Opinion
Docket No. 3906.
1945-04-26
STANLEY J. KLEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Leonard M. Rieser, Esq., for the petitioner. Edward C. Adams, Esq., for the respondent.
Petitioner was president and sole stockholder of X corporation. The dividends on X's preferred stock had not been paid for several years before 1939. In that year X intended to pay current dividends and dividends in arrears on the preferred stock. Prior to such payment petitioner created a trust to which he conveyed the preferred stock. He and a close business associate were named as cotrustees, with the power in petitioner to remove that or any other cotrustee and appoint a successor. That trust was to terminate on the death of settlor or his wife or any beneficiary named by him, whichever was latest. The income of the trust was to be accumulated for 20 years, or until the death of petitioner or his wife. At the end of the period of accumulation if petitioner was alive (petitioner was 37 years old in 1939) the income was to be paid to petitioner's wife, or to any other beneficiary who might be selected by petitioner from time to time. Upon termination of the trust the corpus (including accumulated income) was to be paid to those persons designated by petitioner by will or otherwise. The trust was otherwise irrevocable. Held, the income of trust for year 1941 was properly taxable to petitioner under section 22(a) of the Internal Revenue Code. Leonard M. Rieser, Esq., for the petitioner. Edward C. Adams, Esq., for the respondent.
Respondent has determined a deficiency of $6,173.60 in petitioner's income tax for the year 1941 by reason of his including in petitioner's income during the taxable year the income of a certain trust created by petitioner in 1939.
FINDINGS OF FACT.
The parties have filed a partial stipulation of fact and we find the facts to be as stipulated. The stipulated facts which are material to an understanding of the issue herein, and facts found from the evidence adduced at the hearing, are as follows:
Petitioner filed his income tax return for the year 1941 with the collector of internal revenue for the district of New Jersey. This return showed a net income of $104,641.60 subject to tax.
In 1939 petitioner was the owner of all of the outstanding common and preferred stock of the Empire Box Corporation and was president and a director of that corporation. He was 37 years old in that year.
In December 1939 the corporation was about to declare current and arrearage dividends upon its 7 percent preferred stock, of which petitioner held 1,497 shares. On December 8, 1939, the petitioner, knowing of the corporation's intention to pay current dividends of $3.50 per share and arrearage dividends in the amount of $60,756.50, created the trust hereinafter described. This he did after conferring with his personal attorney and a tax advisor. His purpose in creating the trust was to prevent himself from immediately putting back into the business of the corporation the proceeds of the anticipated dividends, a practice indulged in by him in the past which subjected his entire personal fortune to the full risks of one business, to avoid as much as possible taxation incident to the receipt of these dividends, and to minimize his future income taxes.
On December 9, 1939, petitioner was married but had no children. His wife, Anne Klein, was then 33 years old. Prior to December 9, 1939, petitioner and his wife had discussed the adoption of a son, and they did adopt a child in a later year. The life expectancy of both petitioner and his wife was in excess of 20 years in 1939.
On December 9, 1939, petitioner conveyed to himself and to Charles W. Stiefel, Jr. (a friend, a business associate, and counsel for a corporation in which petitioner had a 30 percent interest), as trustees, all of the preferred stock of the Empire Box Corporation. The trust agreement was introduced in evidence and is incorporated herein by reference. The second article thereof, divided into 21 paragraphs, granted to the trustees broad and detailed powers of management. Other provisions of the trust agreement which are here pertinent are as follows:
ARTICLE III.
The income received by said Trustees upon the principal of said Trust shall be accumulated and added to the principal of said Trust until the first to occur of the following events:
(a) The death of the Trustor.
(b) The death of ANNE KLEIN, wife of Trustor.
(c) The arrival of the 8 day of December, 1959.
During such period in which the income shall be accumulated and added to the principal of said Trust, the Trustees shall invest and reinvest and keep the Trust Fund invested in any kind of property real or personal, including by way of illustration but not of limitation, common and preferred stocks, voting trust certificates, bonds, notes, debentures, mortgages, shares or interests in investment trusts, shares or interest in common trust funds, single or annual premium endowment or life insurance contracts upon the life of any beneficiary hereunder, (but expressly excluding investment in any such contract issued upon the life of, or payable to, or for the benefit of the Trustor), investments that yield a high rate of income or no income at all and wasting investments without regard to the proportion any such investment or investments of a similar character may bear to the total corpus of the Trust or whether or not such investments are in new issues or in new or foreign enterprises and without being limited to the classes of investments in which Trustees are or may be authorized by statute or case or rule of Court to invest trust funds; intending hereby to authorize the Trustees to act in such manner as they shall believe to be for the best interest of the trust, regarding it as a whole, even though particular investments might not otherwise be proper.
Upon the termination of the period during which the income shall be accumulated, the Trustees shall pay the entire net income of the Trust Fund thereafter received by them and until the termination of this Trust, such payments to be made at such convenient intervals, but not less frequently than annually, as the Trustees may in their discretion deem best, in manner following:
(a) To ANNE KLEIN so long as she may live, or
(b) To such other beneficiaries, including or excluding ANNE KLEIN, in such proportions as the Trustor shall have at any time or from time to time hereafter designated in manner hereinafter provided, or
(c) In the event of the death, either prior or subsequent to the termination of such period, of ANNE KLEIN or of any other beneficiary who may hereafter be named by the Trustor (if at the time of such death such decedent is a beneficiary hereof) and the Trustor fails to designate a substitute beneficiary or beneficiaries thereof within ninety (90) days after such death or within ninety (90) days after the termination of such period, whichever is the later, then the share of income which such decedent would have received, if living, shall be paid to PAUL C. KLEIN, of Chicago, Cook County, Illinois, brother of Trustor.
Provided, however, that no part of such income shall at any time or under any circumstances be paid to or for the benefit of the Trustor.
After the period has terminated during which the income shall be accumulated and added to the principal of the Trust Fund, the Trustees may continue to hold, until the termination of this Trust, the property, real or personal, at that time in the trust estate or payable to the trust estate by reason of the occurrence of the event terminating such period of accumulation, but all investments and reinvestments by them made thereafter shall be limited to investments in bonds of the United States of America or any State of the United States or political sub-division thereof, first mortgages on or secured by income producing real estate (provided that the entire debt secured by such mortgage is held by said Trustees, and further provided that not more than twenty-five percent (25%) of the entire corpus of said trust shall be invested in such first mortgages), bonds, notes, debentures, mortgages or preferred stock of any corporations which are listed upon the New York Exchange and which have paid the entire interest or dividend therein provided without interruption for five (5) years preceding such investment, and single or annual premium endowment or life insurance contracts upon the life of any then beneficiary hereunder but expressly excluding any such insurance contract issued upon the life of, or payable to or for the benefit of, the Trustor.
ARTICLE IV.
If the first to occur of the foregoing events, the happening of which terminates the period of accumulation, is the arrival of December 8th, 1959, and if prior to that date the Trustor has designated some person or persons other than ANNE KLEIN, wife of Trustor, beneficiary of the income, or some part thereof, thereafter to be distributed by said Trustees, such other beneficiary or beneficiaries shall have the right and option with respect to such beneficiaries' respective proportions of that part of the trust estate as may at such time be invested in or represented by endowment or life insurance contracts, to require said Trustees to leave the then principal sums, proceeds or values of such insurance contracts at interest with the insurance company, which interest shall be distributed by such Trustees when received by them to the then beneficiary or beneficiaries or to require said Trustees to have the then principal sums or values of such insurance contracts paid in one lump sum to said Trustees to be invested by said Trustees and the income therefrom distributed to such beneficiary or beneficiaries in manner hereinbefore provided. If ANNE KLEIN, wife of Trustor, is the beneficiary or one of the beneficiaries at said time, however, she shall not have such right and option with respect to her proportionate share but said Trustees may thereafter deal with such insurance contracts or the proceeds or values thereof as they deem to be for the best interests of the trust estate.
Upon the death of Trustor (irrespective of whether such death terminates or is subsequent to the period of accumulation) and provided that the Trustor has not, in manner hereinafter provided, appointed any person or persons to the exclusion of ANNE KLEIN to be the beneficiary or beneficiaries of the entire income of said trust, ANNE KLEIN, wife of Trustor, shall have the right and option, with respect to her proportion of that part of the Trust Fund then invested in or represented by endowment or life insurance contracts, to require the Trustees to have the then principal sums, proceeds or values of any such policies paid in installments certain for such number of years as she shall elect, which installments, shall be distributed when received by said Trustees to ANNE KLEIN, or to exercise either of the options hereinabove granted to beneficiaries other than ANNE KLEIN with respect to endowment or life insurance policies, and upon the exercise by her of either of such options, the income therefrom or from the reinvestment thereof shall be distributed to ANNE KLEIN upon receipt thereof by the Trustees until the termination of the Trust.
ARTICLE V.
This Trust shall terminate upon the first to occur of the following events:
(a) The death of the last surviving of the Trustor and ANNE KLEIN, his wife.
(b) The death of the Trustor, if at the time of his death ANNE KLEIN is not one of the beneficiaries of the income thereafter to be distributed by the Trustees.
Upon the termination hereof the principal and accumulated income, if any, of said Trust shall be distributed by said Trustees to such persons and in such proportions as the Trustor may hereafter in writing appoint in manner hereinafter provided, or may by his last Will and Testament appoint, or, in default of such appointment by Trustor, to PAUL C. KLEIN.
ARTICLE VI.
This indenture and agreement is intended to be, and is hereby declared to be irrevocable, provided, however, that the Trustor reserves the right and shall have the power at any time during his life by an instrument in writing delivered to the Trustees or upon his death by his last Will and Testament, to modify or alter this agreement by removing his then co-trustee and appointing another individual or trust company as co-trustee in the place and stead of the co-trustee so removed, by disposing of the distributable income of the trust estate as originally constituted, or as it may exist from time to time, otherwise than as originally provided in this indenture, by altering the proportion or amount of income to be paid to, or applied to the use of any one or more of the beneficiaries upon the termination of the period of accumulation, by cancelling any benefaction to any one or more of the beneficiaries, by substituting another beneficiary or beneficiaries in the place of any one or more of them, by adding to the number of beneficiaries, by providing for the proportion or amount of income to be paid or applied to the use of such additional or substitute beneficiaries upon the termination of the period of accumulation; provided, however, that in no event shall any such modification or alteration direct that the said income or any part thereof be accumulated for, paid to or applied to the use or benefit of the Trustor.
ARTICLE X.
If and as often as the Trustees deem the same advantageous to the trust they may, by an instrument in writing, appoint as successor Trustees hereunder any two individuals or a trust company wherever situate. Such successor Trustee or Trustees so appointed, upon its or their written acceptance of such appointment, shall have all the titles, powers, rights and duties of the original Trustees but shall exercise the same under the supervision and in accordance with the directions of the Trustees herein named who shall act as Advisors to the successor Trustee or Trustees so appointed. The Advisors may in their discretion remove any such successor Trustee or Trustees hereunder, such removal to be evidenced by a writing sent by the Advisors and delivered to the Trustees. Upon the removal or resignation of any such successor Trustee so appointed the Advisors shall have the power to reappoint themselves or to appoint two other individuals or a trust company, wherever situate, successor Trustee or Trustees hereunder. If the Advisors shall reappoint themselves as Trustees they shall thereupon have all the titles, powers, rights and duties they originally had as Trustees; if the Advisors shall appoint other individuals or a trust company as Trustee or Trustees, such successor Trustee or Trustees so appointed shall have all the titles, rights, powers and duties of the original Trustees but shall exercise the same under the supervision and in accordance with the directions of the Advisors, provided, however, that any successor Trustee or Trustees so appointed by the Trustees, other than themselves, shall make no sale, investment or reinvestment of any property or money at any time constituting a portion of the trust estate, nor perform any discretionary power herein given the Trustees, except upon the written direction of the Advisors and the Advisors shall be solely responsible for all sales, investments and reinvestments made upon and in compliance with any such direction.
ARTICLE XI.
In the event of the death, (prior to the termination of the trust), resignation, removal or inability of STANLEY J. KLEIN to act as Trustee hereunder, then WILLIAM FELSTINER of New Rochelle, Westchester County, New York, shall be and hereby is appointed as successor Trustee to STANLEY J. KLEIN. In the event of the death, resignation, removal or inability of CHARLES W. STIEFEL, JR., to act as Trustee, then JOSEPH L. LYONS of Chicago, Cook County, Illinois, is hereby appointed as his successor Trustee.
Each and every act and deed of the Trustees named herein and their successors named herein, shall be by their joint act and neither shall exercise or perform any power or act alone, except, however, in the event that by reason of the death, resignation, refusal or inability of his co-Trustee to act STANLEY J. KLEIN is the sole Trustee hereunder then STANLEY J. KLEIN shall have full power and authority to exercise alone all the powers and rights granted to the Trustees named herein and their named successors until the appointment and acceptance of such appointment by his co-Trustees but such co-Trustee shall in all events be appointed within four (4) months of the occurrence of such vacancy.
The Trustees and any successor Trustee appointed and acting hereunder shall be entitled to reasonable compensation for their services.
The trust hereby created shall be deemed to be an Illinois trust and shall be in all respects governed by the laws of the State of Illinois.
IN WITNESS WHEREOF the Trustor and the Trustees have hereunto set their hands and seals and the Trustees hereby acknowledge receipt from the Trustor of Certificate Nos. Eleven (11) duly endorsed by the holder thereof as therein designated, evidencing the ownership of One Thousand Four Hundred Ninety-seven (1,497) shares of the One Hundred ($100.00) Dollar par value Seven Per Cent Cumulative Preferred stock of Empire Central Box Corporation, a Delaware corporation, the day and year first above written.
The successor trustees named in article XI were business associates and friends of petitioner. One was his personal attorney and the other was an officer of a corporation in which petitioner held a 30 percent interest.
On or about December 27, 1940, the trustees exchanged the 7 per cent preferred stock of Empire (1,497 shares) held by them for 6 percent debentures of that corporation having a face value of $149,700. The preferred stock was canceled and the corporate charter of Empire was amended so that the common stock, all of which was owned by petitioner, was thereafter the sole authorized and outstanding stock of the corporation. A sinking fund for the payment of the debentures was set up, but the debentures were made subordinate to the claims of creditors in an amount equal to the principal amount of the debentures outstanding.
The income of the trust for the taxable year was $8,947.24. Petitioner was, in reality, the owner of this income during the taxable year and it was properly included by respondent in petitioner's taxable income for the year.
OPINION.
KERN, Judge:
We have set out in some detail the provisions of the trust instrument here involved, since it is most ingenious and presents a question which is both novel and difficult. As to the difficulties incident in general to the class of cases represented by the one now before us, see the concurring opinion of Sanborn, J., in Stockstrom v. Commissioner, 148 Fed.(2d) 491.
The respondent has determined and now contends that the income of the trust created by petitioner is taxable to him under section 22(a) of the Internal Revenue Code as interpreted by Helvering v. Clifford, 309 U.S. 331, and other cases.
The petitioner, while implicitly conceding that the trust income would be taxable to him after 1959, under the rule of Commissioner v. Buck, 120 Fed. (2d) 775, contends that during the taxable year, on account of the requirement that the income of the trust be accumulated rather than distributed, he had no such powers over the trust income as to warrant a conclusion that he was the owner of it for tax purposes.
While no cases are cited by either party which are directly in point, the petitioner relies heavily on the case of Commissioner v. Bateman, 127 Fed. (2d) 266. Briefly stated, the facts in that case were than the settlor granted a considerable sum in trust to three independent trustees, with full powers of management, and provided that 5 percent of the trust income was to be accumulated during the existence of the trust (which was to last during the settlor's life) and that upon her death the corpus, including the accumulated income, was to go to those persons designated by her will or to her heirs. The question whether the 5 percent of the trust income thus accumulated during the life of the settlor was taxable to her under section 22(a) and the doctrine of the Clifford case was considered at length by the Circuit Court. The distinguished jurist who wrote the opinion on behalf of that court, Judge Magruder, was quite evidently troubled by the problem posed by that case, but reached the conclusion that section 22(a) was not applicable.
However, that case, it is apparent, was much stronger for the taxpayer than is the one which is now before us. In this case the settlor is also one of two cotrustees having broad administrative powers; he has the absolute power to remove his cotrustee; the original cotrustee and his designated successor were close business associates of petitioner; the corpus of the trust consisted of securities of a corporation completely dominated by petitioner; and the petitioner settlor not only had the power to provide for the disposition of the accumulated income upon his death, but also had the power to designate the beneficiary or beneficiaries who should enjoy the income after 1959, if the trust should last that long (and that date was well within petitioner's life expectancy).
We are of the opinion that the facts here present are more analogous to Commissioner v. Buck, supra, than to the Bateman case.
One of the peculiarities of the trust before us is that, despite the manifold provisions of the exquisitely drawn trust agreement, there is no beneficiary with a vested indefeasible equitable interest. Petitioner's wife or brother may be the actual beneficiary, but it rests in petitioner's power at all times to determine who shall be the beneficiary of the trust, and for how long and in what amounts, and who shall receive the corpus upon the termination of the trust. The net effect of the arrangement here is that petitioner devoted securities in a business controlled by him to a trust controlled by him for the purpose of accumulating a fund which will ultimately go to such persons as he may decide upon, and the income from which shall ultimately be paid to those beneficiaries whom he may choose, such accumulation to be made without the payment of those taxes which would have been paid if he had himself made the accumulations without the benefit of the trust device. Cf. Morsman v. Commissioner, 90 Fed.(2d) 18.
We conclude that respondent did not err in taxing to petitioner the income of the trust in question during the taxable year.
Decision will be entered for the respondent.