Living Funded Trust v. Commissioner

*161 This is a proceeding for the redetermination of a deficiency in income tax for the period November 12 to December 31, 1932, in the amount of $753.74. The sole issue is*763 whether petitioner is an association taxable as a corporation. The facts set out hereinbelow were stipulated by the parties.

FINDINGS OF FACT.

On or about October 12, 1932, Harry E. Lyman, a citizen and resident of Topeka, Kansas, executed and delivered a certain trust agreement, entitled "Living Funded Trust Agreement of Harry E. Lyman", between himself as party of the first part and himself, Wendell P. Lyman and Alice L. Dibble, as trustees, parties of the second part, and Ivan W. Dibble and the National Bank of Topeka, as substitute trustees, parties of the third part.

The trust agreement provided in material part as follows:

WHEREAS, said Grantor desires to create an irrevocable living funded trust by transferring to the Trustees certain stocks, bonds, securities and other real and personal property * * * for the benefit of Grantor's wife, Anna M. Lyman, Grantor's children, Wendell P. Lyman and Alice L. Dibble, and for certain other beneficiaries hereinafter named, and for such other purposes as hereinafter provided.

By the first paragraph, the grantor agreed to transfer irrevocably to the joint trustees all of his right, title, and interest in and to the properties*764 described in the schedule attached to the agreement, and all other property which might, during his lifetime, be transferred *162 to the trustees, in trust for the benefit of his wife, son, and daughter, and such other beneficiaries and for such other purposes as thereinafter provided.

The grantor authorized and empowered the remaining joint trustees or trustee, upon his death, to select an additional joint trustee, who should continue as joint trustee only during the time deemed advisable by the grantor's son and daughter, joint trustees.

SECOND: The Trustee is hereby authorized and empowered to manage the said trust property with full power and authority in the discretion of the Trustee and in the same manner and to the same extent as the Grantor could or would do in the absence of this Trust Agreement; the Trustee is expressly authorized to sell, contract for sale, lease, mortgage, pledge, hypothecate or otherwise deal with any property or assets that may from time to time comprise this trust estate; to operate any business or interest in business comprised in this trust estate, or in which it is in any manner interested, or which might in the discretion of the Trustee*765 be advantageously operated in connection with this trust estate; to invest and reinvest the property, real or personal, as in the discretion of the Trustee may be deemed most advisable for the benefit of the trust herein created, including the use of such portions of income and principal as the Trustee may deem advisable for the purpose of paying premiums in any life insurance policies upon the life of the Grantor, the proceeds of which policies of life insurance, upon the death of said Grantor, shall become a part of the assets of this trust estate, to be administered and distributed as hereinafter provided for the administration and distribution of the income and principal of this trust estate. During the lifetime of said Grantor the Joint-Trustees herein, who are referred to under the word "Trustee", are hereby expressly authorized and empowered to employ for a limited or unlimited time, a manager or one or more managers, for any or all of the property comprising this trust estate, and are authorized to delegate to such manager or managers such powers or authority herein vested in the Trustee as to said Trustee may be deemed most advisable. The Trustee hereof is also expressly*766 authorized to purchase from the Executor or Administrator of Grantor's estate any property, real or personal, contained in said estate, and is also expressly authorized to make loans to such Executor or Administrator of Grantor's estate, either secured or unsecured, and at such rate of interest as the Trustee shall deem advisable, Provided, however, the Trustee hereof shall not be responsible for any loss resulting to this trust estate by reason of retaining as a part of this trust estate any property purchased from Grantor's general estate.

THIRD: During the lifetime of the Grantor the Trustee shall distribute in convenient installments, preferably monthly, the net income of this trust estate to Grantor's wife, Anna M. Lyman, Grantor's son, Wendell P. Lyman, and Grantor's daughter, Alice L. Dibble, in such manner and in such proportion as the Trustee may deem most advisable, including the right in the event of the death of either of Grantor's children, to distribute such deceased child's share of said net income to the surviving issue of such deceased child. Upon the death of Grantor during the lifetime of Grantor's wife, Anna M. Lyman, then all the net income hereunder up to*767 a sum equivalent to Five Hundred Dollars ($500.00) per month, shall be distributed to Grantor's said wife in convenient installments, preferably monthly, during her lifetime. Any portion of said net income in excess of Five hundred Dollars ($500.00) per month shall be distributed to Grantor's said children share and share alike, the issue of either deceased child to receive the parent's share by right of representation.

*163 Upon the death of the grantor and his wife, it was directed that the net income of the trust be distributed, share and share alike, to the grantor's son and daughter, and upon the death of either son or daughter, leaving surviving issue, the residue of the trust was to be divided into two equal shares, the income therefrom to be paid to the issue of each deceased child for stated periods, and the corpus thereafter to be distributed to such issue.

By the fourth paragraph, it was provided that if at any time during the continuance of the trust it became necessary or advisable to use some portion of the principal for the maintenance, welfare, comfort, or happiness of the grantor's wife, son, and daughter, or for the education of the surviving issue of*768 grantor's children, the trustees were authorized and empowered to use so much of the principal as they might deem necessary, and the grantor suggested that the trustees be liberal in construing, for the benefit of his wife, children, and/or grandchildren any conditions or circumstances that might require the use or distribution of the principal to provide for their maintenance, welfare, comfort, or happiness.

The fifth paragraph of the trust instrument vested in the trustees full and complete legal and equitable title to all of the property and estate embraced within the trust, both as to principal and income therefrom, subject only to the execution of the trusts, and provided that neither the principal nor income of the trust estate should be liable for the debts of any beneficiary, nor subject to seizure by any creditor of any deneficiary under any writ or proceeding at law or in equity, and that no beneficiary should have any power to sell, assign, transfer, encumber, or in any other manner anticipate pate or dispose of his or her interest in the trust estate, or the income produced thereby, prior to its actual receipt by such beneficiary.

The sixth paragraph empowered the*769 trustees, in case it became necessary to divide the principal of the trust, to make such division or distribution in kind, or partly in kind and partly in money, as they might deem advisable.

The seventh paragraph required the trustees to keep books of account showing all transactions relating to the trust funds, and in each year to furnish to each beneficiary a statement showing how the funds were invested and all transactions relating thereto.

On or about October 12, 1932, Harry E. Lyman conveyed by bill of sale to the trustees certain property known as the City Hand Laundry and Topeka Towel Supply Co. and Dry Cleaning Hatters & Dyers of Topeka, Kansas. Anna M. Lyman, his wife, joined with him in the conveyance.

On or about October 13, 1932, Harry E. Lyman conveyed to the trustees by warranty deed certain residence property in Kansas City, Missouri, which was held for rental purposes.

*164 On or about October 12, 1932, Alice L. Dibble, daughter of Harry E. Lyman, conveyed to the trustees by warranty deed certain properties described as lots 312, 121, and 123 in Topeka, Kansas. The property described as lot 312 was improved with a business building and held for*770 rental purposes. The property described as lots 121 and 123 constituted the real estate upon which was located the City Hand Laundry and Topeka Towel Supply Co. and Dry Cleaning Hatters & Dyers of Topeka, Kansas, referred to above.

On or about October 12, 1932, Alice L. Dibble conveyed to the trustees by general warranty deed a tract of land containing approximately 5.89 acres in Douglas County, Kansas. This was a small gardening tract, held for rental purposes.

On or about December 17, 1932, Anna M. Lyman conveyed to the trustees lots 116 and 118 on Van Buren Street in Topeka, Kansas, held for rental purposes.

On or about October 13, 1932, Anna M. Lyman conveyed to the trustees certain real estate in Clay County, Missouri, improved with a building suitable for manufacturing or warehouse purposes, and held for rental purposes.

On or about December 21, 1932, Wendell P. Lyman, son of Harry E. Lyman, conveyed to the trustees certain property in Kansas City, Missouri, improved with a residence building and held for rental purposes.

On or about December 14, 1932, S. W. Lyman, a brother of Harry E. Lyman, and Frances Lyman, wife of S. W. Lyman, conveyed to the trustees certain*771 property in Kansas City, Missouri, held for rental purposes.

The respective donors and the values of the properties when conveyed to the trust were as follows:

No change in the method or proportion of the distributions of the net income of the trust was made upon the conveyance of additional property to the trust by Anna M. Lyman, Alice L. Dibble, Wendell P. Lyman, and S. W. Lyman.

No stock certificates, certificates of beneficial interest, tranferable or nontransferable, were provided by the trust agreement, and none has been issued thereunder.

Pursuant to the provisions of the trust agreement, the trustees thereunder appointed Harry E. Lyman general manager of the properties of the trust, for which supervisory services he received compensation of $2,500 for the taxable year ended December 31, 1932.

*165 For the taxable year ended December 31, 1932, a fiduciary return, form 1041, was filed on behalf of the trust. This return disclosed that the trust*772 derived total net income of $5,481.74, consisting of net profit from the City Hand Laundry in the amount of $5,190.39 and rents in the amount of $291.35. The return further disclosed that the entire net income of the trust for the taxable year was distributable in equal parts to Anna M. Lyman and Alice L. Dibble.

The beneficiaries, Anna M. Lyman and Alice L. Dibble, to whom the net income of the trust for the taxable year was distributed, made individual returns and paid the respective individual income taxes based thereon.

In the exercise of the discretion vested in them, the trustees made no distribution of income to Wendell P. Lyman for the taxable year.

Upon audit of the fiduciary return above mentioned, an internal revenue agent prepared, or caused to be prepared, a return for the trust on form 1040, taxing to the trust the entire net income of the trust for the year ended December 31, 1932. At the same time the internal revenue agent concluded that there were overassessments with respect to the beneficiaries, Anna M. Lyman and Alice L. Dibble. This action of the revenue agent was based upon his finding that the net income shown by the fiduciary return to have been*773 distributed to the beneficiaries was not actually distributed on or prior to December 31, 1932. Such distribution was made on or after January 1, 1933.

All of the properties held by the trust during the taxable year were tracts of rental real estate from which income was derived in the form of rents, except the property known and described as the City Hand Laundry and Topeka Towel Supply Co. The Topeka Towel Supply Co. was merely a department of the City Hand Laundry. The City Hand Laundry was an ordinary commercial laundry, catering to domestic and industrial patronage. Harry E. Lyman, in his capacity as manager of the trust properties, exercised general supervision over the laundry, but the immediate management of the laundry was vested in a manager and an assistant manager, who devoted their entire time to the business of the laundry.

OPINION.

HILL: Respondent has determined that petitioner is an association taxable as a corporation, and has computed the deficiency on that basis. Petitioner assigns such action as error.

The Revenue Act of 1932, in section 13, levies a tax upon the net income of corporations, and in section 1111(a)(2), provides that "the term 'corporation' *774 includes associations, joint-stock companies, and insurance companies."

*166 Neither the facts nor the parties suggest that petitioner is a joint-stock company or an insurance company, and obviously it is not. The sole question is whether it is an "association" within the meaning of the quoted statute.

The Supreme Court of the United States, in , defined the word "association" as used in the revenue acts in the following language:

The word "association" appears to be used in the Act in its ordinary meaning. It has been defined as a term "used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise."

In the cited case, the Court held that the Hecht Real Estate Trust was an association taxable as a corporation, saying:

The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being*775 for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder.

That the trust involved in the case at bar is distinguishable from the Hecht trust in many vital respects is at once apparent. In the case under consideration the beneficiaries did not establish a trust for the management of properties owned by them as tenants in common. They did not associate themselves together for the prosecution of a common enterprise; they did not create an "association" upon the methods and forms used by corporations; they had no part in establishing the trust, and were without power to modify the trust agreement or to terminate the trust. The trust, irrevocable by its terms, *776 was established by Harry E. Lyman, who was himself in no event a beneficiary. The primary purpose of the grantor was to provide "for the maintenance, welfare, comfort and happiness" of his wife, son, and daughter, and grandchildren, if any. It was the method selected by him for the making of gifts for the benefit of those who were the natural objects of his bounty.

The trust is not operated in essential respects according to corporate forms of management. The beneficiaries as such, have no control over the affairs of the trust. The trustees were all designated by the grantor, except only that after his death the son and daughter might select an additional trustee to serve at their pleasure.

*167 No stock certificates or certificates of beneficial interest, transferable or nontransferable, are provided by the trust instrument. Title to all trust properties is vested in the trustees, subject to the execution of the trusts, and the net income is not distributable upon the basis of capital contributions of the respective beneficiaries. While the periodical distribution of the net income is mandatory under the terms of the trust agreement, the manner and proportion of*777 distribution during the grantor's lifetime are matters within the discretion of the trustees. After the grantor's death, the manner and proportion of distribution are fixed by the trust instrument.

Neither the principal nor income of the trust estate is liable for the debts of the beneficiaries, and no beneficiary has any power to sell, assign, encumber or otherwise anticipate or dispose of his or her interest in the corpus or income, prior to its actual receipt.

A trust established by the owners of property who voluntarily associate themselves together for the purpose of holding and operating the property for business purposes and according to corporate form is materially different from a trust such as we are dealing with here. The fundamental distinction is clearly indicated in the following extract from the opinion of the court in :

* * * A distinction is to be made between an agreement between individuals in the form of a trust and an express trust created by an ancestor, although they may have some features in common. The controlling distinction is that one is a voluntary association of individuals*778 for convenience and profit, the other a method of equitably distributing a legacy or donation. Congress has recognized this distinction, classing the former as associations, to be taxed as corporations, and at the same time providing for a separate and distinct method of taxing the income of estates and trusts created by will or deed, classing them together for that purpose.

In , it is pointed out that the term "association" implies associates, who enter into a joint enterprise for the transaction of business and the sharing of its gains. The principal additional characteristics of such an association are stated to be, (1) vesting in the trustees title to the property embarked in the undertaking; (2) designation of the trustees as a continuing body; (3) centralized management; (4) security of the enterprise from termination or interruption by the death of the owners of the beneficial interests; (5) transfer of beneficial interests without affecting continuity of the enterprise, and the introduction of large numbers of participants; and (6) limitation of the personal liability of the participants to the property embarked*779 in the undertaking. To the same general effect, see also ; ; ; ; .

When viewed in the light of the essential attributes above enumerated, we think it is plain that the trust in the present case does not fall into the classification of associations taxable as corporations.

The facts of the instant case, in all material aspects, are similar to ; affirmed on this point at . On authority of the decisions cited, we hold that petitioner is not an association taxable as a corporation. Respondent's determination is reversed.

Apparently all tax due at the rates applicable to a fiduciary has been paid either by the trustees or beneficiaries. In any event, respondent has not determined, nor is he here claiming, any deficiency in tax due from petitioner as a fiduciary.

Judgment will be entered*780 for the petitioner.