Opinion ID: 324987
Heading Depth: 2
Heading Rank: 1

Heading: Trusts for the Benefit of Catherine and Celeste

Text: 5 The first issue is the includibility in the decedent's gross estate of the entire corpus and accumulated income of two inter vivos trusts, one for the primary benefit of his daughter Catherine, and the other for the primary benefit of his daughter Celeste. 6 The relevant portions of the trust for Catherine are quoted below. The trust for Celeste was identical except for the difference in names. Decedent designated himself and a friend as trustees of both trusts. 7 'FIRST: The Trustees shall receive, hold, manage, sell, exchange, invest and reinvest such property and every part thereof in the manner hereinafter specified, and shall collect, recover and receive the rents, issues, interest and income thereof, hereinafter called 'income' and, after deducting such expenses in connection with the administration of the trust as, in the opinion of the Trustees, are properly payable from income, shall pay the balance of the said income to CATHERINE J. H. DE SCHULTHESS, the daughter of the Donor, during the term of her natural life, at such intervals as the Trustees, in their sole discretion, may determine. During the minority of the said CATHERINE J. H. DE SCHULTHESS the said income may be accumulated or paid to AMELIE DE SCHULTHESS, the mother of the said CATHERINE J. H. DE SCHULTHESS, or to the guardian of CATHERINE J. H. DE SCHULTHESS, for the support, education, maintenance and general welfare of the said infant, but such decision to accumulate or pay the income during such minority is to be made solely in the uncontrolled discretion of the Trustees. Any income accumulated when the said CATHERINE J. H. DE SCHULTHESS shall attain the age of twenty-one (21) years shall be paid over to her at that time. 8 'SECOND: Upon the death of the said CATHERINE J. H. DE SCHULTHESS, this trust shall terminate, and the principal thereof shall then be paid and distributed to the issue of the said CATHERINE J. H. DE SCHULTHESS, in equal shares per stirpes and not per capita. If the said CATHERINE J. H. DE SCHULTHESS shall die leaving no issue then the trust principal shall be paid and distributed to her sister   . 9 'THIRD: The Donor hereby authorizes and empowers the Trustees at any time during the continuance of the trust to pay to the said CATHERINE J. H. DE SCHULTHESS, or to apply for her benefit out of the principal of the trust, such amounts, if any, as the Trustees may deem necessary or proper, and their judgment with respect to the time and amount of any such payments of principal shall be final and conclusive beyond any dispute or appeal. Any payment or payments of principal under this Article may only be made in the event both Trustees hereunder concur in such payment or payments, and such payment or payments may in no manner be applied, directly or indirectly, to the benefit of the Donor. 10 '  .nly 11 'FOURTEENTH: In case of the death, resignation, removal, disability or inability (for any reason whatsoever) further to act of any Trustee hereunder, the surviving or remaining Trustee shall have the right to appoint a successor Truster from time to time, such successor Trustee, upon executing a duly acknowledged written acceptance of the trusteeship, to be and become vested with all the estate, title, authorities, rights, powers, duties, privileges, immunities and discretions granted to his predecessors, with like effect as if originally named as Trustee hereunder. 12 '  .ors 13 'EIGHTEENTH: All questions pertaining to the validity, construction and administration of the trust shall be determined in accordance with the laws of the State of New Jersey. 14 '  .'TH: 15 Each trust was created in December 1956 with a corpus of approximately $641,000. Prior to the decedent's death each trust earned approximately $63,000 in net income, $37,000 of which was paid to each beneficiary in five annual installments and $26,000 of which was allowed to accumulate in the trust. 16 On decedent's federal estate tax return, the trusts were identified, but no portion of either was included in the gross estate. The Commissioner determined that the entire corpus and undistributed accumulated income of each trust were includible under sections 2036 and 2038 of the Internal Revenue Code, 26 U.S.C. §§ 2036, 2038, and asserted a deficiency in estate taxes. The district court, rejecting part of the Commissioner's determination, held that none of the accumulated income and only the actuarial value of the remainder interests (21.187 per cent of the corpus of Catherine's trust and 20.021 per cent of the corpus of Celeste's) was includible in the gross estate. 17 The appeal asserts the Commissioner's original position. The taxpayers have not cross-appealed from the district court's holding that the actuarial value of the remainder interests is includible, and that issue is not before us. 18 Section 2038(a)(1) of the Code provides that there shall be included in a decedent's gross estate all property gratuitously transferred by the decedent 'where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power    by the decedent alone or by the decedent in conjunction with any other person    to alter, amend, revoke, or terminate   .' Similarly, section 2036(a)(2), which often overlaps section 2038 in its coverage, requires the inclusion of all gratuitously transferred property over which the decedent has retained 'the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy    the income therefrom.' 19 The government contends that the powers of decedent and his co-trustee to distribute principal to decedent's daughters whenever they deemed such payments to be 'necessary and proper' and to accumulate trust income or to pay it out in their 'uncontrolled discretion' for the girls' 'support, education, maintenance and general welfare' constituted a power 'to alter, amend, revoke, or terminate' within the meaning of section 2038. The government also contends that these powers gave the decedent the ability to shift income from his daughters to their heirs and, thus, to designate the persons who would receive the enjoyment of the property within the meaning of section 2036(a)(2). 20 The district court concluded, and the taxpayers do not dispute, that since the decedent had the power to pay out principal as he deemed 'necessary and proper,' he retained sufficient control over the remainder interest of each trust to justify its inclusion in his gross estate. However, the court also held that the decedent had retained no power to affect the beneficial enjoyment of the income of either trust, except to the extent that such power was limited by an ascertainable, external, objective standard. Although the question is a close one, we agree with the district court that the standard was ascertainable. The Court of Appeals for the First Circuit has said: 21 'The trust provision which is uniformly held to provide an ascertainable standard is one which, though variously expressed, authorizes such distributions as may be needed to continue the beneficiary's accustomed way of life   Old Colony Trust Co. v. United States, 423 F.2d 601, 604 (1st Cir. 1970). 22 The provision at issue here, authorizing payments of income for the 'support, education, maintenance and general welfare' of decedent's daughters, requires the trustees to maintain the daughters in their accustomed way of life and, hence, provides a sufficiently objective standard. See Estate of Ford v. Commissioner, 450 F.2d 878 (2d Cir. 1971), aff'g 53 T.C. 114 (1969); United States v. Powell, 307 F.2d 821, 826--828 (10th Cir. 1962); Jennings v. Smith, 161 F.2d 74 (2d Cir. 1947); C. Lowndes, R. Kramer & J. McCord, Federal Estate and Gift Taxes, § 8.9 at 157--58. See generally Note, The Doctrine of External Standards Under Sections 2036(a)(2) and 2038, 52 Minn.L.Rev. 1071 (1968). 23 From this conclusion it follows that the present value of a portion of the income interests was properly excluded from the decedent's gross estate. At the time of decedent's death, the daughters had an enforceable right to enjoy that portion of the trust income necessary to maintain them in their accustomed way of life. The government has elsewhere conceded the propriety of excluding from the gross estate the present value of a fixed, indefeasible income right even though the decedent retained the power to pay corpus prematurely to the income beneficiary. See Walter v. United States, 295 F.2d 720 (6th Cir. 1961). See also Revenue Ruling 70--513, 1970--72 Cum.Bull. 194, which holds that under section 2038 only the value of the remainder interest, and not the entire corpus, of a trust is includible in the decedent's gross estate where the enjoyment of a life estate is vested in the beneficiary and is not subject to reduction through exercise of the decedent's reserved power to terminate the trust and to pay over the corpus to the life beneficiary. 24 But the daughters here had an enforceable right to enjoy currently only a portion of the full income stream prior to reaching twenty-one years of age--i.e., that amount necessary to maintain them in their accustomed way of life. With respect to the remaining income, the decedent had two options: he could either allow that income to accumulate until the girls reached 21, or he could provide for present enjoyment of the income by paying over the corpus with its full income-generating capacity. Thus, the decedent possessed a degree of control over the enjoyment of that segment of the future income he was not required to distribute currently which precludes exclusion of its actuarial value from his gross estate. See United States v. O'Malley, 383 U.S. 627, 631, 86 S.Ct. 1123, 16 L.Ed.2d 145 (1966); Lobor v. United States, 346 U.S. 335, 337, 74 S.Ct. 98, 98 L.Ed. 15 (1953). 25 The government argues that under Estate of Varian v. Commissioner, 396 F.2d 753 (9th Cir. 1968), aff'g 47 T.C. 34 (1966), the entire corpus of the trusts must be included in the gross estate. Varian does not compel such a result. In Varian, the trust instrument provided: 26 '3. Distribution of Income and Principal. 27 '(a) The Trustees shall pay to or apply for the benefit of the child such sums as may in the Trustees' discretion be necessary for the child's support, maintenance and education. 28 '(b) In the discretion of Trustees, the principal and income or any portion thereof, may be payable to the child at any time before attaining the age of 21 years. 29 '  .' 47 T.C. at 38. 30 The Tax Court held that the second clause conferred a completely unrestricted power over the distribution of income and principal which destroyed whatever objective standard may have been contained in the first clause. 47 T.C. at 43--44. We are presented with trust provisions which are substantially similar to those in Varian in all significant respects but one: Here, the unrestricted power extends only to the payment of principal. We recognize, of course, that in terms of economic effect the addition of an unrestricted power over a future income stream adds very little to the discretion possessed by a trustee with an unrestricted power over the principal. 31 But in determining whether an unrestricted power in one provision of a trust destroys an ascertainable income standard in another trust provision, we refuse to extend the logic of Varian to the situation where the unfettered power applies only to payment of principal. To do so would create conflict with the concededly 2 proper principle that the present value of a fixed income right is excludible where the decedent retains a discretionary power to pay the corpus prematurely to the income beneficiary. 32 The amount of previously accumulated income was properly excluded. Once the decision had been made to accumulate part of the income, this accumulation was placed beyond the reach of the trustees. The accumulated income would be paid to the children when they reached 21. Although the trustees could pay out the principal early, they could not prematurely distribute the accumulated income. Unlike the accumulated income held taxable in United States v. O'Malley, the accumulated income here did not become part of the trust principal and was not subject to the powers decedent reserved over the principal. 33 We hold, then, that under sections 2036(a)(2) and 2038(a)(1) the decedent's reserved power to distribute the principal of the trusts at any time requires the inclusion of the corpus of each trust, reduced by the actuarial value of that segment of the future income stream which the decedent would be obligated to distribute currently to his daughters. 3 We further hold that the exclusion of previously accumulated income was proper. The case must be remanded to the district court for a factual determination of the amount of the includible sum.