . The instrument herein involved provides that "net income" shall be distributed to the beneficiaries. What that term means, as used therein, must be determined without regard to definitions in tax laws subsequently enacted. The contemporaneous construction of the trust instrument is not disclosed by the record. *3011 There is no proof nor even any contention that a reserve or sinking fund for the replacement of obsolete structures was set up and maintained by annual additions thereto from income prior to the taxable years.
The instrument contains no specific provisions which make it the duty of the trustees to reserve a sinking fund from income. If there is any authority for the procedure which resulted in this controversy it is found in article II of the trust instrument, which gives the trustees power "To maintain, improve and insure the premises," but we can not regard this language as a direction to the trustees that the expenses so authorized shall be paid out of a fund reserved from the income of the trust. Maintenance may mean no more than that the property shall be kept in repair, which probably has been done by payments from income prior to distribution. Insurance is an operating expense also chargeable to income and, in no way, an element to be considered in establishing a reserve for depreciation. In the same article, and also in article III, the trustees are authorized to "contract debts on the faith and credit *1048 of said property and to secure the same by mortgages, *3012 bonds, or otherwise, for the purpose of improving said property to the amount of $100,000," which must be regarded as a provision for the replacement of obsolete structures and the continuance or increase of income without setting apart any reserve or sinking fund made up of annual deductions from the income of the trust.
The petitioner contends that by providing for the distribution of "net income" only, the trust instrument has authorized a reserve from income to replace depreciated assets of the corpus. We can not agree with such contention. The expressions "rent and profit," "income," and "net income," are all equivalent and mean nothing more than the profit remaining after the deduction of expenses of management, or the rent which may be obtained for the use of the property. ; ; ; Bouvier's Law Dictionary; Words and Phrases.
We have held, in , that where the trustees create an unauthorized reserve out of trust income to replace depreciated assets of the corpus, the amounts withheld were distributable*3013 and taxable to the beneficiaries. The governing instrument in that case directed the trustees to "pay over one equal third part of the said rents, interest, income, and profits." We consider the Stern case controlling in the instant proceedings and, upon authority thereof, approve the determination of the respondent.
Reviewed by the Board.
Decision will be entered under Rule 50.
MILLIKEN concurs in the result.