1943 U.S. Tax Ct. LEXIS 174">*174 Decisions will be entered for respondent.
Income from part of petitioner's interest in family partnership of which he was managing and controlling partner, held, taxable to him notwithstanding assignment to trust for his minor children over which he had broad powers of control. Helvering v. Clifford, 309 U.S. 331">309 U.S. 331.
1 T.C. 1008">*1008 These proceedings put in issue deficiencies in income tax for the year 1939 of $ 2,561.80 for Gayle Geard Armstrong and $ 761.37 for Murphy Shannon Armstrong.
The primary question involved is whether the distributive share of profits of a partnership of which petitioner Gayle G. Armstrong was a member should be increased by the amount of the income attributable to an undivided one-twentieth interest in such partnership alleged to have been transferred in trust by Gayle Armstrong for the benefit of his two minor children.
FINDINGS OF FACT.
The facts stipulated by the parties are found accordingly. These facts, together with other evidence adduced at the hearing, are as1943 U.S. Tax Ct. LEXIS 174">*175 follows:
Gayle Geard Armstrong, hereinafter for convenience referred to as petitioner, is the husband of the other petitioner, Murphy Shannon Armstrong. They filed individual income tax returns for the taxable year in question with the collector of internal revenue for the district of New Mexico at Albuquerque, New Mexico, under the community property laws of that state. The partnership, which was the primary source of petitioner's income, filed its return on an accrual basis and for a fiscal year ending May 31. The returns of petitioner and his wife and the trust, hereinafter mentioned, were filed on a calendar year basis.
For many years prior to June 5, 1937, petitioner and his father, Geard B. Armstrong, had been equal partners in the firm of Armstrong & Armstrong, which was principally engaged in the business of road contracting and livestock ranching. The partnership had been formed when petitioner was 19 years old.
1 T.C. 1008">*1009 On June 5, 1937, petitioner's father died testate. All his assets were community property and under the laws of New Mexico one-half passed to his widow without administration, and the other half under his will was left to his widow, Clara Armstrong, 1943 U.S. Tax Ct. LEXIS 174">*176 and to his four children, petitioner, Geard B. Armstrong, Jr., Jack B. Armstrong, and Iva Armstrong Richardson. Petitioner was named executor of his father's estate and was authorized in his discretion to carry on the partnership business as a partnership for one year after decedent's death. The father expressed the desire in his will that if it was to be continued for longer than one year the business should be incorporated.
The original partnership was dissolved June 5, 1937, on the death of petitioner's father. On July 27, 1937, a new partnership agreement was signed and entered into by petitioner personally, Clara H. Armstrong, and petitioner, as executor of his father's estate, to carry on the business under the firm name of Armstrong & Armstrong. In that agreement the interest of the parties was stated to be as follows: Petitioner, 50 percent, Clara H. Armstrong, 25 percent, and Gayle G. Armstrong, executor, 25 percent. The July 27, 1937, partnership carried on the business under the management of petitioner during the period required for the administration of decedent's estate.
On June 5, 1938, after discussion of the matter of carrying on the partnership business after1943 U.S. Tax Ct. LEXIS 174">*177 the closing of the estate, a new partnership agreement was prepared bearing that date. It was executed October 17, 1938, by petitioner, joined by his wife for community interest purposes, as "party of the first part" and Clara H. Armstrong and petitioner's brothers and sister as "parties of the second." The assets of the partnership consisted, inter alia, of real estate, ranches, farms, a packing house, livestock, equipment, accounts and notes receivable and securities in the sum of $ 40,000 or $ 50,000. The interests of the partners and the basis for allocating profits and losses of the partnership business were stated in the agreement of June 5, 1938, to be as follows:
An undivided 11/20 interest (55%) -- Gayle G. Armstrong
An undivided 6/20 interest (30%) -- Clara Armstrong
An undivided 1/20 interest (5%) -- Iva Armstrong Richardson
An undivided 1/20 interest (5%) -- Geard B. Armstrong, Jr.
An undivided 1/20 interest (5%) -- J. B. Armstrong
Each of the parties was stated to have a voice in the management and control of the partnership business, but it was "mutually agreed" that petitioner was to be given the general management, supervision, and control of the partnership1943 U.S. Tax Ct. LEXIS 174">*178 business. The affairs of the partnership are discussed at length in partnership meetings held at least once a year, and all matters of policy concerning its operations are approved by all the partners. Petitioner has a standing offer to purchase the interest of any dissatisfied partner.
1 T.C. 1008">*1010 On June 5, 1938, petitioner executed a "Declaration of Trust," purporting to transfer as of June 1, 1938, to himself as trustee in trust for the benefit of his two minor children, Billie Bert Armstrong, a son (then 18 years of age), and Gayle Armstrong, a daughter (then 13 years of age), the 5 percent interest in the partnership which petitioner inherited from his father's estate. The trust instrument provided, inter alia, as follows:
That the undersigned Trustee shall have, and is hereby vested with, the following powers and discretions:
* * * *
(b) To borrow, mortgage, pledge, transfer in trust or otherwise encumber all or any portion of the Trust Estate in any manner which to the Trustee may seem desirable, or to the best interest of the Trust Estate.
* * * *
(e) To invest the principal and the income that is accumulated in any property or securities, whether or not permissible1943 U.S. Tax Ct. LEXIS 174">*179 by law for investment of trust funds.
(f) To have and exercise all of the powers and privileges of an owner in reference to bonds, shares of stock and other securities included in or acquired by the Trust Estate in any manner, including, but not limited to, voting, giving proxies, payment of calls, assessments and other sums deemed expedient or advisable by the Trustee for the protection of the interests of the Trust Estate, with the right to participate in voting trusts, pooling agreements, mergers and other devices or arrangements, or reorganizations or proceedings in connection therewith, where in the judgment of the Trustee, it is necessary or advisable or for the protection of the Trust Estate or any portion thereof.
(g) To hold property of the Trust Estate in his own name or in the name of his nominee or appointee, with or without disclosure of fiduciary relationship, and to make the Trust Estate responsible for the acts of any such nominee or appointee affecting such property. To make advances of his own funds to the Trust Estate for any purposes, such advances with interest thereon to constitute a first lien on the whole of the Trust Estate and gross income therefrom, and1943 U.S. Tax Ct. LEXIS 174">*180 to be first repaid out of the gross income, or in the discretion of the Trustee the principal of the Trust Estate. To reimburse himself from the income or principal of the Trust Estate for any loss, liability or expense incurred by reason of his ownership or holding of any property received or held in trust hereunder.
(h) The Trustee shall not be held to account for any losses incurred by the Trust Estate on account of his errors in judgment or discretions made in connection with the handling, control and distributions of the Trust property, and the Trustee's decision in all matters concerning the Trust Estate shall be final and conclusive on all persons interested in this Trust or the Trust Estate. The powers of the Trustee enumerated herein shall not be construed as limiting the powers of the Trustee, but the Trustee shall have power to do and perform every act and thing necessary or incident to such general powers, and in addition thereto is hereby vested with all powers in connection with said Trust Estate which an individual could lawfully exercise over his own individual property or estate.
The instrument further provided that the entire net income was to be accumulated and1943 U.S. Tax Ct. LEXIS 174">*181 become a part of the corpus; that the trust was irrevocable and was to terminate upon Gayle Armstrong's attaining the age of 25 years, when it was to vest equally in the two beneficiaries 1 T.C. 1008">*1011 or in the case of death of one of the beneficiaries upon the survivor's becoming 25 years of age. It was provided that, upon the death of both beneficiaries prior to reaching 25, the trust was to end and the entire trust estate was to vest in their mother. The beneficiaries were "restrained from anticipating, encumbering, alienating, or in any manner assigning their interests in the Trust Estate," and it was provided that the "Trust Estate shall not be subject to the liabilities or obligations of such Beneficiaries, or to judgments or other legal process, bankruptcy proceedings, claims of creditors or others. All income or principal shall be payable and deliverable only and personally to the Beneficiaries hereunder, and said property, or any portion thereof, or income therefrom may be distributed to said Beneficiaries in equal portions at any time deemed advisable by the Trustee." No recordation was made of the declaration of trust with the county recorder of the county where the partnership1943 U.S. Tax Ct. LEXIS 174">*182 business of Armstrong & Armstrong was conducted showing a transfer of any part of petitioner's interest in the partnership business to his two minor children.
On March 4, 1939, petitioner filed a Federal gift tax return reporting the alleged transfer of a 5 percent interest in the partnership in trust for the benefit of his two minor children. The return showed a value of $ 23,821.65 for such interest and resulted in no tax.
Almost immediately after his father's death and during the period of administration petitioner decided to transfer the one-twentieth interest in the partnership which he had inherited from his father to himself as trustee for his two minor children. He discussed the matter with the attorneys for the estate, who were also the attorneys for the partnership, and with the accountant and office manager of the partnership and with all the new partners. Most of the new partners saw the trust instrument and all of them acquiesced in his execution of it. Petitioner's eldest brother went over it carefully. The accountant discussed the declaration of trust with all the partners and went over various drafts of it with petitioner, the attorneys, and all other partners.
1943 U.S. Tax Ct. LEXIS 174">*183 Petitioner's reasons for creating the trust were that he owned a 50 percent interest in the partnership from the beginning, which interest was community property; that the interest he would acquire from his father's estate would be separate property and he desired to avoid the difficulties which might arise out of their commingling; that he desired to express his love and affection for his children by establishing a fund to start them out in life; that he lacked other suitable property to give them; that the partnership interest had just been valued for estate purposes and there would be no question of valuation for gift tax purposes; and that he was interested in having his son work into a position of responsibility in the partnership. Petitioner 1 T.C. 1008">*1012 was advised that the only way he could accomplish his purposes was to make an irrevocable gift. His accountant suggested that he have his attorneys draw an irrevocable trust and that he execute it.
Petitioner's attorneys advised him that he could legally give a fractional interest in the partnership to his children and that as trustee for them he could be a member of the partnership.
The trust agreement and the partnership agreement1943 U.S. Tax Ct. LEXIS 174">*184 were drawn by the same lawyers at substantially the same time. The partnership agreement was completed a little earlier than the trust agreement. They were both in final form and agreed upon by all of the parties in May of 1938. As indicated, the trust agreement was executed June 5, 1938, and the partnership agreement was not executed until October 17, 1938. The execution of the latter was delayed because the various partners were otherwise engaged or away from New Mexico.
The accountant for the partnership was instructed to set up the books of the partnership and record its operations as of June 1, 1938. This he did after discussion with the partners and the attorneys and after reading the trust and partnership instruments. The "presentation" sheet for the fiscal year beginning June 1, 1938, set up after discussion with the partners of their proportionate shares in the partnership, recited that the partnership was composed as follows:
| G. G. Armstrong | 50% |
| G. G. Armstrong, trustee | 5% |
| Clara Armstrong | 30% |
| G. B. Armstrong, Jr | 5% |
| J. B. Armstrong | 5% |
| Iva Richardson | 5% |
When the parties met to execute the partnership agreement on October 17, 1938, the general ledger accounts1943 U.S. Tax Ct. LEXIS 174">*185 and the "presentation" sheet were before them and all of the partners had examined the books or examined them at that time. They knew of the declaration of trust and regarded G. G. Armstrong, trustee, as a member of the partnership. The execution of the partnership contained only one "G. G. Armstrong" signature with no designation of trusteeship.
A similar presentation sheet was included in the general ledger for the next fiscal year and indicated similar interests.
The books of the partnership carried a general control or capital account comprised of the original investment in the partnership business together with the surplus or undivided profits of the business which had not been distributed or credited to the investment accounts of the respective partners. The books contained withdrawal accounts in the name of the various partners listed in the partnership agreement and also withdrawal accounts in the name of G. G. Armstrong, trustee, for each of his minor children. The withdrawal accounts represent the amounts withdrawn and credits and debits made to such accounts of partnership funds and other miscellaneous moneys. The 1 T.C. 1008">*1013 first entries made in the withdrawal accounts1943 U.S. Tax Ct. LEXIS 174">*186 in the name of G. G. Armstrong, trustee for B. B. Armstrong, and G. G. Armstrong, trustee for Gayle Armstrong, were credit transfers from petitioner's personal account entered on March 28, 1939.
During the year 1939 there were no cash withdrawals against the trustee account for distribution to Gayle Armstrong. Petitioner furnished her entire support and maintenance.
All the net income from the interest in question was accumulated until, in the fall of 1939, B. B. Armstrong went away to law school in Virginia, when funds withdrawn from the partnership were used for his support and education. Such sums were charged against the withdrawal account in the name of G. G. Armstrong, trustee for B. B. Armstrong.
There was no bank account in the name of petitioner as trustee for the children. Partnership funds credited on the books to his accounts as trustee were deposited in the bank in the name of the partnership.
Petitioner was never appointed by any court to have the care and management of his minor children's assets.
Clara Armstrong and Iva Armstrong Richardson have never taken active part in the business of the partnership.
Jack B. Armstrong was working for the partnership on a salary1943 U.S. Tax Ct. LEXIS 174">*187 as a construction foreman at the time of the death of his father in 1937. He continued in this capacity for approximately one year and then went into business for himself on financing from the partnership.
G. B. Armstrong, Jr., started to work for the partnership at the time of his father's death and has continued to do so. He has been employed as foreman in the ranch operations, assisting in the management of the livestock and agricultural activities of the partnership. He receives a salary in addition to his share of the partnership profits. His salary at the present time is at the rate of $ 300 per month.
Gayle Armstrong was born July 6, 1924. She has taken no active part in the operations of the partnership. At the time of the gift she was a school girl living at home.
Billie Bert Armstrong was born April 18, 1920, and was 18 years old at the date of the execution of the trust. He has worked as an employee from time to time in the contracting portion of the business, which is the most important activity of the business. He worked for the partnership every summer while he was attending school since he was 13 or 14 years of age, progressing from water boy to timekeeper to1943 U.S. Tax Ct. LEXIS 174">*188 various jobs as foreman to superintendent. He was treated as other employees in similar positions.
During 1938 Billie Bert attended the New Mexico Military Institute's junior college, from which he graduated in the spring of 1939. As previously stated, he then attended the law school of Washington 1 T.C. 1008">*1014 and Lee University. He was given a free rein in both his personal and financial affairs at college without supervision from his father. It was because petitioner thought Billie Bert was old enough to take care of his own affairs and because he wanted him to know how to handle money that he let Billie Bert directly withdraw money as he wished from Billie Bert's account with the partnership.
Petitioner furnished Billie Bert's support during his vacations at home and gave him considerable sums of money from time to time.
When Billie Bert was 11 years old petitioner took out some life insurance on the former's life, payable to Murphy S. Armstrong. From the fall of 1939 Billie Bert paid the premiums on these life insurance policies from his share of the partnership income by checks which were charged to his withdrawal account. Salary and personal funds of Billie Bert were credited1943 U.S. Tax Ct. LEXIS 174">*189 to the withdrawal account from the inception of the trust until January 1, 1940, in the aggregate amount of $ 184.44. Dividends from the other property held for him in the amount of $ 171.67 were also credited to the withdrawal account.
On April 18, 1941, Billie Bert became 21 years of age and petitioner, in accordance with a prior decision to terminate the trust as to Billie Bert, gave him the choice of selling his interest in the partnership for cash or becoming an individual partner in the business, owning outright the interest formerly held in trust. Billie Bert elected to become a partner and by deed dated May 31, 1941, the last day of the partnership's fiscal year, petitioner made the transfer. The deed contained a recital of the formation of the partnership and the declaration of trust, and transferred to Billie Bert "an undivided 1/40 interest in and to the whole of the partnership business of Armstrong & Armstrong." Billie Bert executed on June 5, 1941, an acknowledgment of the receipt of his interest in the trust estate wherein he consented to the dissolution of the trust and released petitioner from any and all liability.
During the year 1941 Clara Armstrong decided 1943 U.S. Tax Ct. LEXIS 174">*190 to give away a 5 percent interest in the partnership to her four children. At petitioner's request she divided his share between his children, Billie Bert's share being given to him outright and the share given to Gayle being added to the trust. Petitioner made this request to avoid acquiring separate property.
To record formally the above changes in the partnership interest all of the partners executed a supplementary partnership agreement wherein petitioner was a party personally and as trustee for Gayle, and Bille Bert was a party in his own right.
Federal individual income tax returns for 1939 were filed for petitioners and their children. Five percent of the partnership net income was allocated to and reported for the children, 2 1/2 percent, respectively, 1 T.C. 1008">*1015 in their returns. Dividends received by the children from other property held for them and the salary earned by Billie Bert during the summer of 1939 were not included and reported in their respective income tax returns nor in that of the parents.
Respondent determined that the "alleged transfer of a one-twentieth interest in the partnership of Armstrong and Armstrong to * * * [the] children did not relieve * 1943 U.S. Tax Ct. LEXIS 174">*191 * * [petitioner] from the income tax liability on * * * [his] portion of the distributive net income of $ 9,888.24 from said partnership interest."
Petitioner remained in control of the trust property, and in substance the owner thereof, and retained direct and indirect benefits from the income.
OPINION.
The effect upon petitioner's tax liability of the purported transfer to his children of a part of his interest in a family partnership seems to us to turn, in this instance, not so much upon the peculiarities of the assignment of partnership shares, cf. , as upon the trust form which petitioner selected to execute the gift and the bearing upon these facts of the principles of .
As in the Clifford case, petitioner placed himself in complete practical control over the property constituting the trust, which here was the partnership interest. He was "to have and exercise all of the powers and privileges of an owner," and was "vested with all powers in connection with said Trust Estate which an individual could lawfully exercise over his own individual1943 U.S. Tax Ct. LEXIS 174">*192 property or estate." As in the Clifford case he was authorized "to hold property of the Trust Estate in his own name or in the name of his nominee or appointee, with or without disclosure of fiduciary relationship." As in the Clifford case, "the Trustee's decision in all matters concerning the Trust Estate shall be final and conclusive on all persons interested in this Trust or the Trust Estate," the beneficiaries could not demand any part of the principal and income until the trust came to an end, and they had no interest which could be anticipated, alienated, "or in any manner" assigned. While the trustee could "invest the principal and the income that is accumulated in any property or securities, whether or not permissible by law for investment of trust funds" and "shall not be held to account for any losses incurred * * * on account of his errors in judgment or discretions," he was entitled "to reimburse himself from the income or principal * * * for any loss, liability or expense incurred by reason of his ownership or holding of any property received or held in trust hereunder," and he could "make advances of his own funds to the Trust Estate for any purposes, such advances1943 U.S. Tax Ct. LEXIS 174">*193 with interest 1 T.C. 1008">*1016 thereon to constitute a first lien on the whole of the Trust Estate and gross income therefrom, and to be first repaid out of the gross income, or in the discretion of the Trustee the principal."
To any assertion that these were powers of a trustee and not of petitioner as the owner of income-producing property and the head of a family, there are two answers. The first is to quote from the opinion in the Clifford case:
* * * If it be said that such control is the type of dominion exercised by any trustee, the answer is simple. We have at best a temporary reallocation of income within an intimate family group. * * * In those circumstances the all-important factor might be retention by him of control over the principal.
The second is that throughout the instrument creating the trust petitioner in his individual capacity is indiscriminately referred to as "Trustee." For example, "the undersigned Trustee shall have * * * the following powers and discretions:
(g) * * * To make advances of his own funds to the Trust Estate * * * and to be first repaid * * *. To reimburse himself from the income or principal of the Trust Estate * * *.
These are evident1943 U.S. Tax Ct. LEXIS 174">*194 references to the petitioner in his individual capacity, to his individual claims, and to his individual property. The opening sentence of the recital states that "Gayle G. Armstrong of Roswell, New Mexico," is "hereinafter referred to as 'Trustee.'" It is thus impossible from the language of the instrument to distinguish what reference is intended as imposing an obligation of a fiduciary character from what is designed to grant to the individual known as Gayle G. Armstrong the inclusive powers and discretions which the trust instrument confers.
These considerations, coupled with the element that the subject matter of the trust was the family business of which petitioner was the operating head and that the trust's interest combined with his own gave him majority control, bring the present controversy within the field of the principle of such cases as , decided on the authority of Helvering v. Clifford. We there pointed out:
* * * The "principal investment" of the trust was stock of the company in which petitioner was "actively interested."
* * * Petitioner * * * does remain in a position to participate in the1943 U.S. Tax Ct. LEXIS 174">*195 affairs of the business in which he is actively interested, a prerogative which proceeds from the retained equivalent of ownership of his interest in that enterprise. This is an attribute of proprietorship frequently of greater significance than the right to receive income. When we combine it with the power to force the retention of that investment and the "benefits flowing to him indirectly through the wife" [here the children] we can not avoid the conclusion that "With that control in his hands he would keep direct command over all that he needed to remain in substantially the same financial situation as before."
1 T.C. 1008">*1017 See also . And that some such idea was in the mind of petitioner and his associates appears from the partnership agreement itself, where he is listed without further detail as the owner of an 11/20 or 55 percent interest, a result possible only by viewing him as exercising the combined control of his own share and that of the trust.
Petitioner concedes that the "factor in this case in common with the Clifford case is the broad power of management and control1943 U.S. Tax Ct. LEXIS 174">*196 vested in the Petitioner as trustee." He asserts that "This broad power of control, however, stemmed chiefly from the partnership agreement." As we have seen, it arose from a combination of the partnership and the existence and structure of the trust. But it is hard to say that this detail is significant. The control over the partnership interest and the possibility of its exercise by means of the trust are the important factors. See ; affd. (C. C. A., 5th Cir.), ; certiorari denied, . Petitioner retained it by the method in which he himself fashioned the trust in a way and to an extent which would not have been possible had he made a complete and outright gift. Cf. ; but see ; ; certiorari denied, .
Nor are we able to agree with the assertion that this item 1943 U.S. Tax Ct. LEXIS 174">*197 of control is the sole analogy to the Clifford case. Certainly there was the same reallocation of income within petitioner's intimate family group. And in fact, the term of the trust, while not as short as that of the Clifford case, was still limited to 12 years, and might be less. The significance of the duration of the trust varies inversely with the extent of the grantor's control. . Here, as we have seen, that is virtually complete. It is perhaps not without significance that all of the cases relied upon by petitioner, with the exception of , were decided prior to the Clifford case.
So far, we have made no reference to the possibility, in addition to all that has been said, that the trust income was itself susceptible in petitioner's discretion of use in payment of expenses which we might otherwise expect to be a charge against the petitioner's personal funds. We can now take it as settled that it is this possibility, and not the extent of its occurrence, which renders a grantor taxable. .1943 U.S. Tax Ct. LEXIS 174">*198 And the fact that such a use is made by the grantor-trustee himself is the best proof that the trust income is available for such purposes. ; affd. (C. C. A., 8th Cir.), ; certiorari denied, .
1 T.C. 1008">*1018 The evidence shows that funds of the trust were used to pay the law school expenses of one of the beneficiaries while he was still a minor. We need not dwell too long on whether a law school education is the sort of necessity for which a father is ordinarily held legally responsible. The duty of support would normally remain and these funds were in part used for that purpose. If the state law exculpated petitioner from that duty, he has not succeeded in showing it. . More than this, however, in the case of , now a landmark in this field, the argument was made that expenditures for petitioner's adult children were not legal obligations. "So much," says the Court:
may be conceded, 1943 U.S. Tax Ct. LEXIS 174">*199 if the matter were bottomed solely on a legal obligation to the children. * * *
* * * petitioner is a man of wealth, and the maintenance of a more or less elaborate establishment as a home for himself and his wife is in keeping with his estate and rank in life * * *.
The maintenance, operation, and upkeep of a dwelling as a home for a man and his wife connote something more than the mere food and shelter for the two spouses alone. It includes a place to which friends and the children and other relatives of the man and his wife may come and visit and be socially entertained from time to time. So much inexorable custom would seem to dictate. Hardly, we think, may it successfully be contended that the provisions of the trust instrument here under inquiry had in contemplation or held within their intendments that the wife of one occupying the rank and station of the petitioner should be required to unduly limit her friendly and social duties * * *.
So here, it may be questioned whether it could have been intended that the son of a man of such substance as petitioner appears to be should be expected while still a minor to forego attendance at an institution of higher learning and support1943 U.S. Tax Ct. LEXIS 174">*200 while engaging in his studies there. We mention these circumstances not because we intend, or consider it necessary, to pass upon the independent applicability to these facts of the doctrine of , and its many counterparts, but rather, in view of the intimate connection between the theory of that case and Clifford's, to indicate an additional reason why it seems to us impossible to suggest that petitioner did not have effective benefits from both principal and income of the trust in controversy to an extent at least as great as those present in Helvering v. Clifford. We think the evidence bears overwhelmingly in that direction, and for the reasons stated we have found as an ultimate fact that petitioner remained the owner of the income in dispute and so was subject to tax upon it.
Decisions will be entered for respondent.