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UNITED STATE V. BYRUM, 408 U. S. 125 (1972) - US SUPREME COURT DECISIONS ON-LINE
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(a) A settlor's retention of broad management powers did not necessarily subject an inter vivos trust to the federal estate tax. Pp. 408 U. S. 131-135. chanroblesvirtualawlibrary
Decedent, Milliken C. Byrum, created in 1958 an irrevocable trust to which he transferred shares of stock in three closely held corporations. Prior to transfer, he owned at least 71% of the outstanding stock of each corporation. The beneficiaries were his children or, in the event of their death before the termination of the trust, their surviving children. The trust instrument specified that there be a corporate trustee. Byrum designated as sole trustee an independent corporation, Huntington National Bank. The trust agreement vested chanroblesvirtualawlibrary
in the trustee broad and detailed powers with respect to the control and management of the trust property. These powers were exercisable in the trustee's sole discretion, subject to certain rights reserved by Byrum: (i) to vote the shares of unlisted stock held in the trust estate; (ii) to disapprove the sale or transfer of any trust assets, including the shares transferred to the trust; (iii) to approve investments and reinvestments; and (iv) to remove the trustee and "designate another corporate Trustee to serve as successor." Until the youngest living child reached age 21, the trustee was authorized in its "absolute and sole discretion" to pay the income and principal of the trust to or for the benefit of the beneficiaries, "with due regard to their individual needs for education, care, maintenance and support." After the youngest child reached 21, the trust was to be divided into a separate trust for each child, to terminate when the beneficiaries reached 35. The trustee was authorized in its discretion to pay income and principal from these trusts to the beneficiaries for emergency or other "worthy need," including education. [Footnote 1] chanroblesvirtualawlibrary
When he died in 1964, Byrum owned less than 50% of the common stock in two of the corporations and 59% in the third. The trust had retained the shares chanroblesvirtualawlibrary
transferred to it, with the result that Byrum had continued to have the right to vote not less than 71% of the common stock in each of the three' corporations. [Footnote 2] chanroblesvirtualawlibrary
Following Byrum's death, the Commissioner of Internal Revenue determined that the transferred stock was properly included within Byrum's gross estate under § 2036(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 2036(a). That section provides for the inclusion in a decedent's gross estate of all property which the decedent has transferred by inter vivos transaction, if he has retained for his lifetime "(1) the possession or enjoyment of, or the right to the income from, the property" transferred, or "(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income chanroblesvirtualawlibrary
The Government relies primarily on its claim, made under § 2036(a)(2), that Byrum retained the right to chanroblesvirtualawlibrary
At the outset, we observe that this Court has never held that trust property must be included in a settlor's gross estate solely because the settlor retained the power chanroblesvirtualawlibrary
to manage trust assets. On the contrary, since our decision in Reinecke v. Northern Trust Co., 278 U. S. 339 (1929), it has been recognized that a settlor's retention of broad powers of management does not necessarily subject an inter vivos trust to the federal estate tax. [Footnote 5] Although there was no statutory analogue to § 2036(a)(2) when Northern Trust was decided, several lower court decisions decided after the enactment of the predecessor of § 2036(a)(2) have upheld the settlor's right to exercise managerial powers without incurring estate tax liability. [Footnote 6] In Estate of King v. Commissioner, 37 T.C. 973 (1962), a settlor reserved the power to direct the trustee in the management and investment of trust assets. The Government argued that the settlor was thereby empowered to cause investments to be made in such a manner as to control significantly the flow of income into the trust. The Tax Court rejected this argument, and held for the taxpayer. Although the court recognized that the settlor had reserved "wide latitude in the exercise of his discretion as to the types of investments to be made," id. at 980, it did not find this control over the flow of income to be equivalent chanroblesvirtualawlibrary
Essentially, the power retained by Byrum is the same managerial power retained by the settlors in Northern Trust and in King. Although neither case controls this one -- Northern Trust because it was not decided under § 2036(a)(2) or a predecessor; and King because it is a lower court opinion -- the existence of such precedents carries weight. [Footnote 7] The holding of Northern Trust, that the settlor of a trust may retain broad powers of management without adverse estate tax consequences, may have been relied upon in the drafting of hundreds of inter vivos trusts. [Footnote 8] The modification of this principle now sought by the Government could have a seriously adverse impact, especially upon settlors (and their estates) who happen to have been "controlling" stockholders chanroblesvirtualawlibrary
Id. at 383 U. S. 631. As the retention of this legal right by the settlor, acting as a trustee "in conjunction" with the other trustees, chanroblesvirtualawlibrary
It must be conceded that Byrum reserved no such "right" in the trust instrument or otherwise. The term "right," certainly when used in a tax statute, must be given its normal and customary meaning. It connotes an ascertainable and legally enforceable power, such as that involved in O'Malley. [Footnote 9] Here, the right ascribed to Byrum was the power to use his majority position and influence over the corporate directors to "regulate the flow of dividends" to the trust. That "right" was chanroblesvirtualawlibrary
Byrum did retain the legal right to vote shares held by the trust and to veto investments and reinvestments. But the corporate trustee alone, not Byrum, had the right to pay out or withhold income, and thereby to designate who among the beneficiaries enjoyed such income. Whatever power Byrum may have possessed with respect to the flow of income into the trust was derived not from an enforceable legal right specified in the trust instrument, but from the fact that he could elect a majority of the directors of the three corporations. The power to elect the directors conferred no legal right to command them to pay or not to pay dividends. A majority shareholder has a fiduciary duty not to misuse his power by promoting his personal interests at the expense of corporate interests. [Footnote 11] Moreover, chanroblesvirtualawlibrary
This approach seems to us chanroblesvirtualawlibrary
There is no reason to suppose that the three corporations controlled by Byrum were other than typical small businesses. The customary vicissitudes of such enterprises -- bad years; product obsolescence; new competition; disastrous litigation; new, inhibiting Government regulations; even bankruptcy -- prevent any certainty or predictability as to earnings or dividends. There is no assurance that a small corporation will have a flow of net earnings or that income earned will in fact be available for dividends. Thus, Byrum's alleged de facto "power to chanroblesvirtualawlibrary
Even where there are corporate earnings, the legal power to declare dividends is vested solely in the corporate board. In making decisions with respect to dividends, the board must consider a number of factors. It must balance the expectation of stockholders to reasonable dividends when earned against corporate needs for retention of earnings. The first responsibility of the board is to safeguard corporate financial viability for the long term. This means, among other things, the retention of sufficient earnings to assure adequate working capital, as well as resources for retirement of debt, for replacement and modernization of plant and equipment, and for growth and expansion. The nature of a corporation's business, as well as the policies and long-range plans of management, are also relevant to dividend payment decisions. [Footnote 15] Directors of a closely held, small corporation must bear in mind the relatively limited access of such an enterprise to capital markets. This may require a more conservative policy with respect to dividends than would be expected of an established corporation with securities listed on national exchanges. [Footnote 16] chanroblesvirtualawlibrary
These various economic considerations are ignored at the directors' peril. Although vested with broad discretion in determining whether, when, and what amount of dividends shall be paid, that discretion is subject to legal restraints. If, in obedience to the will of the majority stockholder, corporate directors disregard the interests of shareholders by accumulating earnings to an unreasonable extent, they are vulnerable to a derivative suit. [Footnote 18] They are similarly vulnerable if they make an unlawful payment of dividends in the absence of net earnings or available surplus, [Footnote 19] or if they fail to exercise chanroblesvirtualawlibrary
Byrum was similarly inhibited by a fiduciary duty from abusing his position as majority shareholder for personal or family advantage to the detriment of the corporation or other stockholders. There were a substantial number of minority stockholders in these corporations who were unrelated to Byrum. [Footnote 20] Had Byrum and the directors violated their duties, the minority shareholders would have had a cause of action under Ohio law. [Footnote 21] The Huntington National Bank, as trustee, was one of the minority stockholders, and it had both the right and the duty to hold Byrum responsible for any wrongful or negligent action as a controlling stockholder or as a director of the corporations. [Footnote 22] Although Byrum had reserved the right to remove the trustee, he would have been imprudent to do this when confronted by the chanroblesvirtualawlibrary
We conclude that Byrum did not have an unconstrained de facto power to regulate the flow of dividends to the trust, much less the "right" to designate who was to enjoy the income from trust property. His ability to affect, but not control, trust income was a qualitatively different power from that of the settlor in O'Malley, who had a specific and enforceable right to control the income paid to the beneficiaries. [Footnote 23] Even had Byrum managed to flood the trust with income, he had no way of compelling the trustee to pay it out, rather than accumulate it. Nor could he prevent the trustee from making payments from other trust assets, [Footnote 24] although admittedly there were few of these at the time of Byrum's death. We cannot assume, however, that no other assets would come into the trust from reinvestments or other gifts. [Footnote 25] chanroblesvirtualawlibrary
We find no merit to the Government's contention that Byrum's de facto "control," subject as it was to the economic and legal constraints set forth above, was tantamount to the right to designate the persons who shall enjoy trust income, specified by § 2036(a)(2). [Footnote 26] chanroblesvirtualawlibrary
It is well settled that the terms "enjoy" and "enjoyment," as used in various estate tax statutes, "are not terms of art, but connote substantial present economic benefit, rather than technical vesting of title or estates." Commissioner v. Estate of Holmes, 326 U. S. 480, 326 U. S. 486 chanroblesvirtualawlibrary
The Government cites only one case, Estate of Holland v. Commissioner, 1 T.C. 564 (1943), [Footnote 31] in which a decedent had retained the right to vote transferred shares of stock and in which the stock was included chanroblesvirtualawlibrary
As the Government concedes, the mere retention of the "right to vote" shares does not constitute the type of "enjoyment" in the property itself contemplated by § 2036(a)(1). In addition to being against the weight of precedent, the Government's argument that Byrum retained "enjoyment" within the meaning of § 2036(a)(1) is conceptually unsound. This argument implies, as it must under the express language of § 2036(a), that Byrum "retained for his life . . . (1) the possession or enjoyment" of the "property" transferred to the trust or the "income" therefrom. The only property he transferred was corporate stock. He did not transfer "control" (in the sense used by the Government) as the trust never owned as much as 50% of the stock of any corporation. Byrum never divested himself of control, as he was able to vote a majority of the shares by virtue of what he owned and the right to vote those placed in chanroblesvirtualawlibrary
Even if Byrum had transferred a majority of the stock, but had retained voting control, he would not have retained "substantial present economic benefit," 326 U.S. at 326 U. S. 486. The Government points to the retention of two "benefits." The first of these, the power to liquidate or chanroblesvirtualawlibrary
merge, is not a present benefit; rather, it is a speculative and contingent benefit which may or may not be realized. Nor is the probability of continued employment and compensation the substantial "enjoyment of . . . [the transferred] property" within the meaning of the statute. The dominant stockholder in a closely held corporation, if he is active and productive, is likely to hold a senior position and to enjoy the advantage of a significant voice in his own compensation. These are inevitable facts of the free enterprise system, but the influence and capability of a controlling stockholder to favor himself are not without constraints. Where there are minority stockholders, as in this case, directors may be held accountable if their employment, compensation, and retention of officers violate their duty to act reasonably in the best interest of the corporation and all of its stockholders. [Footnote 35] Moreover, this duty is policed, albeit indirectly, by the Internal Revenue Service, which disallows the deduction of unreasonable compensation paid to a corporate executive as a business expense. [Footnote 36] We conclude that Byrum's retention of voting control was not the retention of the enjoyment of the transferred property within the meaning of the statute. chanroblesvirtualawlibrary
In this case, the taxpayer's asserted alienation does not measure up to this high standard. Byrum enjoyed the continued privilege of voting the shares he "gave up" to the trust. By means of these shares, he enjoyed majority control of two corporations. He used t chanroblesvirtualawlibrary
Byrum's lifelong enjoyment of the voting power of the trust shares contravenes § 2036(a)(2) as well as § 2036(a)(1) because it afforded him control over which trust beneficiaries -- the life tenants or the remaindermen -- would receive the benefit of the income earned by these shares. He secured this power by making the trust to all intents and purposes exclusively dependent on shares it could not sell in corporations he controlled. [Footnote 2/1] Thus, by instructing the directors he elected in the controlled corporations that he thought dividends should or should not be declared, Byrum was able to open or close the spigot through which income flowed to the trust's life tenants. When Byrum closed the spigot by deferring dividends of the controlled corporations, thereby perpetuating his own "enjoyment" of these funds, he also, in effect, transferred income from the life tenants to the remaindermen whose share values were swollen by the retained income. The extent to which such income transfers can be effected is suggested by the pay-out record of the corporations here in question, as reflected in the trust's accounts. Over the first five years of its existence on shares later valued by the Internal Revenue Service at $89,000, the trust received a total of only $339 in dividends. In the sixth year, Byrum died. The corporations raised their dividend rate from 10¢ a share to $2 per share, and paid $1,498 into the trust. See "Income Cash Ledger," App. 25-26. chanroblesvirtualawlibrary
This reading of Northern Trust is not warranted by the one paragraph in that antique opinion on the point for which it is now cited, see 278 U.S. at 278 U. S. 346-347, nor by the circumstances of that case. No one has ever suggested that Adolphus Bartlett, the settlor in Northern Trust, used or could have used the voting power of the shares he transferred to a trust to control or, indeed, exercise any significant influence in any company. A mere glance at the nature of these securities transferred by Bartlett (e.g., 1,000 shares of the Northern Trust Co., 784 shares of the Commonwealth Edison Co., 300 shares of the Illinois Central R. Co., 200 preferred shares of the Chicago & North Western R. Co., 300 common shares of the Chicago & chanroblesvirtualawlibrary
3. The majority concludes with the assertion that Byrum secured no "substantial present economic benefits" from his retention of control. [Footnote 2/3] It is suggested that control chanroblesvirtualawlibrary
In sum, the majority's discourse on § 2036(a)(1) is an unconvincing rationalization for allowing Byrum the tax-free "enjoyment" of the control privileges he retained through the voting power of shares he supposedly "absolutely" and "unequivocally" gave up. chanroblesvirtualawlibrary
O'Malley makes the majority's position in this case untenable. O'Malley establishes that a settlor serving as a trustee is barred from retaining the power to allocate trust income between a life tenant and a remainderman if he is not constrained by more than general fiduciary requirements. See also Commissioner v. Estate of Holmes, 326 U. S. 480 (1946), [Footnote 2/7] and Lober v. United States, 346 U. S. 335 (1953). Now the majority would have us accept the incompatible position that a settlor seeking tax exemption may keep the power of income allocation by rendering the trust dependent on an income flow he controls because the general fiduciary obligations of a director are sufficient to eliminate the power to designate within the meaning of § 2036(a)(2). [Footnote 2/8] chanroblesvirtualawlibrary
This argument conjures up an image of congressional care in the articulation of § 2036(a)(2) that is entirely at odds with the circumstances of its passage. The 1931 legislation, which first enacted what is now § 2036(a)(2) in language not materially amended since that date, chanroblesvirtualawlibrary
Moreover, it appears from contemporary evidence that, if the use of the word "right" was intended to have any special meaning, it was to expand, rather than to contract, the reach of the restraint effected by the provision in which it appeared. The House Report on chanroblesvirtualawlibrary
383 U.S. at 383 U. S. 632 (emphasis supplied). chanroblesvirtualawlibrary
On the basis of these two authorities, a 1929 Supreme Court decision and an unreviewed 1962 Tax Court decision, the majority concludes that there exists a "generally chanroblesvirtualawlibrary
Of course, the reliance argument is doubly infirm if the majority's rule cannot be said to have "appear[ed] to be established." Did Byrum have a sound basis for calculating that there was no substantial risk of taxation when he persisted in retaining the powers and privileges described above? chanroblesvirtualawlibrary
1 J. Beveridge, Law of Federal Estate Taxation § 8.06, p. 324 (1956). chanroblesvirtualawlibrary
2. The majority argues that there were several lower court cases decided after the enactment of § 2036(a)(2) chanroblesvirtualawlibrary
Second, the majority's analysis of the case law skips over the uncertainty at the time Byrum was drafting his trust agreement about even the general rule that a settlor could retain control over a trust's investments chanroblesvirtualawlibrary
The perception that a settlor ran substantial risk of estate tax if he insisted on retaining power over the chanroblesvirtualawlibrary