*1160 1. Under the terms of the trust deed here involved it is held that only a single trust estate with specified beneficiaries was created. J. C. Wynne et al., Trustees,28 B.T.A. 125">28 B.T.A. 125, followed.
2. In the circumstances herein an amount paid from the corpus of the trust to satisfy claims against the trustors which in part existed at the date of the execution of the trust deed is held to be the discharge of obligations assumed by petitioner when it acquired assets subject to execution for the debts of such trustors. The amount so paid is not an operating expense, a loss, or additional capital investment.
*222 The respondent has determined deficiencies in income tax for the years 1924, 1925, 1926, 1928 and 1929 in the respective amounts of $5,178.29, $16,379.86, $10,726.32, $905.32 and $1,396.59. For its causes of action petitioner asked that the following questions be considered:
(a) Whether income received by petitioner is to be taxed as the income of one trust or as that of three separate trusts.
*1161 (b) Whether in determining income for the years 1925 and 1926 respondent erroneously disallowed depletion in respect of certain oil property.
(c) Whether for the same years respondent erroneously treated certain sums received from the American Refining Company, Inc., in respect of preferred stock in such company held by petitioner as taxable devidends.
(d) Whether petitioner is entitled to treat as an expense, loss or additional capital investment, a large amount paid out of court in 1928 to settle a controversy with receivers of the American Refining Company, Inc., et al., and the attorneys' fees paid in connection therewith.
(e) Whether petitioner sustained a net loss in 1928 that may be applied to the reduction of taxable income in 1929.
At the hearing issues (b) and (c) were settled by stipulation and only (a), (d) and (e) remain for consideration. The parties filed a stipulation, from which we make the following findings of fact.
FINDINGS OF FACT.
The petitioner is a Texas corporation, with its principal office at Wichita Falls, and is the trustee under an express trust for P. P. Langford, Jr., B. H. Langford and Sarah E. Langford, all of whom reside at Wichita*1162 Falls and were minors throughout the years involved in this controversy.
*223 On November 6, 1920, P. P. Langford and his wife, Lula H. Langford, executed a trust deed which included the following terms and conditions which are material to the issues of this proceeding:
That we, P. P. Langford and wife, Lulu H. Langford, of the County of Wichita and State of Texas being desirous of creating a trust for the benefit of the children hereinafter named, do hereby, for and in consideration of the sum of Ten ($10.00) Dollars to us cash in hand paid by the City National Bank of Commerce, and for the love and affection that we bear to our said children, do grant, bargain, sell, convey, transfer and assign unto the said City National Bank of Commerce, a corporation, duly incorporated, of Wichita Falls, Texas, Trustee, and to its successors, all and singular, the following described property, situated in the County of Wichita and State of Texas, and more particularly described as follows, to-wit:
An undivided one-third interest in and to the following described properties:
* * *
To have and to hold the above described property, together with all and singular, the rights and*1163 appurtenances thereunto in anywise belonging, unto the said City National Bank of Commerce and to its successors and substitutes in this trust, and to its and their assigns forever, and we do hereby bind ourselves, our heirs, executors and administrators to warrant and forever defend all and singular said property unto the said City National Bank of Commerce, Trustee, and to its successors and substitutes in this Trust, and to its and their assigns forever, against any person or persons whomsoever lawfully claiming or to claim the same or any part thereof.
This conveyance is made to the said Trustee for the use and benefit of the following named persons, and in the following proportions to each:
An undivided one-third interest in said property in trust for Pierce P. Langford, Jr. An undivided one-third interest in said property in trust for Benjamin H. Langford. An undivided one-third interest in said property in trust for Sarah Elizabeth Langford and will vest in the Trustee, for the benefit of said beneficiaries each an undivided one-ninth interest in the whole of the above described properties.
The Trustee herein named, and its successors or substitute in this Trust, are*1164 hereby given authority and power to sell and convey any or all of said trust estate above described, at any time said Trustee, or its successor or substitutes, sees fit, and upon such terms and conditions as the said Trustee, acting by and through its duly qualified officers, may seem just and proper, granting to the said Trustee full power and authority to make all contracts of any kind or character for the management and operation of said property, to mortgage said property, to reinvest the funds received from the sale of said property, and to do everything necessary or proper in the judgment and discretion of said Trustee, for the faithful management, sale, disposition and handling of said Trust Estate.
The Trustee shall use ordinary and reasonable diligence in the performance of this Trust, and shall not be liable to the beneficiaries, or either of them, for any act, default, failure or neglect in connection with the execution of said Trust, provided said acts do not constitute fraud, embezzlement or wilful breach of trust and the Trustee shall not be in any manner liable for any debt or liability incurred in the management of said Trust Estate.
The Trustee herein shall have*1165 the power and authority at its discretion, to expend and use the income from said trust estate for the maintenance, education and support of said beneficiaries.
*224 This Trust Estate shall cease and determine, as to each beneficiary interested therein, when said beneficiary, and each of them, arrive at the age of twenty-five (25) years, and the Trustee, thereupon, shall deliver to such beneficiary, who arrives at such age of twenty-five (25) years, said beneficiaries interest or proportion of the Trust Estate hereby created, and from such time said beneficiary shall have full power and authority to dispose of said estate as they see fit. Upon the date of the arrival of said beneficiary, and each of them, at the age of twenty-five (25) years, and Trustee shall convey, assign, transfer and deliver to said beneficiary, and each of them, their respective proportions of said Trust Estate hereby created, which shall vest, however, in said beneficiary or beneficiaries at that time regardless of whether or not the transfer and delivery thereof is made. Provided, however, that in the discretion of the Trustee, it may deliver to said beneficiaries, or either of them, its or their*1166 respective proportions of the Trust Estate hereby created, at or after the time said beneficiary arrives at the age of twenty-one (21) years, but this provision is not mandatory upon the Trustee, but is solely upon its sound discretion but it is mandatory to deliver to said beneficiaries the trust estate hereby created at the time said beneficiaries, and each of them, arrive at the age of twenty-five (25) years.
In the event of the death of either of the beneficiaries before they reach the age of twenty-one years said beneficiary's interest in said Estate shall vest in the surviving beneficiaries in equal proportion, but if only one survive, then the said estate shall, nevertheless, be held in trust for said beneficiary, or in the event of the death of all of said beneficiaries before the distribution of said Trust Estate, as hereinbefore provided, then the said trust estate shall pass and descend to the legal heirs of said beneficiaries, according to the laws of descent and distribution then in effect in this State.
* * *
Any children which may be born to the said P. P. Langford and wife, Lulu Langford, during their wedlock, shall share equally, share and share alike, under*1167 this trust, with the children named herein and upon the same terms.
* * *
At the time the trust agreement was executed, P. P. Langford was and had been for some time a member of the partnership, American Refining Co., Inc., of Wichita Falls, Texas, and by reason of various endorsements and guarantees, was then liable for all of the partnership liabilities, aggregating several hundred thousand dollars. He also became liable for a large portion of the indebtedness of the American Refining Co., Inc., through endorsement and guarantees. That corporation was organized in 1921.
The partnership and the corporation became heavily involved financially and on August 22, 1927, their property, as well as the properties of seven individuals who were members of the partnership and stockholders of the corporation, were placed in the hands of receivers as a result of a suit brought in the United States District Court for the Northern District of Texas(Universal Oil Products Co. v. American Refining Co.).
*225 This receivership included the personal eatates of P. P. Langford and wife. Inasmuch as the receivers did not find sufficient assets in the personal estates to meet*1168 the claims of creditors, they announced their intention of filing a suit, the object of which would be to have declared invalid the trust deed from Langford and wife, executed November 6, 1920, to the City National Bank of Commerce, as trustee, and to subject the assets then being held by the trust, to the payment of claims against P. P. Langford, as an individual and as a member of the partnership, and as guarantor and endorser of the obligations of the corporation.
Counsel was employed to protect the interests of the trust and/or P. P. Langford, in the threatened litigation. Following discussions and negotiations, on March 16, 1928, a letter was addressed to the receivers, signed "The Langford Investment Co. by W. A. Langford, V.P.", which set out a proposed basis of settlement. It was proposed to deliver to the receivers notes and accounts receivable then held by the trust aggregating $712,445.86, and $75,000 in cash. In addition it was stipulated that Langford and wife would convey to the creditors' committee all their equity in the property theretofore surrendered to the receivers and that Langford would agree to assume one half of all Federal income taxes which might finally*1169 be determined to be owing by the said P. P. Langford and wife for all prior years. The payment of this last named obligation was guaranteed by the Langford Investment Co., trustee. The receivers in return were to agree to the following:
The payments, transfers, cancellations and assignments above proposed, when made, shall operate to settle in favor of said trust and to settle the full liability, if any, of its present assets for the payment of the debts of P. P. Langford and Lulu H. Langford, and an instrument properly executed by the receivers' and creditors' committees acknowledging such validity and containing such release, shall be executed and delivered. The creditors' committee shall in addition release the said P. P. Langford and Lulu H. Langford from all liabilities on all obligations held or controlled by said creditors' committee.
In addition to the above the creditors' committee was to dismiss the bankruptcy petition then pending against P. P. Langford.
The proposals were accepted by the receivers on March 21, 1928, and when presented to court were approved on April 16, 1928, as follows:
And it further appeared to the Court, and the Court so finds that such*1170 settlement is for the best interest of said minors to end all controversies by the said receiver, and said minors and said trust estate, and that it is therefore, ordered, adjudged, and decreed by the Court, that such settlement in all things be confirmed.
*226 The settlement was made under advice of counsel and in good faith. From the inception of the trust, Langford had been in need of ready cash, and this was supplied from time to time by the trust, practically all of the advances or withdrawals being carried in an open account. No interest was paid by Langford to the trust, nor was any interest accrued on the books of the trust against Langford.
The cancellations, transfers and payments finally made in the settlement with the receivers were as follows:
| Date | Item | Amount |
| Apr. 16, 1928 | Check Security National Bank, | $26,481.67 |
| $25,000 note and interest, $1,481.67 | ||
| Apr. 16, 1928 | Check Security National Bank, | 17,940.66 |
| $17,000 note and interest, $940.66 | ||
| Apr. 16, 1928 | Receivers American Refining Co., | 75,000.00 |
| et al., cash | ||
| Apr. 16, 1928 | Surrender and cancellation of notes | 100,000.00 |
| receivable, American Ref. Co. | ||
| P. P. Langford | 57,000.00 | |
| P. P. Langford | 37,500.00 | |
| P. P. Langford | 9,000.00 | |
| May 12, 1928 | Personal account of P. P. Langford | 493,167.61 |
| July 11, 1928 | Note to receivers to cover income | 20,000.00 |
| tax payment of P. P. Langford, personal | ||
| Total | 836,089.94 |
*1171 Immediately preceding this settlement, the net worth of the trust, as shown by its books, was approximately $1,500,000, the assets consisting principally of cash, notes and accounts receivable, ranches, leases, royalties, stocks and bonds.
The payments and transfers made to the receivers enumerated above and the $4,000 attorneys' fees were charged to profit and loss on the books of the trust, and on the fiduciary return filed for petitioner for the year 1928, this $836,089.94 was deducted from gross income as a loss sustained, and the $4,000 attorneys' fees was deducted as legal expense.
If the Board hold that the sums paid in said settlement and as attorneys' fees should be deducted as ordinary and necessary expenses, or as losses, or are to be capitalized and treated as additional cost of the properties remaining on hand, after the settlement was made, there is no dificiency in taxes due for either of the years 1928 or 1929.
OPINION.
LANSDON: At the hearing the parties filed the following stipulation in settlement of issues (b) and (c):
| There shall be deducted from net income | |
| for 1925, as determined by respondent | |
| the following sums: | |
| For depletion erroneously disallowed | $6,379.85 |
| For disbursements from capital made by | 5,250.00 |
| American Refining Company, Inc., and | |
| erroneously treated as dividends | |
| and for the year 1926 for the same reasons: | |
| Depletion | 8,666.26 |
| American Refining Co., Inc., dividends | 7,000.00 |
*1172 *227 In so far as the deficiencies for 1925 and 1926 are affected by the above, they will be adjusted in a recomputation under Rule 50.
In the proceeding at Docket No. 43451, , there was exactly the same question, based on a trust deed substantially similar to that upon which petitioner relies to support the contention stated in issue (a). In that proceeding we affirmed the determination of the Commissioner. Accordingly, on the authority of that decision we hold that the deed here in question created a single trust estate with three beneficiaries, and affirm the determination of the respondent.
Issue (d) raises the question as to whether the amount of $836,089.94 by which the corpus of the trust estate was reduced in the circumstances set out in our findings of fact should be regarded as a loss to the petitioner, an ordinary expense, or additional capital cost of the assets remaining in the corpus for the purpose of computing depletion and depreciation of the properties of the trust in the years 1928 and 1929. The determinstion of the respondent is adverse to all the contentions of the petitioner.
There*1173 is nothing in the record upon which we can base a finding of fact that the amount in question was a business expense incurred or paid by the petitioner in 1928. This expenditure was not in connection with any business which the trustees, under the terms of the trust deed, were authorized to transact. In our opinion petitioner's first claim as to this disbursement must be denied. In the circumstances it is also impossible to discover any legal or factual basis for allowing the amount in controversy as a loss sustained in the taxable year. It satisfied none of the conditions of that section of the Revenue Act of 1928 1 which defines deductible losses. In our opinion the reduction of the corpus of the trust in 1928 as set forth above was not a loss deductible from petitioner's income for that year.
*1174 Petitioner contends if not allowable as a deduction from income either as an expense paid or a loss sustained in the taxable year, then the amount in question should be capitalized and added to petitioner's bases for the depletion and depreciation of the remaining property. The basis for this theory is the allegation that the *228 amounts paid to the receiver of the American Refining Co., Inc., constituted cost of defending title to the property of the petitioner. The threatened suit, however, was not the purpose of attacking title to any of the petitioner's property, but to secure the invalidation of the trust deed, apparently upon the theory that such instrument had been executed for the purpose of fraudulently avoiding payment of debts owed by the trustors. No attack on the title of the petitioner to its property was contemplated and it is clear that if the deed was executed lawfully and in good faith the title of the petitioner to the property conveyed was perfect.
The more reasonable hypothesis is that at the time the property was transferred it was then, in equity at least, impressed with a trust in favor of the creditors of the trustors and that the petitioner, *1175 having acquired such properties without consideration, was liable as a transferee for the debts of the trustors. If this is true, then the assets acquired by the petitioner were in substantially the same position that any property is when transferred subject to a mortgage or other lien. We think this is the true situation here. It is stipulated that the trustors were heavily in debt at the date of the transfer of these properties to the petitioner. There is no evidence that such debts were not greater than the value of the property retained by the trustors. In the circumstances herein we think it was part of the burden of proof of the petitioner to show that the transfers to it did not render the trustors insolvent. There is nothing to show that all the property so transferred was not subject to execution under the laws of Texas for the debts of the trustors. The transaction in question was no more than the discharge of obligations which the trust estate assumed when it received property subject to liens. it merely reduced the corpus of the trust to its unencumbered value and should not be regarded as a capitalizable item.
Attorneys' fees in the amount of $4,000 were paid*1176 in connection with the settlement of the controversy with the receivers of the American Refining Co., Inc. Since we hold that such fees were not paid in defense of title to property, but were incurred in connection with the handling of petitioner's affairs, it is our opinion that this amount is an allowable deduction from income in 1928 as a business expense.
Since the effect of our conclusion above is to affirm the Commissioner's determination that petitioner had taxable income in 1928, the claim for the deduction of a net loss carried forward from that year to 1929 must be denied.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 23. (e) Losses by individuals. - In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -
(1) if incurred in trade or business; or
(2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or
(3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwrick, or other casualty, or from theft.
SEC. 169. The benefit of the special deduction for net losses allowed by section 117 shall be allowed to an estate or trust under regulations prescribed by the Commissioner with the approval of the Secretary. ↩