Court Opinion

ID: 4628454
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:03:23.703669+00
Date Added: 2024-06-11T07:57:12.656831
License: Public Domain

ARTHUR LETTS, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Letts v. CommissionerDocket No. 92857.United States Board of Tax Appeals41 B.T.A. 1172; 1940 BTA LEXIS 1093; May 16, 1940, Promulgated *1093  The settlor of a trust, established pursuant to an agreement made with his wife in contemplation of divorce, held, not taxable on the trust income distributed to his divorced wife for her maintenance and support where the divorce decree releasing him from all obligation to support was not subject to later modification and the settlor made no guarantees of income or principal in the trust instrument.  Helvering v. Fuller,310 U.S. 69">310 U.S. 69; held, further, the settlor is taxable on the amounts of trust income distributed to his divorced wife and used by her for the support of his minor children.  Wellman P. Thayer, Esq., T. R. Dempsey, Esq., and A. Calder Mackay, Esq., for the petitioner.  E. A. Tonjes, Esq., for the respondent.  HILL *1173  This proceeding is brought for a redetermination of deficiencies in income taxes for the calendar years 1934 and 1935 in the amounts respectively of $597.72 and $349.33.  These deficiencies are based on the respondent's determination, in issue here, that the net income of a trust established by petitioner for the support of his divorced wife and minor children is taxable to the settlor. *1094  The facts have been largely stipulated and are set forth only in their substance hereinafter.  FINDINGS OF FACT.  The petitioner is an individual, a resident now, and during the taxable years, of Reno, Nevada.  On July 23, 1930, the petitioner and his then wife, Bessie E. Letts, who were living separate and apart, domiciled in California, entered into an agreement which stated that the petitioner and his wife wished to thereby "fully establish and settle their respective rights to the custody and control of the said children, and their respective rights to and claims upon all property now held or that may hereafter be acquired by them or either of them, and also to settle their respective rights to and claims against each other for support and maintenance, and the support, maintenance and education of said children", Diane Letts and David Letts, each then aged six years.  The agreement provided that Bessie E. Letts should have the custody of the children and should support them out of the moneys to be paid her under the agreement.  The petitioner agreed to pay to his wife $3,000 per month during his life for her maintenance and for the support of the children and agreed further*1095  to pay to his wife within one year $100,000 to be used by her for the purchase of a suitable home.  The contract provided in addition that the petitioner would establish an irrevocable trust with a principal of $775,000, to be paid to trustees at the following times and in the following amounts: (1) $375,000 payable within 3 1/2 years, the obligation to pay to be evidenced by the present execution of a demand note in that amount secured by a mortgage on a certain parcel of the petitioner's realty.  The note and mortgage so executed were to serve also as security for the performance of the obligations under the contract and the foreclosure of the mortgage was authorized on the default of the petitioner; (2) $400,000 payable on or before June 1, 1933.  These amounts were to be consolidated, when paid, into one trust to be held and administered as follows: * * * [to be] held and managed by the said Bank, as trustee, in the usual and customary manner to provide regular income therefrom during the lives of the second party hereto [Bessie E. Letts] and the said adopted children of the parties hereto, and during the life of the last survivor of said persons; the *1174  net income*1096  from said trust fund shall be paid by said trustee to the second party hereto in regular monthly or quarter-yearly installments during her life or until the said adopted children shall have reached the age of twenty-one (21) years, and thereafter one-third (1/3) of said net income shall be distributed to said adopted children, or to the survivor of them, during the remainder of their lives or life, and the other two-thirds (2/3) of said net income shall be distributed to the second party hereto during the remainder of her life, and after the death of the second party hereto all of said net income shall be distributed to the said adopted children, share and share alike, or to the survivor of them, or after the death of the survivor of said children all of said net income shall be distributed to the second party hereto; and upon the death of the last survivor of the second party and said two adopted children said trust shall terminate and the corpus of principal thereof shall be distributed two-thirds (2/3) thereof to the heirs, legatees or devisees of the second party hereto, one-sixth (1/6) thereof to the heirs, legatees or devisees of the said David Letts, and the remaining one-sixth*1097  (1/6) thereof to the heirs, legatees and devisees of the said Diane Letts.  On the establishment of the trust in the principal amount of $775,000, it was further provided that the petitioner was to be relieved from his $3,000 monthly obligation, and the establishment of the trust in any lesser amount was to relieve the petitioner pro tanto from that obligation.  His failure to establish the trust in any amount was to result in the continuance of his obligation to pay to his wife $3,000 monthly for the duration of his life, and he contracted, further, in that case to establish a testamentary trust by his will with a corpus of $775,000 and with terms identical to those set out above.  By further provision of the agreement the parties each released all rights in the property then owned or thereafter acquired by the other and all other rights growing out of the marital status, including claims for alimony, support, and inheritance.  On October 22, 1930, Arthur Letts, Jr., was granted a decree of divorce from Bessie E. Letts in the Second District Court of the State of Nevada, by the terms of which he and Bessie E. Letts were "absolutely released from the bonds of matrimony heretofore*1098  existing between them, and from all of the obligations thereof." The decree made no provision for alimony or the support of the children and made no mention of the agreement of July 23, 1930.  During the year 1931 Bessie E. Letts (now Bessie H. Hann) remarried.  The petitioner on April 25, 1934, executed a declaration of trust which recited that the trust established thereunder was in pursuance of the terms of the agreement of July 23, 1930, and that petitioner had transferred to the trustee the principal sum of $775,000, to be held in trust during the lives of Bessie E. Hann and the petitioner's two children.  The terms of the trust under which the income and eventually the corpus were to be distributed were identical with those provided therefor in the original agreement and set out above.  The *1175  petitioner reserved no power to revoke the trust nor any power of management in the corpus.  The trustee was given by the declaration of trust certain broad powers of management and investment of the trust corpus, with the right to retain any securities or property received from the settlor, to reinvest any proceeds of sale in securities legal for such purposes under California*1099  law, and to make distinction in its discretion between principal and income.  The trust instrument provided for certain amounts of compensation to be paid quarterly to the trustee, dependent on the value of the trust property.  The petitioner did not guarantee either in the trust instrument or in the contract of July 23, 1930, that the value of the trust corpus after its establishment would remain above or at any given amount, nor did he guarantee or underwrite any amount below which the income of the trust should not fall.  During the taxable year 1934 the trust had net taxable income, derived from interest paid on corporation and tax-free convenant bonds, in the amount of $3,087.44.  The trust received further in that year $11,570.02 as interest on other tax-exempt bonds.  There was distributed to Bessie E. (Letts) Hann the sum of $5,650.22 out of the trust income in the year 1934.  During the taxable year 1935 the trust had taxable income of $6,154, of which $4,020 represented interest on which a tax of 2 percent was paid at the source.  The trust received in addition, in 1935, $24,438.47 of tax-exempt interest.  A sum of $22,800 was distributed during 1935 to Bessie E. *1100  (Letts) Hann out of the trust income.  In 1935 the trustee paid taxes of $434.10 and miscellaneous expenses of $6.82, and paid to itself as compensation for its services as trustee the sum of $6,228.42.  OPINION.  HILL: The several issues raised here for decision are (1) whether the petitioner is taxable on the income of a trust distributed to his divorced wife where the trust was established pursuant to a predivorce divorce agreement by which the petitioner's wife released him from all claims to support and maintenance in return for his establishment of the trust here involved, and (2) whether any part of the income so distributed is taxable to the petitioner because used by the beneficiary for the support of petitioner's children as provided in the trust instrument.  The petitioner urges as an additional contention that if he is taxable on the income of the trust distributed he is entitled to a deduction for compensation paid to the trustee which was disallowed by the Commissioner in computing the net income of the trust.  *1176  Our decision on the first point is controlled by *1101 Helvering v. Fuller,310 U.S. 69">310 U.S. 69, which differs in no material respect from the case presently before us.  The significant facts in both cases are that by the terms of the agreement entered into before the divorce the husband was released unconditionally from all obligations to support his wife in return for setting up the trust; that the settlor did not undertake to guarantee or underwrite in any manner either the value of the corpus of the trust after its establishment or the continuance of any given income from the trust; and that the decree of divorce absolving the parties from all rights and claims against each other was final and not subject to any later modification by the court.  See also Tuttle v. Commissioner, 89 Fed.(2d) 112. Cf. Helvering v. Fitch,309 U.S. 149">309 U.S. 149; Helvering v. Leonard,310 U.S. 80">310 U.S. 80. We note the slight difference as to the last mentioned point between the Fuller case and that one before us now in that the Nevada court in the former mentioned and approved the agreement of the parties in its decree whereas here the decree of the court is barren of any reference to the agreement*1102  reached before the divorce or of any provision for alimony.  In either case, we think, it is plain that the failure of the decree to reserve any rights of modification deprives the court of all power to subsequently alter the decree, whether or not it makes provision for alimony or approves any agreement entered into by the parties as a rough substitute therefor.  The law of Nevada is correctly stated in Sweeney v. Sweeney,42 Nev. 431">42 Nev. 431; 179 Pac. 638: * * * A decree a vinculo is final, and the jurisdiction of the court over the parties is after the expiration of the term at an end; and just as there can be no grant of alimony after such a divorce, so there can be no change in the award of alimony, unless the right to make such a change is reserved by the court in its decree, as it may be, or is given by statute, as it often is.  * * * But when there is no such statute (and we have none), and where the decree does not reserve the right to the court (as it does not here) to alter the decree for alimony, no such authority exists.  * * * The same is true as to provisions in a final judgment of divorce for the support of children of the marriage.  * * *1103  * See also Lewis v. Lewis,53 Nev. 398">53 Nev. 398. Cf. Aseltine v. 2d. Judicial District Court,57 Nev. 269">57 Nev. 269. On the first point the petitioner is sustained.  The next issue presented - that of the taxability of peritioner on the income of the trust used for the support of his children - poses, first, the question of whether the petitioner had any obligation to supply their maintenance.  Under the Civil Code of California, where the children were domiciled with their mother during the years in question, the parent into whose custody the children are given is required to support and educate them: *1177  Obligation of parents for the support of their children.  The parent entitled to the custody of a child must give him support and education suitable to his circumstances.  If the support and education which the father of a legitimate child is able to give are inadequate, the mother must assist him to the extent of her ability.  [California Civil Code, Sec. 196.]This section has been held not to relieve the father in any case from the obligation to support his children where the mother having their custody is unable to support them. *1104 Pacific Gold Dredging Co. v. Industrial Acc. Com.,184 Cal. 462">184 Cal. 462; 194 Pac. 1; White v. White,83 Cal. App. 356">83 Cal.App. 356; 256 Pac. 579, and cases there cited.  The record does not show that Bessie E. Hann was able to support the children during the taxable years except by means of the amounts paid her from the income of the trust for that purpose.  In the absence of any showing to the contrary, we must assume therefore that the support and maintenance of petitioner's children was supplied during the taxable years out of the trust income paid to Bessie E. Hann for that purpose and that the petitioner's continuing obligation under California law to supply the keep of his children, who would have been otherwise without support and maintenance, was thereby discharged.  The petitioner is, therefore, taxable on the amounts of trust income used during the taxable years for the support of his two children.  There is no evidence in the record as to the amounts which were actually expended for the two children during the taxable years by Bessie E. Hann out of the trust income paid over to her.  We think, however, that the provisions*1105  of the trust instrument offer an accurate estimate of the amounts thus utilized.  The settlor has provided that one-third of the income of the trust is to be paid in equal shares to his children after they have attained the age of 21 years.  This amount reduces by that much the trust income to be paid toBessie E. Hann commensurate with the obligations of which she is relieved on the coming of age of the children.  The same measure is used in setting off a portion of the trust corpus for distribution on the termination of the trust to the heirs or devisees of the two children.  We think the parties to the trust instrument have unmistakably indicated that one-third of the trust corpus is in effect set aside for the use of the children, the income from that portion of the principal being paid to the mother of the children for their maintenance during their minority and to them directly after they have attained the age of 21 years and the principal itself being subject to their disposition at death.  We hold therefore that one-third of the trust income paid over to Bessie E. Hann during the taxable years was intended and was used for the support and maintenance of David and Diane Letts. *1106 Murray Brookman,41 B.T.A. 557">41 B.T.A. 557; Ernestine Mitchell,38 B.T.A. 1336">38 B.T.A. 1336. *1178  These amounts are taxable to the petitioner as trust income applied in satisfaction of his continuing obligation to support his minor children. The final contention of the petitioner is that, if he is held taxable on any part of the trust income he is entitled to deduct compensation paid by the trust to the trustee, taxes, and other miscellaneous expense of the trust, all of which were disallowed by the Commissioner in computing the income of the trust.  On this point the respondent must be sustained.  The petitioner is taxed on a portion of the trust income not on any theory that the trust is a mere agency and indistinguishable from the trustor's own affairs, but rather for the reason that such portion of the trust income was applied on his obligations and thus represents income to him in that amount.  The trust is still a separate taxable entity and entitled to deduct its own allowable expenses.  See Anderson v. Wilson,289 U.S. 20">289 U.S. 20; *1107 T. Rosslyn Beatty,28 B.T.A. 1286">28 B.T.A. 1286; J. Cornelius Rathborne,37 B.T.A. 607">37 B.T.A. 607; affd., 103 Fed.(2d) 301. Whether or not the Commissioner erred in disallowing these deductions in computing the taxable income of the trust we, of course, do not decide here.  In any event, the petitioner is not entitled to such deductions.  Decision will be entered under Rule 50.