*1410 1. TRUST, OR ASSOCIATION. Where the settlors of a trust were the owners of a large estate consisting of cotton gins, oil wells, farm lands, ranch property, etc., and desired to make a donation to their children and conveyed all their property to trustees for the equal benefit of their said children, after reserving to themselves a child's part, and conferred upon the trustees the power to hold, manage, and operate the property and to sell, invest and reinvest, and prohibited the beneficiaries from selling or otherwise disposing of their shares of the trust estate, and no beneficial certificates were issued to the beneficiaries and other corporate forms were not observed, the trust thereby created is not an association taxable as a corporation but is a fiduciary taxable under section 219 of the applicable revenue acts. Wilson Syndicate Trust,14 B.T.A. 508">14 B.T.A. 508; affd., 39 Fed.(2d) 43; Wilson Trust,20 B.T.A. 549">20 B.T.A. 549, followed.
2. INCOME - WHERE TRUSTEE HAS DISCRETION TO ACCUMULATE OR DISTRIBUTE. Where the original trust deed operative for two of the taxable years, contains a provision giving the trustees an option to declare dividends out*1411 of any profits that may accrue to said estate, which may be paid to each of the beneficiaries or retained in the business as the trustees may determine, the question whether the income shall be accumulated or distributed is one which rests within the discretion of the trustees, and whether the income is taxable to the fiduciary or is taxable to the beneficiaries depends upon the way the trustees exercise their discretion. William E. Scripps et al., Trustees,1 B.T.A. 491">1 B.T.A. 491, followed.
3. INCOME - TRUSTEE REQUIRED TO DISTRIBUTE. Where early in 1924 a supplement to the original trust deed became effective which required the trustees to make annual distribution of income to the beneficiaries, the income of the trust thereafter is taxable to the beneficiaries and not to the fiduciary and this is true whether the income was actually distributed or not. Estate of Henry Mayer,16 B.T.A. 1164">16 B.T.A. 1164, followed.
4. PENALTIES - AD VALOREM. Where the fiduciary filed tentative information returns on Form 1041, but did not give thereon complete information as to income and deductions of the trust, but at a later date filed amended returns which did give such complete*1412 information, and where prior to the filing of such tentative returns the fiduciary had secured permission from the Commissioner of Internal Revenue to file such tentative returns, provided amended returns were filed later, giving the complete information required, and this was done within the permitted time, the Commissioner was in error in imposing penalties based upon the ground that petitioner had not filed returns on Form 1120, required of all corporations and associations doing business as corporations. This is especially true because we hold petitioner is not taxable as a corporation.
5. DIVIDENDS RECEIVED BY THE TRUST. Where in the taxable years in which the income is held to be taxable to the trust, dividends are received from corporations, these dividends should be added to the income of the trust and are taxable at surtax rates.
*1215 This proceeding is for the redetermination of deficiencies and delinquency penalties for the years and in the amounts hereinafter set forth:
| Year | Deficiency | Penalty |
| 1922 | $9,742.69 | $2,435.67 |
| 1923 | 18,475.60 | 4,618.90 |
| 1924 | 13,221.96 | 3,305.49 |
| 1925 | 18,068.19 | 4,517.05 |
| 1926 | 6,282.99 | 1,570.75 |
| Total | 65,791.43 | 16,447.86 |
*1413 The petition alleges that the respondent committed error in determining the aforesaid deficiencies and penalties, as follows:
(a) Erroneously asserting tax liability upon the petitioner as an association.
(b) Failing to credit the petitioner with the amounts paid as taxes upon the net income of the petitioner, by the ten beneficiaries, partners, or stockholders in the Guitar Trust Estate.
(c) Erroneously asserting that no returns were filed by the petitioner and basing penalties upon that error.
(d) In disallowing a bad debt deduction in 1922 of $10,520.78 for the worthless account of C. M. Bailey.
(e) In disallowing additional compensation paid to employees in 1924 in the amount of $420.
(f) In disallowing additional compensation paid to employees in 1925 in the amount of $960.
(g) In disallowing additional compensation paid to employees in 1926 in the amount of $645.
(h) In disallowing as ordinary and necessary expense in 1926 the amount of $100 paid to the Abilene Chamber of Commerce as petitioner's pro rata part of the expense incurred in maintaining a highway for business purposes.
At the hearing the respondent amended his answer by alleging, in the*1414 alternative, that, if the Board finds and determines that the petitioner is taxable as a fiduciary, the petitioner's taxable net income for each of the years 1922 to 1926, inclusive, has been understated by the Commissioner through failure to include in net income the dividends from domestic corporations which were reported by the petitioner in its information returns and the Board should redetermine the correct deficiencies for the years 1922 to 1926 accordingly. Also at the hearing the respondent conceded error with respect to the penalty asserted for 1926. Petitioner offered no evidence on assignment of error (b) and did not refer to it in its brief and that assignment will be considered as abandoned.
*1216 In its brief petitioner withdrew allegation (d), supra, and accordingly this report contains no findings of fact with respect thereto.
FINDINGS OF FACT.
The petitioner was created by a trust instrument executed by John Guitar, Sr., and his wife, Laura O. Guitar, under date of December 30, 1921. During the years 1922 to 1926, inclusive, the petitioner was engaged in business, with its principal office in Abilene, Texas.
Prior to the execution of the aforesaid*1415 instrument, John Guitar, Sr., and his wife had accumulated considerable property which under the laws of Texas was owned jointly by the members of the marital community. John Guitar, Sr., was engaged in the cottonseed oil business, cotton gin business, ranch business and farming. As their eight children were all becoming grown, the parents considered the best means of handling the property for their benefit. At first they thought of dividing the property by deeding a special piece to each child, but later decided that this plan might be difficult to execute and put into effect. They finally decided that the best thing to do would be to deed the property to trustees who could carry on the business as it had been before and each child would have an equal interest in the property. The two oldest boys, John Guitar, Jr., and Repps B. Guitar, had been in business with their father for years; were grown men; and were acquainted with the business. It was determined by John Guitar, Sr., to make them trustees along with himself.
John Guitar, Sr., personally drafted the instrument hereinafter set forth without seeking the advice of counsel. He did, however, consult with his wife about*1416 the terms and she agreed with him on the whole matter before they signed and executed the agreement on December 30, 1921. Prior to the execution of the instrument the children were not advised about the intentions of their parents, but immediately thereafter they were informed of what had been done. The provisions of this instrument read in part as follows:
KNOW ALL MEN BY THESE PRESENTS:
That we, John Guitar, Sr., and wife Laura O. Guitar being desirous of distributing our estate so that our children may enjoy the use and benefit thereof during our life time as their separate and individual property, and in consideration of the natural love and affection which we bear to our children have granted, sold and conveyed, and by these presents grant, sell and convey to John Guitar Jr. and Repps B. Guitar Trustees, and John Guitar Sr. shall act as one of the trustees, this number of three trustees shall be maintained during the term of this trust, should one of the trustees die or become incompacitated [incapacitated] to so act, then in that event the remaining trustees shall immediately name another from among the beneficiaries.
*1217 The following real estate and personal*1417 property is hereby conveyed:
* * *
Together with all buildings, machinery, tools, implements, and live stock of all kinds, and any and all improvements of whatsoever nature now located or situated on any or all of the before mentioned real estate here conveyed.
The said estate here conveyed to the said trustees shall consist of ten equal undivided parts or shares, one part of which shall be retained by the said John Guitar, Sr., and one part by the said Laura O. Guitar, and the beneficial interest of the remaining eight parts shall be, and is hereby vested in our said children on the terms and for the uses as hereinafter set forth; the said trustees as hereinbefore named shall have the sole exclusive management and control of the said estate during the term of this trust.
They may sell and dispose of the whole or any part of said estate for such prices and on such terms and conditions as they may see fit; they may mortgage and encumber the same; they may reinvest the proceeds of the whole or any part derived from the sale of the said property as they may see fit; they are hereby authorized to control, manage and conduct the present business in which the said John Guitar Sr. *1418 is engaged, fully and freely as if they owned said property in absolute right and fee simple: They may conduct the said business under whatever name or names they may see fit, and may sell all or any portion of our present business and engage in other business and enterprises of any kind that they may see fit, and they may do all things necessary, convenient and proper in the management and conduct of any business they see fit, using the whole or any part of said estate which is hereby conveyed to them for said purposes.
But the beneficial interest of said property is hereby declared to be in all of our said children to-wit: John Guitar Jr., Repps B. Guitar, Earl Beal Guitar, Virginia Witherspoon, wife of Guy P. Witherspoon, Laura O. Belcher, wife of John C. Belcher, Mary Guitar, Katherine Guitar, and Ruth Guitar.
The said trustees shall make an accounting with the beneficiaries herein once each year during the term of this trust, and the trustees shall, at their option declare a dividend out of any profits that may have accrued to said estate, which may be paid to each of the beneficiaries herein named, or retained in the business as the trustees may determine.
To be included*1419 in the administration of the trust estate herein shall be paid a reasonable compensation to the trustees for their services which may be determined by themselves.
The beneficiaries hereunder will have no voice in the control and management of said estate, and they shall not mortgage or encumber their beneficial interest, or in any wise dispose of said interest until they have received same from the trustees.
In the ordinary management of the business affairs of said trust estate any one of the said trustees may act and bind the estate except in the conveyance of the real estate, in which it will be necessary for at least two trustees to join.
Should any of the beneficiaries named herein die during the term of this trust, the beneficial interest in same shall be held for his or her descendants if any, share and share alike, and if said beneficiary should die without leaving any issue, the interest of said beneficiary in said trust estate [shall] revert to and become the property of the remaining beneficiaries named herein, to be held in common by them and their descendants.
This trust is to continue five years after the death of John Guitar Sr., when the trustees shall*1420 either terminate or continue the same if they should so elect, but in any event this trust shall terminate within twenty-five years after the death of the said John Guitar Sr.
* * *
*1218 The foregoing instrument was filed for record in Taylor County, Texas, the county in which the petitioner's principal office was located, on December 1, 1922, and was duly recorded in the deed records of said county on December 13, 1922. Thereafter the instrument was duly recorded in the County of Mitchell, December 23, 1922, where property of the petitioner was located. It was also recorded in other counties where the settlors of the trust had property.
Some time after the aforesaid instrument was executed, the grantors duly executed the following instrument, purporting thereby to supplement the provisions contained in the original instrument:
SUPPLEMENT TO TRUST DEED AGREEMENT DATED DECEMBER 30th, 1921, and filed for record December 23rd, 1922.
This supplement made to cancel paragraph three page five of the original deed of trust which is as follows:
"The said trustees shall make an accounting with the beneficiaries herein once each year during the term of this trust, and*1421 the trustees shall, at their option declare a dividend out of any profits that may have accrued to said estate which may be paid to each of the beneficiaries herein named, or retained in the business as the trustees may determine."
AND TO SUPPLEMENT THEREFOR THE FOLLOWING:
The said trustees shall make an accounting with the beneficiaries herein once each year during the term of this trust, and each of the ten beneficiaries is to be credited with one tenth of the annual income of this trust estate or charged with one tenth of the loss whichever the case may be, this income may be drawn out at any time by the beneficiaries, the beneficial interest however must remain intact until the final termination of the trust and is subject to all the conditions named in the original deed of trust.
Witness our hands this January 10th, A.D. 1922:
JOHN GUITAR, SR.
LAURA O. GUITAR.
The foregoing supplement was filed for record in Taylor County, Texas, on March 12, 1924, and was duly recorded on the following day. Thereafter the instrument was recorded in the various counties in which property of the petitioner was located.
The properties conveyed by the grantors had previously been*1422 managed and operated by John Guitar, Sr., and his two oldest sons, John Guitar, Jr., and Repps B. Guitar, who, together with their father, are named as trustees in the above instrument. John Guitar, Jr., handled the cotton business, the ginning business, and the business transacted in the Abilene territory; Repps B. Guitar stayed at Big Springs, Texas, 100 miles west of Abilene, where he handled the ranches and the cattle business; and John Guitar, Sr., supervised and directed all these various business activities. After the execution of the trust agreement, the said businesses were carried on in the same manner as prior thereto and each trustee continued to decide questions arising in his particular business as he had done prior to assuming *1219 his fiduciary capacity. John Guitar, Sr., and John Guitar, Jr., being located in Abilene and in adjacent offices in the same building, sometimes discussed their business transactions together, but the three trustees never met for business purposes.
The beneficiaries of the trust never held a meeting, nor did any of them ever assign or attempt to assign any part or all of his or her beneficial interest. No certificates of interest*1423 were ever issued to any of the beneficiaries.
The transfer of properties evidenced by the trust instrument was recorded on petitioner's books of account by the following entries, bearing date of December 31, 1921:
| Jno. Guitar Invested Capital, (Tr.) | $1,079,335.80 | |
| Jno. Guitar, Sr., Invested Capital | $107,933.58 | |
| Mrs. Jno. Guitar, Invested Capital | 107,933.58 | |
| Jno. Guitar, Jr., Invested Capital | 107,933.58 | |
| Repps B. Guitar, Invested Capital | 107,933.58 | |
| Earl B. Guitar, Invested Capital | 107,933.58 | |
| Mrs. Virginia Witherspoon, Invested Capital | 107,933.58 | |
| Mrs. Laura O. Belcher, Invested Capital | 107,933.58 | |
| Miss Katherine Guitar, Invested Capital | 107,933.58 | |
| Miss Mary Guitar, Invested Capital | 107,933.58 | |
| Miss Ruth Guitar, Invested Capital | 107,933.58 |
At the end of each year thereafter one-tenth of the profits of the business as shown by the books was credited to the invested capital account of each beneficiary. Entries made in petitioner's journal December 31, 1923, will serve as an illustration of similar entries made for the several taxable years. They are as follows:
| December 31 | ||
| P & L | $150,555.27 | |
| To Invested Capital Jno. Guitar | $15,055.52 | |
| To Invested Capital Mrs. Laura O. Guitar | 15,055.53 | |
| To Invested Capital Jno. Guitar, Jr | 15,055.52 | |
| To Invested Capital Repps B. Guitar | 15,055.52 | |
| To Invested Capital Earl B. Guitar | 15,055.53 | |
| To Invested Capital Mrs. V. Witherspoon | 15,055.53 | |
| To Invested Capital Mrs. Laura O. Belcher | 15,055.53 | |
| To Invested Capital Mrs. Katherine Woods | 15,055.53 | |
| To Invested Capital Miss Mary Guitar | 15,055.53 | |
| To Invested Capital Miss Ruth Guitar | 15,055.53 | |
| Distribution of net profit year 1923. |
*1424 No ledger sheets were introduced in evidence showing how these journal entries appeared on the ledger.
At or about Christmas time in 1924, 1925 and 1926, the petitioner gave $420, $960 and $645, respectively, to a few of its old employees, some of whom had worked under John Guitar, Sr., for thirty-three years. The explanation appearing in petitioner's books of account with respect to each of the entries reflecting these disbursements is the single word "Christmas."
*1220 In 1926 the petitioner contributed $100 into a special fund raised by the Abilene Chamber of Commerce to resurface with gravel a road running between Abilene and Markel, the first town west of Abilene. The petitioner used this road to haul cotton from that territory to its gins in Abilene. The road is a part of the Bankhead Highway, extending to El Paso, and was 25 miles away from petitioner's nearest farm. Petitioner had several storehouses in Abilene and the highway served that town.
On March 13, 1923, the petitioner filed with the collector of internal revenue at Dallas, on Form 1041, a fiduciary return of income for 1922, upon which was typed the statement, "Supplemental Detailed Report to*1425 Follow." In the schedule entitled "Beneficiaries' Shares of Income and Credits" on said return the petitioner allocated the total net income of $59,225.04 among the ten beneficiaries. On or about April 7, 1923, the petitioner filed a "Supplement to Form 1041 year 1922," which showed in detail how the total net income of $59,225.04 was computed. On May 30, 1924, an amended fiduciary return of income for 1922 was filed with the collector, showing a total net income of $67,420.77, which was allocated on said return among the ten beneficiaries. The explanation on the amended return of the additional income reported for 1922 states that amount of such income was unknown until the latter part of 1923, after an audit of the Pardue & Guitar partnership of Loving, New Mexico.
On March 14, 1924, petitioner filed with the collector of internal revenue at Dallas, on Form 1041, a fiduciary return of income for 1923 upon which was typed the statement "Supplemental Detailed Report to Follow." On said return the petitioner reported a total net income of $148,804.82, which included dividends of $1,000, and showed the share of each beneficiary as one-tenth of the dividends and income. On April 21, 1924, petitioner*1426 filed with the collector a "Supplement to form 1041, year 1923," giving in detail the figures which resulted in the net income of $148,804.82 previously reported. For the taxable years 1922 and 1923, and prior to filing the tentative returns on Form 1041 for those years, petitioner secured permission from the Commissioner of Internal Revenue to file supplemental returns as a fiduciary at a later date and these supplemental returns were filed within the time of the extensions as granted by the Commissioner.
Under date of February 28, 1925, the petitioner applied for a thirty-day extension to file the income-tax return for the year 1924. The letter granting such extension reads in part as follows:
An extension of time to April 15, 1925, is hereby granted within which to complete the returns of the above-mentioned taxpayers [the Guitar Trust Estate and the individual beneficiaries] provided tentative returns are filed with the*1221 proper collector of internal revenue on or before March 15, 1925 and payment made at that time of at least one-fourth of the total estimated tax shown thereon to be due.
* * *
By a "tentative return" is meant a return on the appropriate*1427 income tax form, showing only the name and address of the taxpayer and the estimated amount, if any, of the tax due. The items and schedules shown on the form need not be filled in. [Italics supplied.]
* * *
On March 12, 1925, the petitioner filed a fiduciary return for 1924 on Form 1041, which was marked "Tentative Return," and on whcih the net income was reported as $20,000. No distribution of this sum was shown on said return, nor were any of the other items or schedules filled in. On April 14, 1925, the petitioner filed with the collector of internal revenue at Dallas, on Form 1041, a fiduciary return of income for 1924, which reported a total net income of $105,355.70, and showed the share of each beneficiary as one-tenth of the total income, but no other items or schedules on said return were filled in. Thereafter, and on or about May 27, 1925, the petitioner filed a "Supplement to Form 1041" for the year 1924, showing in detail how the total net income previously reported was computed.
On March 13, 1926, the petitioner filed, on Form 1041, a fiduciary return of income for 1925 marked "Tentative," which showed an estimated share for each beneficiary of $10,000. *1428 On May 15, 1926, the petitioner filed, on Form 1041, a fiduciary return of income for 1925, marked "Amended," which gave in complete detail the computations, resulting in a total net income of $121,513.23. The total net income reported for 1925 included dividends of $4,000, which, together with the other income, was allocated one-tenth to each beneficiary. The total net income reported for 1926 included $2,890 in dividends on stock of domestic corporations.
Upon auditing petitioner's returns for the years in question the respondent determined that petitioner was an "association" and, therefore, that the net income of the trust for each year was taxable at corporate rates. The payments to employees during 1924, 1925 and 1926 were disallowed as deductions, upon the theory that said payments were Christmas gifts. The $100 contribution to Abilene Chamber of Commerce was disallowed as a deduction, upon the theory that this contribution bore no reasonable relationship to the current business of petitioner so as to constitute it an ordinary and necessary expense of the business.
The deficiency notice is dated December 21, 1927, and contains the following statement: "The adjustments*1429 which result in the additional tax shown above have been explained in detail in the report of the *1222 internal revenue agent, who investigated your books of account and records, a copy of which was furnished you."
Petitioner introduced in evidence the revenue agent's report above referred to. With reference to penalties, the revenue agent's report recommended as follows:
For each of the years 1922 to 1926, the trust estate filed a fiduciary return on form 1041 on which the entire income was shown as having been credited or distributed in ten equal shares to the ten trustees. Inasmuch as the Bureau has ruled under date of August 18, 1927 * * * that the trust estate is subject to tax as an association under Art. 1504, Regulations 69, and is subject to the delinquency penalty of 25 per cent for failure to file returns as an association on form 1120, the tax liability is adjusted in accordance therewith in this report.
OPINION.
BLACK: The principal issue involved in this proceeding is whether petitioner is a trust taxable, if at all, under the provision of section 219 of the applicable revenue acts, or whether it is an association taxable as a corporation.
*1430 Section 2(a)(2) of the applicable revenue acts says: "The term 'corporation' includes associations, joint stock companies and insurance companies." Clearly, petitioner is not a joint stock company such as the Supreme Court held taxable as a corporation in . In that case, R. M. Waggoner and associates entered into a written agreement which provided for the formation of an "unincorporated joint-stock association to be known as Burk-Waggoner Oil Association" and the agreement entered into carried out the purposes of the parties. The Supreme Court, in discussing the nature of joint stock companies, said:
Unincorporated joint stock associations, although technically partnerships under the law of many states, are not in common parlance referred to as such. They have usually a fixed capital stock divided into shares represented by certificates transferable only upon the books of the company, manage their affairs by a board of directors and executive officers and conduct their business in the general form and mode of procedure of a corporation. Because of this resemblance in form and effectiveness, these business*1431 organizations are subjected by the act to these taxes as corporations.
We think it requires no argument to hold that under the above quoted definition of joint-stock companies, petitioner does not fit into the classification. It had no fixed capital stock; it issued no shares represented by certificates transferable only upon the books of the company; it had no board of directors and executive officers, unless the three trustees might be classified as such; and it did not conduct its business in the general form and mode of procedure of a corporation.
*1223 In , the Supreme Court, in discussing the meaning of the word "association" as used in the applicable revenue act, said:
The word "association" appears to be used in the Act in its ordinary meaning. It has been defined as a term "used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise."
In applying the above definition to one of the trusts which it had before it, the court held that the Hecht Real Estate Trust, which had been*1432 established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common, was an association taxable as a corporation. On that point the court said:
The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, remove a trustee, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder.
In the instant case no certificates of beneficial interest were issued and the beneficiaries*1433 had no power to sell or dispose of their interest in the trust corpus. The trust instrument specifically provided:
The beneficiaries hereunder will have no voice in the control and management of said estate and they shall not mortgage or encumber their beneficial interest, or in any wise dispose of said interest, until they have received same from the trustees.
Also, the instant case does not present a situation where parties owning property as tenants in common (as in the Hecht Real Estate Trust) voluntarily associate themselves together under the trust agreement to operate the property for business purposes. The eight children of the settlors of the trust in the instant case owned no interest whatever in the property at the time the trust deed was executed. They knew nothing about the plans for its execution until after its actual execution. It is clear that the purpose to be accomplished by the execution of the trust deed was to make a donation by the settlors of the trust to their children of an equal interest in their property, after they had reserved a share each to themselves, and to accomplish this without dividing the property. This purpose *1224 was explained*1434 by John Guitar, Sr., one of the settlors of the trust, in his testimony at the hearing as follows:
Q. Mr. Guitar, will you explain to the Board what the reason was for the creation of this trust?
A. Well, my wife and I had accumulated a right smart property, and had a large family of children, and they were all getting grown, and it kind of puzzled us how to best handle the property for the children. We first thought we would divide it up by deeding a special piece to each child, but saw we couldn't make a proper division that way by doing that; and we finally decided the best thing to do was to deed it to a trustee to carry it on the same way, each child having an interest in the property. We wanted each child to have the same interest exactly that the other one had.
This sort of an arrangement is, we think, very different from that which was made by members of the Hecht family when, as owners and tenants in common of real estate in Boston, used for offices and business purposes, they voluntarily associated themselves together in the Hecht Real Estate Trust to hold and operate the property for business purposes. We think the distinction between that situation and the*1435 one we have before us in the instant case, was well stated by the court in , wherein the court said:
* * * A distinction is to be made between an agreement between individuals in the form of a trust and an express trust created by an ancestor, although they may have some features in common. The controlling distinction is that one is a voluntary association of individuals for convenience and profit, the other a method of equitably distributing legacy or donation. Congress has recognized this distinction, classing the former as associations, to be taxed as corporations, and at the same time providing for a separate and distinct method of taxing the income of estates and trusts created by will or deed, classing them together for that purpose. Section 219, Revenue Act of 1921 (42 Stat. 246).
We followed , in .
In our judgment the evidence shows that the chief purpose of the trust deed which we have before us for construction was the equitable distribution of donations which the settlors desired to make to their*1436 children without the necessity of immediate partition. We think petitioner was the sort of an entity which Congress intended to tax as a trust under the provisions of section 219 of the applicable revenue acts. We, therefore, sustain petitioner's assignment of error (a) and hold that respondent erred in seeking to tax petitioner as an association taxable as a corporation.
The next issue for our determination is whether or not the income of the trust or any part of it in each of the taxable years is, under section 219 of the applicable revenue acts, taxable to the petitioner *1225 as a fiduciary or whether the income was taxable to the several beneficiaries in proportion to their respective shares. Petitioner in its petition alleges that it filed information returns on Form 1041, giving information as to the correct amount of the income of the trust for each of the taxable years and showing the beneficiaries among whom it was apportioned and that each of these beneficiaries in turn reported the amount which was apportioned to him and that this was the correct method of handling the matter under section 219 of the applicable revenue acts.
Plainly, under the provisions*1437 of section 219 of the applicable revenue acts, the income of a fiduciary may fall into several classifications:
(1) Income which the fiduciary is under a mandatory duty to accumulate and hold for future distribution under the terms of the will or trust. This kind of income is taxable to the fiduciary and not to the beneficiaries.
(2) Income which the fiduciary is under a mandatory duty to distribute "periodically, whether or not at regular intervals" says the 1921 Act. "Currently" say the 1924 and 1926 Acts. So much of the income as falls within this classification is taxable to the beneficiaries and not to the fiduciary. And this is true, whether the income is actually distributed or not. .
(3) Income which in the discretion of the fiduciary may be either distributed or accumulated.
The 1921 Act does not by express language contain this latter classification (3), but this Board has construed it to have that meaning. ; *1438 ; . This classification is expressly made in section 219 of the 1924 and 1926 Acts. Where this kind of income comes into the hands of the fiduciary and he exercises the discretion vested in him to accumulate, the income is taxable to the fiduciary and not to the beneficiaries. . But in cases where the fiduciary exercises his discretion to distribute, then all such income as is paid or properly credited during the taxable year to the beneficiary is taxable to the beneficiary and not to the fiduciary.
Into which one or more of the above classifications does petitioner's income fall? To answer this question will require an examination of the original trust deed dated December 30, 1921, and the purported supplement to the trust deed bearing the alleged date of January 10, 1922.
*1226 The original trust deed contains the following paragraph with reference to income:
The said trustees shall make na accounting with the beneficiaries herein once each year during the terms*1439 of this trust and the trustees shall, at their option, declare a dividend out of any profits that may have accrued to said estate, which may be paid to each of the beneficiaries herein named, or retained in the business as the trustees may determine. [Italics supplied.]
Under the above quoted provision it is plain that the trustees are not under any mandatory duty to distribute the income of the trust, but are given the option to either accumulate income or to declare dividends and pay them. If this is the clause which was operative during the taxable years, it would being the income of the fiduciary within classification (3) which we have enumerated, and the question as to whether the income is taxable to the fiduciary or is taxable to the beneficiaries depends upon how the trustees exercised their discretion - upon what they actually did. Petitioner contends however that the supplement was operative during each of the taxable years and not the above quoted clause of the original deed, and that the trustees were required under the supplement to distribute the income and therefore the income was taxable to the beneficiaries and not to the fiduciary. Respondent disputes*1440 the effectiveness of the alleged supplement at any time, and contends that it was a mere nullity, and that, acting under the authority of the original trust deed, the trustees exercised their option to accumulate income rather than to declare dividends, and therefore all the income for each of the taxable years is taxable to the fiduciary except comparatively small amounts which were actually distributed to the beneficiaries in the respective taxable years and which are not in dispute. In the alternative, petitioner contends that even if the supplement were not effective, the action of the trustees in dividing the net income in each of the taxable years into ten equal parts and crediting same to the invested capital account of each of the beneficiaries, was, under the above quoted paragraph of the original deed, an exercise of the discretion to declare and pay dividends and was equivalent to an actual distribution and made the income taxable to the beneficiaries in proportion to their respective shares and not to the fiduciary.
Before passing upon these respective contentions of respondent and petitioner, we shall decide whether or not the alleged supplement to the original trust*1441 agreement was effective and, if so, when it became effective. If it was effective in all the taxable years, then we think it placed a mandatory duty upon the trustees to distribute currently the income of the trust to the beneficiaries and that such income would be taxable to the beneficiaries and not to the fiduciary, and this would be true whether such income was actually distributed or not.
*1227 Said supplement purported to substitute for the already quoted paragraph of the original trust deed a paragraph reading as follows:
The said trustees shall make an accounting with the beneficiaries herein once each year during the term of this trust, and each of the ten beneficiaries is to be credited with one-tenth of the annual income of this trust estate or charged with one-tenth of the loss whichever the case may be, this income may be drawn out at any time by the beneficiaries, the beneficial interest, however, must remain intact until the final termination of the trust and is subject to all the conditions named in the original deed of trust. [Italics supplied.]
This supplement purports to have been executed and delivered*1442 only 11 days after the original trust deed and practically contemporaneously therewith, but evidently this is not true.
This purported supplement mentions as a part of its heading the recording of the original trust deed and gives the date of one of its recordings, to wit, December 23, 1922, which was nearly one year after the date of the execution of the original trust deed, to wit, December 30, 1921. Manifestly, if the purported supplement was in fact executed on the date which it purports, to wit, January 10, 1922, it could not have made mention of the recording of the original trust deed, which took place in one of the counties on December 23, 1922. The supplement can not be treated as having been contemporaneously executed with the original trust deed.
The certificate of recording attached to this supplement shows that it was first filed for record in Taylor County, Texas, on March 12, 1924, and was duly recorded the next day, March 13, 1924. The date which this supplement bears manifestly not being the correct date of its execution, and no evidence having been offered showing the true date on which it was executed and having no information on that point, we think that*1443 the earliest date that it should be held to be effective is the date when it is shown to have been filed for record, to wit, March 12, 1924. We hold, therefore, that the taxable years 1922 and 1923 are unaffected by it, and that as to those taxable years the rights and obligations of the parties must be determined by the original trust deed. This, as we have already stated, created a trust wherein was vested in the trustees the option to distribute or not as they saw fit. Was the manner of crediting on the books of petitioner to the "invested capital" accounts of the several beneficiaries within the taxable years 1922 and 1923 such a "proper paying or crediting" to the beneficiaries, within the meaning of the law, as makes the income taxable to the beneficiaries and not to the fiduciary?
Respondent contends that the alleged credits to the beneficiaries were not of such a nature as to finally and irrevocably place the amounts at the disposal of the individual beneficiaries. "The fact that they made no attempt to withdraw the amounts except in relatively *1228 small amounts, coupled with the fact that the credits were not made to individual accounts payable but to the*1444 same 'invested capital' accounts to which the corpus of the trust had theretofore been credited," says respondent, "indicates unmistakably the intention to retain the amounts in the business rather than to subject the amounts to the free disposition of the individual beneficiaries."
We think respondent must be sustained in these contentions. Petitioner relies on An examination of the facts in that case will show that the settlor of the trust made it mandatory on the trustees to distribute 50 per cent of the dividends from certain stocks to his children and left it in their discretion as to whether they would distribute the remaining 50 per cent of the dividends to said children or use it in the improvement of the property from which the dividends were derived. In all the taxable years involved in that proceeding and in years prior thereto the trustees had not only distributed the 50 per cent of the dividends which had been made mandatory upon them, but also had distributed in each year the remaining 50 per cent of the dividends as to which they had a certain amount of discretion. On these facts we held that the entire*1445 income of the trust was income to be "periodically" distributed to the beneficiaries within the meaning of the Revenue Acts of 1918 and 1921 and was taxable to the beneficiaries and not to the fiduciary. Only by holding in the instant case that the credits made in 1922 and 1923 to the "invested capital" accounts of the several beneficiaries were in the same category as the actual distributions of income which the trustees made in the Scripps case, would we be justified in holding that the same rule applied to both cases. Such a holding we do not think would be justified.
The situation which we have in the instant case is also different from that which existed in , wherein the court held that the action of the trustees in dealing with the income of certain minor beneficiaries was equivalent to a distribution to them within the taxable years and that the income was therefore taxable to the beneficiaries and not to the fiduciaries. In that case the facts showed that the trustees purchased, with the surplus income of the minor beneficiaries within the years it was available to them, separate securities and within the same*1446 years segregated these securities from the corpus of the estate and kept them separate as the property of these minor children. The court held that this action was a "distribution" within the taxable year within the meaning of section 219 of the revenue act.
In the instant case we have no such facts before us. There was no investing of the income of each beneficiary in separate securities and segregating these securities from the rest of the corpus of the estate. As respondent points out, there was not even a crediting *1229 to the personal account of each beneficiary, but only a crediting to the "invested capital" account of each beneficiary, thus evidencing an intention to keep these profits in the business rather than to distribute them.
Under the circumstances which we have narrated, we think the trust income credited to the invested capital accounts of the beneficiaries in 1922 and 1923 was not a proper paying or crediting within the meaning of the law and is taxable to the fiduciary and not to the beneficiaries. Cf. *1447 .
As to the taxable years 1924, 1925 and 1926, we hold that the supplement to the original trust deed which was executed by the settlors of the trust, and appears to have been acquiesced in and acted upon by all the parties, was effective from the date it was filed for record and governs the taxable years 1924, 1925 and 1926. For reasons which we have already stated, we can not hold it effective for any time earlier than the date of its recording because plainly it was not executed on the date which it purports to bear. Under the paragraph of the supplement relating to disposition of income, and which was to take the place of the paragraph in the original trust deed relating to the same subject matter (both of which we have already quoted), we hold that it was mandatory upon petitioner to make annual distribution of its income to the beneficiaries and that petitioner is entitled to take as deductions under section 219(b)(2) of the Revenue Acts of 1924 and 1926, the amount of the net income shown by its books at the end of each of the taxable years 1924, 1925 and 1926. This is true, even though the crediting of the income to the*1448 "invested capital" account of the respective beneficiaries on petitioner's books did not, as we have already held, amount to an actual distribution of such income to the beneficiaries. For, where the trust instrument makes it mandatory on the trustees to distribute the income "currently" to the beneficiaries, it is taxable to them and not to the fiduciary, whether it is actually distributed or not. , and other cases there cited.
The next issue relates to penalties asserted by respondent for all the taxable years, except 1926, as to which respondent has conceded error in assessing the penalty.
Our holding that petitioner's income for 1924 and 1925 is taxable to the beneficiaries and not to the fiduciary does away with the issue of penalties for those two years, for as the penalties asserted are ad valorem penalties, there can be no penalties if there is no tax.
This leaves us only to decide whether the Commissioner's assessment of penalties for 1922 and 1923 should be approved. In determining the validity of the respondent's action in assessing these penalties, it must be remembered that the fiduciary reported income *1230 *1449 on a calendar year basis and must, therefore, under the provisions of section 227(a) of the Revenue Act of 1921, make its return "on or before the 15th day of March." This section allows the Commissioner to grant extensions of time for filing returns, the provisions of the 1921 Act with respect thereto reading as follows:
The Commissioner may grant a reasonable extension of time for filing returns whenever in his judgment good cause exists and shall keep a record of every such extension and the reason therefor.
The return required by the statute is one which will show specifically the items of gross income and the deductions and credits allowed by the revenue acts. The law makes no provision for so-called "tentative" returns, which have become more or less familiar by virtue of the fact that the respondent is authorized to grant an extension of time for filing a return. This authority in the respondent to grant extensions is, no doubt, the basis for his regulations that a taxpayer may be required to file a tentative return on or before the due date in procuring an extension of time. Article 443, Regulations 62 and 65.
In this proceeding the trustees, for each of the taxable*1450 years 1922 and 1923, filed on or prior to the due date the so-called "tentative" returns. We find from a consideration of all the evidence that, for each of the years 1922 and 1923, prior to filing the tentative returns petitioner had secured permission from the Commissioner to file completed returns at a later date and that such completed returns were filed within the time as extended by the Commissioner. Under these circumstances no penalties should be imposed and we sustain petitioner's assignment of error (c).
It is unnecessary for us to rule upon petitioner's assignments of error (e), (f), (g) and (h), because they relate to deductions claimed by petitioner in years in which we have held the fiduciary is not taxable on the income involved. Even if we decided these issues in favor of respondent, it would only serve to increase the taxable income of the several beneficiaries, because we have already held that under the supplement effective for 1924, 1925 and 1926 all the net income of the estate was distributable to the several beneficiaries and was therefore taxable to them and not to the fiduciary. We do not have the beneficiaries before us and hence it would be irrelevant*1451 to decide the above issues.
Respondent's alternative contention to the effect that if the Board finds and determines that the petitioner is taxable as a fiduciary, the petitioner's taxable net income for each of the years 1922 to 1926, inclusive, has been understated by the Commissioner through failure to include in net income the dividends from domestic corporations which were reported by the petitioner in its information returns, is sustained as to the years 1922 and 1923. In a recomputation of the *1231 deficiencies for those years, such dividends should be included in petitioner's net income and the deficiencies increased accordingly, if it has that effect.
Reviewed by the Board.
Decision will be entered under Rule 50.
MARQUETTE and SEAWELL dissent.