Earl Warren: United States, Petitioner, versus Charles E. O'Malley et al. Mr. Solicitor General, you may continue your argument.
Thurgood Marshall: Mr. Chief Justice and may it please the Court. When we recessed yesterday, I had covered the fact that the dissident during his lifetime had set up these trusts and as to the disposition to be made of these trusts and pointed out that in the trust instruments themselves, the dissident and his co-trustees retained the power over the disposition of the trust income. And I also pointed out that it appeared to be conceded that the corpus of the trusts, the original stocks were admittedly covered under Section 811 of the 1939 Code and that under that statute the value of the dissident's debts and the shares of stock which constitute this original trust should be lumped in. And that the only point was whether or not what had accumulated as a result of the holding of the stock was to be included in the dissident's estate as you read Section 811. The Seventh Circuit said the original corpus went into the gross estate but the accumulated interest stocks and whatever you might call it, did not come under 811 and it's the Government's position that this was clear error because it was more in line with the purpose of 811 to include all in the dissident's gross estate. The reason for that is two-fold and we take the position that when the statute says, “all property”, it meant just that. That the stocks that were included were put into the trust and they were not actually transferred until after the dissident's death. The real point of dispute or the word “transfer” is that the taxpayer says that the transfer occurred when the trust was set up. It's our position that the transfer did not actually occur until the dissident's death. And we say also that the property normally would include whatever came about as a result of the action of the trustees, the three trustees including the dissident. When the dividends were declared on the stock of this tightly owned corporation, if the dividends remained there that would be one thing in cash. Instead of leaving all of them there, some were distributed, other dividends were used to purchase additional stock. The position it seems to me is untenable that the -- for example, suppose a dissident prior of course to his death had used the money to purchase some other stock. That would be one thing. Suppose the dissident during his lifetime had transferred additional shares of his tightly owned corporation to the trust it would be almost unthinkable that you could draw a line between those two sets of stocks. As a matter of fact, it appears so simple to me that the statute mean to what it says because if you will notice neither brief has any discussion of the legislative history and we were hard push to find legislative history on this exact point, it's just not there. The earliest is back in the 19 -- the 69th Congress in the first session. The old 1926 Act but it just mentions it, there's no argument. I've -- the Government takes the position that all property means “all property” and you can't draw the line. And finally, I would mention that the dispute between the -- the Sixth Circuit agrees with the Seventh Circuit and the First Circuit and the case which is cited in our brief at the Footnote -- on page 5. The First Circuit went, although, it's under the later statute which is Section 20 -- 2036, the language is so practically identical with the first one. And we submit that the First Circuit is correct that the Seventh Circuit is in error and we urged the Court to reverse the Seventh Circuit and make it clear that in construing Section 811, which is now 2036, it includes all the property and not to dividing between what was given 133 years ago and what exists at the time of dissident's death.
Earl Warren: Mr. Solicitor General, --
Thurgood Marshall: Yes, sir.
Earl Warren: -- I don't know whether it's important to -- in the (Inaudible) -- to the decision of this case but did he reserve the right also to distribute the corpus that he so chose?
Thurgood Marshall: To -- each one of the -- only to the beneficiaries.
Earl Warren: Yes. To the beneficiary --
Thurgood Marshall: Well he--
Earl Warren: -- when he put it, distributed it at anytime during his lifetime or was it just the income that he could --
Thurgood Marshall: Oh, it's just the income, was just --
Earl Warren: Just the income --
Thurgood Marshall: -- the income as I remember. Was it just the income? Yes, sir, as I remember it.
Earl Warren: Yes.
Tom C. Clark: Well, they agree with the corpus if they (Inaudible) --
Thurgood Marshall: Everybody agrees that the original shares of stock go in.
Tom C. Clark: Yes, but he could only consider the income?
Thurgood Marshall: Yes, sir. And that's the control that we say was there. He had the control.
Tom C. Clark: And more control of the income and then (Inaudible).
Thurgood Marshall: That's exactly it and yet they put one in and left the other out. And the petitioner did not -- rather the respondent has not at all in anyway attacked that portion of the Seventh Circuit's decision.
Earl Warren: Very well. Mr. Fieldman.
Leon Fieldman: Mr. Chief Justice, may it please the Court. I think it might be helpful if I review just for a moment or two some the salient facts with regard to these five trusts created by the taxpayer, but now deceased taxpayer. These trusts were created in December and January, December of 1936 and January of 1937. Each of the trust was irrevocable. The settlor did not have the right to alter, amend, revoke or terminate any of the trusts. The settlor did not reserve a life income interest in any of the trusts. The settlor was not a remainder man under any of the trusts and the settlor had no right of reversion under any of the trusts. The only right, the only narrow right that the settlor had here was a right which he could exercise along with two other trustees because he was one of the three trustees of each trust. And that narrow right was this, that although each trust agreement specified that the trust income was to be paid to the trust beneficiary, the three trustees voting together could vote to retain a portion of the trust income and add it to the trust principle. Once it became a portion of the trust principle, it was then distributed with the trust principle when the trust terminated. That was the only right that the settlor had and this was a right as one of three co-trustees.
Potter Stewart: Was there a corresponding right to invade the corpus or not?
Leon Fieldman: Yes, Your Honor. There was, again, exercised all by all three co-trustees. Now when these trusts were first created, the settlor transferred to them shares of stock as the Solicitor General stated. From that time on until the settlor's death, 13 years later, there were no further transfers by the settlor to the trustees of the trust. During those 13 years of course, the trust earned income. And approximately as the record shows, approximately 50% of the income over the years was either paid out to the trust beneficiaries or used to pay income tax payable by the trust. The remaining approximate 50% of the trust income was directed by the trustees to be added to trust principle. Now, the taxpayer did concede below that this power to accumulate trust income which the settlor admittedly had in conjunction with his two co-trustees, did make the corpus, the original transferred corpus of the trust taxable in the taxpayer's estate on the theory that under Section 811 (c) he had the right to designate the persons who could possess or enjoy the property. That is by paying out the income immediately, the trust beneficiaries got it. If however the income was accumulated and added a trust principle, conceivably somebody other than the income beneficiary might get it because in some cases, the income beneficiary's death did not terminate the trust and the principle might therefore go to the income beneficiary's children or grandchildren. So we concede that this right to accumulate or to distribute income does make the principle taxable in the settlor's estate under Section 811 (c). The question here is, was the income earned by these irrevocable trusts during the 13 years between their creation and the settlor's death? Was that income transferred by the settlor to the trusts and thus subject to taxation pursuant to the language of Section 811. The taxpayer submits basically three points that under the statutory language that income is not taxable because it was not transferred by the settlor to the trust. Second, the doctrine of an incomplete transfer mentioned this morning by the Solicitor General has no application of this case. The transfers to the trust in 1936 and 1937 were complete when made. Nothing more had to be done. The doctrine of an Incomplete Transfer as I will expound on later was first enunciated in cases which can have no application to the fact situation here. And thirdly, the decision below is correct and should be affirmed because an affirmance of the decision below does not create any tax in full of any kind large or small as the Government has argued both orally and in it's brief. Now, first is to the statutory language --
Earl Warren: Mr. Fieldman, before you get to that. Would you mind restating your position with regard to the difference between the corpus and the income that it seems rather strange to me that where he had disposed irrevocably the corpus that it would be considered a part of his estate when he died. But that the income from that over which he had some jurisdiction should be -- should not be considered a portion of his estate, I -- I didn't quite get your argument on that?
Leon Fieldman: The answer to that Mr. Chief Justice is this. That under a decision of a Court of Appeals some years ago, it was held that if a settlor retains the right over property which he has transferred and in this case the property he has transferred must be the original corpus. If he retains the right to accumulate or distribute the income arising from that corpus then he has in effect retained a right over the corpus itself. Since the income is the fruit of the corpus if he can designate those to possess or enjoy the fruit then he in effect has retained the power over the corpus which makes the corpus taxable in his estate. Our position is conceding that point that even though he does have the right to designate who is to receive the income. That income is not taxable in his estate for this reason that the statute requires that what is to be taxed in the dissident's estate must have been transferred by the dissident. And our position is that under any normal concept of property law, you cannot -- a settlor cannot transfer income which at the time it's earned by the trust within 13 years after his death belongs only to the trusts, is received only by them. He has no right to sell it. He cannot give it away. He has no rights at all insofar as transfer is concerned over the income. And that is the point Mr. Chief Justice which I now like to expound further. That has to do with the requirement of the statute.
Earl Warren: Oh, the thing that -- the thing that bothers me is that even conceding your premise in the case of the corpus, he has only a very limited right over the --
Leon Fieldman: Correct.
Earl Warren: -- over the property. But so far as the income is concerned he has absolute right --
Leon Fieldman: That's correct.
Earl Warren: -- so far as distribution of it is concerned. And why in the one case where he has a limited right, he should be -- the estate should be taxed but in the other it cannot be. I -- that's my problem.
Leon Fieldman: The answer to that Mr. Chief Justice lies in the statute itself.
Earl Warren: Alright. Alright, you go ahead.
Leon Fieldman: The statute has not one but two requirements for taxability. The Government of course lays very heavy emphasis on the fact that the income falls within one requirement, that is if the settlor can designate those who are to possess or enjoy the income. And that's the second requirement, the right to designate those who possess or enjoy and we can concede it. The settlor does have that right and thus, the second requirement of the statute is met.The first however is not met. And that first requirement stated very specifically by the statute is that the property to be taxed must have been transferred by the settlor. And it's our position that the income was never transferred by the settlor. He transferred only the property. He could not transfer the income because it was never earned and perhaps never would have been earned at the time he transferred it. In subsequent years when the income was earned, it became -- since these were irrevocable trusts which she could not alter, amend or revoke, that income become the property of the trusts. The settlor never owned that income and therefore he could never transfer it. So, with the statute --
Abe Fortas: Would you mind -- I beg your pardon. Would you mind at this point to indicate what your position is with respect to the stock that was purchased added to the corpus, stock that was purchased from trust income?
Leon Fieldman: Yes, Your Honor. That in our position is no different than had trust income then put in a bank account. Now, if both requirements of the statute are not met, if there is no transfer in the first instance then whatever is not transferred cannot be taxed. And I think this simple example might serve to illustrate that. Assuming in this irrevocable trust the third party neither the beneficiary nor the settlor had decided to give a $100,000 to the trustee to add to the trust. This was permitted by the trust agreements. And this third party did give a $100,000 which was added to the principal of the trust and this $100,000 then proceeded to earn trust income. Well as to this trust income, the settlor would have the same rights. He could direct that it'd be paid out or it could direct that it be accumulated. Thus, he had the right to designate the person's who would -- were to possess or enjoy the income from that $100,000. Certainly, we would concede that but I don't think anybody would argue that the $100,000 is to be included in the settlor's estate. And the reason for that is that the first requirement of the statute was never met. That $100,000 was never transferred by the settlor to the trusts. And of course, the same principle applies as to the income earned by the trust not by the settlor after creation of the trusts. Now in addition to the fact that the statute clearly spills out these two requirements, only one of which has met as to the income, the statutory language also it appears indicates quite clearly that income was never meant to be taxed and there's two reasons for this. The first reason is this, the statute when talking about transfers by the settlor has an exception. It says, except in the case of a bona fide sale for an adequate and full consideration in one-year money's worth. Or if you try to apply that exception of this trust income earned during the 13 years after the irrevocable trust were created. He realized that it can have no meaning with regard to that trust income. That trust income was never subject to sale by the settlor either bona fide or otherwise for an adequate or for consideration because that income belonged to the trusts not to the settlor. He could never have sold that and if the exception on the statute is to be read as having any meaning at all. It must mean that what was transferred or what was subject to transfer by the settlor must have at one time been owned by the settlor and transferred by him. If it was not owned by him, it could not be transferred by him and that's the case as to this income. That being so the exception is meaningless. The statute is cited at page 2 of the taxpayer's brief. The second statutory support for the taxpayer's position is also to be found on this few sentences of the statute. Remembering that the statute has two requirements; one, that there be a transfer by the settlor; and two, that the settlor have the right to designate those who shall possess or enjoy the property. And then reading the statute you'll find that when the word transfer is used in the third line of the statute as cited on page 2 of the taxpayer's brief. The word property was used, “transferred property spoken of.” There is no reference to income when there's a talk about transfer. But when the second requirement of the statute is dealt with, on the very last line of the cited statute that is where the settlor is said to have the power to designate those who shall possess or enjoy. At that point, the statute says the property or the income there from. There's no reference to the income in the transferring section of the statute. And the reason for that I think is very simple that it was not the conversion or intention to consider income which might never be earned at the time a settlor creates an irrevocable transfer. They considered that income as having been transferred by the settlor. The property can be transferred, yes, but the income when it is earned and in an irrevocable trust is not the settlor's to transfer. Now, the second reason why we feel that the Seventh Circuit, and the Sixth Circuit, and the Fifth Circuit in the Burns case, there are three circuits in effect which have held these are correct and why the decision below should be affirmed as this. And this is in the sense of a negative reason. The Government argues that this transfer when made to the trust 13 years before the settlor's death was not a complete transfer. It became complete only when he died because he retained this right over the property and if it became complete only then. Then all of the income which was added to the trust during these 13 years also remained the settlor's until his death and therefore was transferred when he died. This doctrine of an incomplete transfer has arisen primarily in three cases decided by this Court. One was the Church and these cases are cited on both grounds. One was the Church estate. There this Court said that the transfer by the settlor to an irrevocable trust was incomplete, it did not become complete until he died and I concede that so. In the Church estate however, Mr. Church retained for his life the right to receive the income from the trusts. So, obviously as a matter of economics he had given away nothing of value to the trust. He retained all the benefit of the trust during his lifetime. And I think it's quite logical therefore to say that those transfers to the trust became complete only when Mr. Church died. But remember here that this is a trust in which the settlor has retained. No income interest at all. The second case which announces this incomplete doctrine is the Rainey case. There are two this Court said that the transfer was incomplete until the settlor's death. But there the settlor retained the right to terminate the trust at anytime. There's no such right here. This trust cannot be altered, amended or revoked, or terminated. And the third case was the Holmes case. There too, there was a right of termination which does not exist here. This transfer to the trust was as complete as it was possible to make it in 1936 or 1937.
Potter Stewart: There's no reversionary right of any kind here?
Leon Fieldman: There's no reversionary right of any kind.
Potter Stewart: No possibility of reversal?
Leon Fieldman: None. Therefore, we say while this doctrine of an incomplete transfer makes sense in the cases in which it was announced. It shouldn't be stretched and tortured to fit the facts here where you have an irrevocable, unalterable trust with no rights retained in the settlor to benefit himself.
Abe Fortas: Mr. Fieldman, you said that the corpus could be invaded.
Leon Fieldman: That's correct.
Abe Fortas: Would you state for what purposes?
Leon Fieldman: For emergency purposes Your Honor.
Abe Fortas: In the interest of the beneficiary.
Leon Fieldman: In the interest of the beneficiary only. That appears on page 25 as to one -- page 25 of the record, about two-thirds the way down the page. Extra funds for providing education, children being in need, and that sort of thing, and that same principle of invasion clause appears in each of the other trust. So then, the taxpayer contends that this transfer to the trust is not covered by the statutory language. That the doctrine of an incomplete transfer has no application here; and third, that there is no loophole that will be either created or enlarged by an affirmance of the decision below. The loophole which the Government suggests is this, that a clever taxpayer taking advantage of this case might create an irrevocable trust of this type, transferred to at his stock and a closely held corporation, have dividends paid to the trust, have the trustees accumulate that trust income and the trust, and then when the taxpayer dies none of the accumulated income will be subject to federal estate tax. Well, if he hadn't been this clever and let the income accumulate in his corporation the value of his stock at the time of his death would reflect that accumulated income and therefore in effect, the accumulated income would be taxed in his estate, that is (Inaudible). And this says the Government, there's a loophole which must be avoided. But of course the taxpayer who looks -- protects loopholes, is not interested in saving federal estate tax at the expense which he pay now just as much if not more federal income tax. And that is precisely what might happen if this loophole were availed of by a taxpayer who I think must be a very unclever tax payment. If the corporate income is paid out as dividends to an irrevocable trust, that irrevocable trust must pay income tax on those dividends as taxpayer just like any other single, unmarried taxpayers. Well, if those corporate dividends are not declared but are retained on the corporation, there is no income tax under the normal situation. So while it's true that the estate tax conceivably maybe avoided by the estate, income tax must necessarily be incurred and the income tax, of course, is paid during one's lifetime. The federal estate tax only after one is dead. Income tax rates of course are quite high and it seems to me that to say that this decision below has kind of open the way for tax avoidance is to be highly unrealistic. I just don't see that any taxpayer would want to do that. So for each of these three reasons, we submit that the decision below is correct. The statutory language has two requirements. One of them is that there must be a transfer by the settlor. The income here was not transferred by the settlor. The second is that the doctrine of an incomplete transfer has no bearing upon this case because this is an irrevocable trust which cannot be altered, amended or revoked and the settlor has retained no income interest, no remainder interest and no reversion of interest. And thirdly, affirmance of the decision below will not open or enlarge any tax in the form of any nature.
Byron R. White: Are the -- have accumulations of the income is accumulated in adequate form or has that -- then suggest as though a gift tax or no?
Leon Fieldman: I don't think the record shows that --
Byron R. White: Well, how about another case, it says, it has the -- Commissioner claims --
Leon Fieldman: It would be (Voice Overlap) --
Byron R. White: -- that these accumulations are subject to gift tax?
Leon Fieldman: Yes.
Byron R. White: On the theory that -- that he didn't make a transfer when he had -- when he added the principles instead of distributing.
Leon Fieldman: That's correct Your Honor. And the reason for that is this, so of course, the gift tax law differentiates between present interest and future interest gifts. If I give three --
Byron R. White: But nevertheless whether they do or they don't it's -- the gift tax would be based on the assumption that there was a transfer.
Leon Fieldman: That's correct.
Byron R. White: Which you deny? So you would say there should be no gift tax whatsoever?
Leon Fieldman: No, I don't argue as to the gift tax at all. I think that's --
Byron R. White: But why -- why is that? I mean, how can this fellow --
Leon Fieldman: Well --
Byron R. White: -- make the transfer if he hasn't anything to transfer?
Leon Fieldman: The reason for that Your Honor is the difference between the estate tax and the gift tax law. They are substantially different and the gift tax law has --
Byron R. White: So transfer doesn't mean that in -- for gift tax purposes or is the same as it does for estate taxes?
Leon Fieldman: It's exactly my point.
Byron R. White: Do you -- let's just say -- let's just -- you just (Inaudible) -- you're relying on the fact that the words of the statute seem to require an anterior transfer.
Leon Fieldman: Correct.
Byron R. White: And the -- and why is that different in a -- than the kind --
Leon Fieldman: Well --
Byron R. White: -- of a transfer necessary to precipitate gift tax liability?
Leon Fieldman: First, for this reason Section 811 (c) dealing with the transfer of course refers only to the federal estate tax. The gift taxation arises under entirely different sections of the Code and of course, it does require a transfer by the settlor in order (Voice Overlap) --
Byron R. White: Well, wouldn't it -- the -- you -- you do -- you do concede then that the settlor here, one of the trustees when he make -- when he accumulates income and adds a principle as an -- he's transferring enough of an interest it's attributable to him to be subject to gift tax.
Leon Fieldman: Yes sir.
Byron R. White: Okay.
Earl Warren: I've just been looking at the opening -- at the first paragraph of the trust and doesn't that purport to sell, assign, transfer, and set over under the trustees that following describes securities and plus the income thereon? It -- on page 24, that the settlor in consideration of the agreements and undertakings here and after made by the trustees, thus hereby sell, assign, transfer, and set over under the trustees and then 75 shares of capital stock go -- paid by insurance company and the trustees are hereby authorized to and agree that they will receive the -- all of the said securities, cash, real estate, or other property as may be transferred and so forth and the income there from for the uses and purposes upon the terms and conditions here and after provided. Isn't that the -- isn't that purport to the advance for -- of the income as well as the corpus sets out.
Leon Fieldman: I think the answer to that Mr. Chief Justice is this, that whenever a income producing asset is transferred, the transfer must necessarily carry with it the right to receive future income payments.
Earl Warren: The right to what?
Leon Fieldman: To receive income payments in the future on that transferred asset. That very point however --
Earl Warren: If beneficiaries do have the right to receive it, do they not?
Leon Fieldman: Yes.
Earl Warren: Except that control is when and how is left with the settlor.
Leon Fieldman: And his two co-trustees.
Earl Warren: Beg -- yes, yes, of course.
Leon Fieldman: And this two co-trustees.
Earl Warren: Yes.
Leon Fieldman: That point incidentally I would like to dwell on for just a moment more. I have cited -- the taxpayer has cited in his brief a case which was cited for one proposition but I think it is very important for this exact point and that's on page 13 of the taxpayer's brief, Maass versus Higgins which is cited in the second line from the bottom of the page. That case has an importance, an entirely different importance and that is this. In that case a taxpayer, this also involved in a estate, took the option of taxing estate assets one year after a death, that is an option in the federal estate tax law, you can either tax the assets or value the assets as of the date of death or one year after death. And in that case the estate took the option of valuing one year after death. And the Commissioner of the Internal Revenue said, “Well, if you value one year after death you got and not include the assets as of one year after death but also all income earned from the date of death until the one year after death.” And this Court said, “No, that's improper. You don't do that. You value only the assets one year after death and not the income earn in the interim.” And the course of its opinion that and I'm quoting now from the decision, “Nor does the promise to pay interest (or subdivided) which is not been legally separated from the asset of which it is an incident have any market value apart from the asset or bear any invariable relation to the value of the capital asset.” The Court also said that, conceding that a bond may involve both the principle and the promise to pay income on the principle. Nonetheless, when the principle is to be taxed you do not assume that the income to be earned thereafter is also to be taxed. And I think that principle applies very clearly here. The principle is transferred and the principle is to be taxed but you do not assume that the right which accompanies the transfer of the principle is to be valued separately and separately taxed. And that's the teaching of Maass v. Higgins which is I say was not cited for that purpose in the brief but I think it's very applicable to this question of the bundle of rights.
Earl Warren: Thank you.
Thurgood Marshall: May it please the Court. I only have one point --
Earl Warren: Mr. Solicitor General.
Thurgood Marshall: -- and that's the Church and other cases and we are in complete disagreement because as I read Church it stand from the proposition that where the settlor -- whether he -- when he can -- when he maintains control to the extent of being able to distribute, he is in for tax purposes, he's in the same category as if he was able to use the money himself. That's what (Voice Overlap) --
Potter Stewart: When he was able to use the money himself and that -- that was the reserve life estate in the settlor, was it not?
Thurgood Marshall: In this case?
Potter Stewart: It's in -- no, no. I know it was (Voice Overlap) --
Thurgood Marshall: No. Oh, it's definitely in the Church case. Yes, sir. That's correct but I mean the language seems to me to draw no the difference between the two. And in this case, he had the right to decide, when I say “he” I mean, he and the other two trustees, had the right to decide what they were going to do with this money and whether they were going to give it to the beneficiaries or not. They couldn't give it to anybody. But they had the right to give it to the beneficiary not -- we think its sufficient control.