Court Opinion

ID: 4614470
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:30:16.901493+00
Date Added: 2024-06-11T07:54:47.025676
License: Public Domain

WILLIAM J. GARLAND AND GRACE O. GARLAND, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Garland v. CommissionerDocket Nos. 93589, 95547.United States Board of Tax Appeals42 B.T.A. 324; 1940 BTA LEXIS 1027; June 28, 1940, Promulgated *1027  1.  Where the settlor of a trust reserves the power to borrow from the trust corpus up to $100,000 on his unsecured notes and reserves further all rights of the insured under certain insurance policies transferred to the trust, held, the trust is revocable within the meaning of section 166 of the Revenue Act of 1934.  2.  Interest from municipal bonds issued under the California Municipal Improvement District Act of April 20, 1915, held, exempt from Federal income tax.  Robert N. Miller, Esq., and Melvin D. Wilson, Esq., for the petitioners.  Byron M. Coon, Esq., for the respondent.  HILL *324  In these consolidated proceedings petitioners seek redetermination of the following deficiencies in income taxes: In Docket No. 93589 for the calendar year 1934 an amount of $953.55; in Docket No. 95547 for the calendar year 1935 an amount of $758.74.  Only a part of each deficiency is, however, in dispute.  The questions arising are whether the petitioners are taxable on the income of a trust paid over during the years in question to the divorced wife of William J. Garland.  In the event the decision on this point is against the petitioners, *1028  the added question arises of whether the interest received by the trust from bonds of a municipality of the State of California is tax-exempt.  Issues other than these have been settled by the parties in conformity with the stipulation set out hereinafter.  The facts have all been stipulated and found accordingly.  We summarize them as follows.  *325  FINDINGS OF FACT.  The petitioners are individuals, husband and wife, residing at 22364 Malibu Road, Malibu Beach, California.  On March 25, 1931, William J. Garland, hereinafter called the petitioner, was married to, but living apart from, his first wife, Alzoa E. Garland (now Alzoa Scott).  On that date the petitioner and his then wife entered into an agreement which, after reciting that the parties were living separate and apart "by reason of unhappy differences", read, in part, as follows: First party desires to make financial provision for Second Party during her life and for the support, maintenance, and education of said (four minor) children, and to this end has this day transferred and conveyed to Title Insurance and Trust Company, a corporation organized and existing under the laws of the State of California, *1029  authorized to conduct a trust business therein, as trustee, certain property which is particularly described in the declaration of trust made by said trustee and which bears its number P9319.  Said declaration of trust has been approved by First Party and has been consented to by Second Party.  Under the provisions of said trust, Second Party is to receive for her sole use and benefit the sum of Twelve Hundred Fifty Dollars ($1250.00) per month, commencing with the date of the receipt by said trustee of distribution of First Party's interest in and to the estate of the late William Garland, deceased.  In addition thereto Second Party is to receive for the care, support, maintenance, and education of said children, through said trust, and commencing likewise with the date of distribution to the said trustee of First Party's interest in said estate of said William J. Garland, deceased, and continuing for the period of twenty (20) years after the creation of said trust, from Five Hundred Dollars ($500.00) per month to Twelve Hundred Fifty Dollars ($1250.00) per month, depending as to amount within said limits, upon the time said payments are by the terms of said declaration of trust provided*1030  to be made.  Pending the commencement of said payments under said Trust First Party has and will make other and further provision for Second Party and said children, as hereinafter mentioned.  The sum of Twelve Hundred Fifty Dollars ($1250.00) per month, payable to Second Party, is a reasonable allowance for her support and maintenance, and said additional sums will provide a reasonable and adequate allowance for the proper care, support, maintenance and education of said children.  By the other terms of the instrument the petitioner's then wife released him of all claims for support, maintenance, or alimony, and agreed to receive the moneys payable to her under the trust for the support of the children and to apply them to that use.  It was agreed between the parties that all property then standing in petitioner's name or jointly in his name and that of his spouse, except for a house which was set apart for the wife, was the separate property of the petitioner.  On the same date the petitioner conveyed to the Title Insurance & Trust Co. his entire interest in the estate of his deceased father and also other specifically enumerated pieces of real and personal property, including*1031  certain insurance policies on the life of petitioner, *326  to be held under a trust the terms of which, besides those enumerated in the agreement described above, were as follows: $60,000 out of the corpus was to be disbursed by the trustee as soon as received for the petitioner's personal use.  A debt of the petitioner in the amount of $35,000 then outstanding against the estate of petitioner's deceased father was also to be discharged from the corpus.  By additional terms of the declaration of trust the trustee was given broad powers of management and the trust was declared to be "irrevocable and unamendable." The trust income was made by the declaration of trust distributable for the payment of premiums on petitioner's life insurance, for the expenses of the trust, and for the payments to petitioner's wife as set out above, and any remainder was to be paid to the petitioner or on his death in specified shares to his wife and children.  The trustee was authorized to invade the corpus to the extent of $50,000 for the benefit of petitioner's wife and children should their needs require it.  The term of the trust was limited to the life of the survivor of petitioner, his then*1032  wife, and his four minor children, provision being made for distribution of income to the issue of any deceased beneficiaries and for the final distribution of the corpus among the surviving issue of the petitioner and his then wife.  The trust instrument provided in addition that the petitioner might borrow on his unsecured note moneys from the trust corpus to the extent of $100,000, or cause the trustee to furnish property from the trust estate as security for loans made to the petitioner from outside sources in that amount.  The moneys thus secured by the trustor were to be retained and used for his own personal use.  It was further provided that in the event of petitioner's default in his loans which should result in a sale under foreclosure, these rights to borrow should cease.  The petitioner reserved no powers of management in the trust corpus nor did he guarantee the continuing value of the trust corpus nor the amount of income it would produce.  There was reserved to the petitioner the right to exercise all of the insured's rights, options, and privileges under the life insurance policies assigned to the trust and to receive all payments, dividends, surrender values, and*1033  benefits accrued or to accrue thereunder.  On March 25, 1931, the petitioner executed a will in which he bequeathed $10,000 to Alzoa E. Garland, stating that no further provision was made for her in view of the trust established as heretofore set out.  After miscellaneous other bequests the petitioner directed the residue of his estate to be held in trust, the income from which was to be distributed, during the lives of Alzoa E. Garland and petitioner's four children, to certain named persons, among which were *327  petitioner's children.  The corpus was, on the death of the last survivor, to be distributed among the issue of the children.  Alzoa E. Garland was granted an interlocutory decree of divorce from petitioner by the Superior Court of Los Angeles County, California, on July 16, 1931, pursuant to suit for divorce filed by her on June 22, 1931.  At the hearing, the court being informed as to the existence of the trust and agreement dated March 25, 1931, and being satisfied that there was no occasion to award alimony or make a property settlement in favor of Alzoa E. Garland and the children, made no such award.  The decree, however, did not make any mention of the*1034  trust agreement.  The custody of the children was awarded by the court to the wife.  Final judgment of divorce, based on the interlocutory decree above described, was entered on July 20, 1932.  Such final judgment contained only such provisions as were contained in the interlocutory decree.  On August 17, 1932, Alzoa E. Garland married Willard L. Scott and is now and ever since has been his wife.  The trustee of the inter vivos trust described above throughout the taxable years owned bonds of the Municipal Improvement District No. 45 of the City of Los Angeles, California, from which interest in the amounts of $750 and $650 was realized in 1934 and 1935, respectively.  The bonds were issued pursuant to state statute, the California Municipal Improvement Act of April 20, 1915, authorizing their issuance for certain public improvements.  By the terms of the bonds the Municipal Improvement District No. 45, through its officers, promised to pay principal and interest in specified sums.  However, it was provided further that the principal and interest of the bonds were payable exclusively out of taxes levied on the taxable property in the district, and the city of Los Angeles*1035  and its officers were exempt from any liability to make payment.  Taxes adequate to pay the bonds, it was stated, had been levied.  The parties have stipulated, and by this reference we adopt their stipulation on these points, that the petitioners are entitled to a deduction from the amounts of net income shown in the deficiency notices of (1) $250 for each of the years 1934 and 1935 for automobile expense, (2) $280 and $2,181.67 for depreciation in 1934, and (3) $1,600 for four additional dependents in 1935.  It is stipulated further and we so find that certain distributions were made by the trustee of the trust established on March 25, 1931, to Alzoa E. Garland (now Alzoa Scott) in both of the years in question which, if taxable to the petitioner, result in an increase in his taxable income for 1934 of $6,090.54 or $6,354.60 dependent on whether the interest received on the municipal bonds is taxable, and an increase for 1935 of $3,732.94 or $3,970.28 dependent on the same contingency.  *328  Finally, it is agreed by the parties that income tax for the year 1934 in the total amount of $382.09 has been paid by the petitioner.  OPINION.  *1036  HILL: The question first presented for our decision is whether the petitioner is taxable on the income distributed to his divorced wife in the years 1934 and 1935 from the trust established on March 25, 1931.  One of the contentions of respondent is that this income is taxable to the petitioner on the basis of , and , in each of which cases the settlor of a trust, entered into in contemplation of divorce, was held taxable on the income used to discharge a continuing obligation to support a divorced spouse.  We deem it unnecessary to pass on this contention of respondent since, in our view, the petitioner must be held taxable on such income on a totally different ground.  He reserved to himself the right to borrow from the trust corpus, without security, amounts aggregating $100,000, or to borrow that amount from outside sources with security furnished by the trustee.  These provisions, regardless of the express terms of the instrument by which the trust was made "irrevocable and unamendable", render the trust pro tanto revocable for taxation purposes.  *1037  The petitioner had the power, in effect, to revest himself with the corpus up to the amount specified and "to retain and use for his own personal use all moneys obtained therefrom." There is no requirement that loans made directly from the trust be repaid, although it is provided that, in the event of the trustor's default by virtue of which there is a sale of the trust corpus pledged as collateral, the right to borrow any additional amounts shall cease.  In these circumstances the present case is controlled by the same principle under which we have held that the reservation of the right to purchase assets of the trust at a price named by the settlor renders the trust revocable under section 166 of the Revenue Act of 1934.  ; ; ; affd., ; . Cf. . The express provisions of the declaration of trust by which the trust is made irrevocable must give way before the realities of the situation.  This conclusion is strengthened by the provision*1038  reserving to the trustor the right " - without consent of the trustee - to receive all payments, dividends, surrender values and benefits accrued or which may accrue to the insured during his life, and may exercise all of the insured's rights, options, and privileges under such policy." The reservation of these rights is tantamount to a reservation of the *329  right to revest in the trustor that part of the corpus which consisted of insurance policies.  In face of the lack of evidence showing that the value of the corpus exceeds $100,000 and the value of the insurance policies over which petitioner reserved control, we must hold the petitioner taxable on the entire income of the trust.  In view of this conclusion it becomes unnecessary to consider the additional contentions of the respondent that the reservation of rights in the insurance policies transferred, the provision for the payment of certain debts of the petitioner out of the corpus, and the application of a part of the income to the payment of insurance premiums make the trust so unsubstantial as to render the grantor taxable under *1039 , as though the trust income arose from petitioner's own independent business dealings.  The final issue - that of the taxability of the interest received by the trust on the California Improvement District bonds held by it - must be resolved in favor of the petitioner.  In , we had before us the question of the taxability of bonds issued, as those here, under the California Municipal Improvement District Act of April 20, 1915.  It was held there that the interest paid on those bonds was tax exempt and we think that case is controlling here.  See also . Accordingly, we hold that the petitioner is not taxable on any amounts received by the trust as interest on the bonds in question.  Reviewed by the Board.  Decision will be entered under Rule 50.