Phipps v. Commissioner

*357 By this proceeding petitioner challenges a determination of a deficiency in his income tax for the year 1935 in the amount of $62,559.30.

*358 The sole issue involved is the propriety of including in petitioner's income for the year in question the income derived from property held iv trust under a trust instrument dated June 3, 1932, in which petitioner was the grantor. Facts hereinafter appearing which are not from a stipulation of the parties have been found from the evidence adduced at the hearing.

FINDINGS OF FACT.

The stipulated facts are hereby found. Petitioner is an individual residing at Westbury, Long Island, New York. His*701 Federal income tax return for the year 1935 was made on the cash receipts and disbursements basis and duly filed with the collector of internal revenue for the third collection district of New York.

Petitioner married in 1931; his wife's name is Harriet Phipps. Their only child, Anne Phipps, was born September 12, 1932. Petitioner is wealthy. His sisters-in-law are also wealthy and he did not want his wife to feel that she was hampered in doing things which she might want to do or was dependent upon him. At the time of their marriage he gave his wife a sum of money upon which she drew occasional checks for her family.

Petitioner's wife believed that it was ignominious to ask her husband for funds to make contributions to her mother's support. Petitioner considered making a settlement on his wife, but was advised by his attorneys to create a trust instead. The attorneys advised him that a gift tax might soon be enacted. He thereupon instructed his attorneys to prepare an appropriate trust instrument.

On June 3, 1932, petitioner, as grantor, executed a trust instrument in which he, his wife, and the Bessember Trust Co. were named trustees. The corpus of the trust was*702 composed of first mortgage bonds and notes aggregating the face amount of $1,276,000 and sundry preferred and common stocks.

The beneficiaries named in the trust were petitioner's wife, Harriet Phipps, and his child, who was then unborn.

The trustees were to manage and invest the corpus, collect the income, and pay it out as follows:

Until the child reached 21 years of age the trustees were to pay in their uncontrolled discretion such part of the net income to petitioner's wife, and such part of the balance to petitioner's wife as custodian for the maintenance, support, and education of the child, as they decided upon. The balance of the income was to be accumulated during the child's minority and paid to her when she became 21.

After the child reached 21 the income was to be paid to petitioner's wife and the child in such proportions as the trustees in their sole and absolute discretion decided upon.

*359 Should petitioner's wife predecease the child, the income was to be paid to the child, but if the child were still in her minority, the trustees could accumulate the income and spend such part of it as in their sole and absolute discretion they decided upon*703 "toward the education, comfort, maintenance and support" of the child.

If the child should predecease her mother, the trustees were to pay out the entire net income of the trust, including accumulations for the benefit of the child, to petitioner's wife.

After the death of petitioner's wife and child the corpus was to be paid to such of petitioner's descendants as the wife by will appointed; if there was no appointment, to petitioner's descendants, per stirpes; if there were no descendants and petitioner was living, to him; and if he was not then living, to the descendants of his brothers and sisters in such proportions as the Bessemer Trust Co. should direct. If the trust was not sooner terminated, it was to continue until the death of petitioner's wife and child.

The trustees were given broad powers of management. Their powers, inter alia, included the power to sell or lease any trust asset at public or private sale "at such prices and upon such terms as it [sic] may deem proper"; to lend any money or trust property "for such terms and purposes, upon such conditions and upon such securities as the Trustees may deem proper, or in the discretion of the Trustees*704 without security"; and to accept in payment for any trust property, sold or leased or otherwise disposed of "any property whatsoever, * * * which the trustees in their sole and absolute discretion may deem proper."

The trust provided that upon the failure of either or both of the individual trustees no successor was to be appointed but the surviving individual trustee and the corporate trustee, or the corporate trustee alone, as the case might be, were to administer the trust; that, upon the failure of the corporate trustee during petitioner's lifetime, petitioner was to appoint a successor and after petitioner's death such successor was to be appointed by petitioner's wife.

The trust instrument further provided that at any time during the life of petitioner, upon the written direction of petitioner's wife, the trustees were to pay over all of the trust estate, both principal and income, then in their hands, to petitioner, upon which the trust was to cease.

The Bessemer Trust Co. was incorporated under the laws of the State of New Jersey on July 23, 1907. Its authorized and outstanding 1,000 shares of capital stock were owned by petitioner, his two brothers, and his two sisters*705 in equal shares, except that since the death of one of petitioner's sisters in 1934, her shares were divided equally among her four sons.

*360 Petitioner has served as a director of the Bessemer Trust Co. from the date of its incorporation to the present and has served as a vice president of the trust company from January 11, 1910, to the present time.

The officers and directors of the Bessemer Trust Co. for the years 1932 to 1934, inclusive, and their relationship to petitioner were as follows:

Officers

Henry C. Phipps, president

Bradley Martin, vice president

Howard*706 Phipps, vice president

David T. Layman, Jr., secretary and treasurer

Roulhac Anderson, asst. sec. and asst. treas.

D. Thomas Moore, cashier.

Officers

The same as for the years 1935 to 1938, inclusive.

Directors

The same as for the years 1935 to 1938, inclusive, except that Michael G. Phipps (nephew) took the place of John H. Phipps, and Townsend B. Martin (nephew) took the place of Henry Bradley Martin.

Officers

The same as for the years 1935 to 1938, inclusive.

Directors

The same as for the year 1939, except that Raymond R. Guest took the place of Winston F. C. Guest.

The Bessemer Trust Co. handles the financial matters for members of the Phipps family and acts as trustee for trusts created by them. It maintains an investment department which employes the services of various investment counsel firms to*707 recommend changes in investments. It subscribes to other investment services and makes investigations to determine the desirability of securities. It provides the same investment services with respect to investment funds of members of the Phipps family as it does for the investment of the funds of trusts created by members of the Phipps family.

The amounts of income payments to the wife were not determined by her, nor, in any of the years in question, by petitioner. They were made upon a determination, by a tax expert in conjunction with a lawyer employed by the Bessemer Trust Co., of the amount of the trust income which, if withdrawn by petitioner's wife, would result in the minimum income tax liability for petitioner's wife and the trust. A letter was then prepared for the signature of petitioner's wife, addressed to the Bessemer Trust Co., requesting payment of the amount so determined; and petitioner's wife signed the letter. Payments were sometimes made prior to the time that the letters making the request for payment were written.

Petitioner's wife never saw the checks from the Bessemer Trust Co. They were deposited directly to her account without her endorsements.

*708 The board of directors of the Bessemer Trust Co. did not take up for consideration in any of the years shown by the record the question whether they should or should not pay petitioner's wife the amount of trust income to be distributed to her.

With respect to matters of the Bessemer Trust Co., family matters, and individual matters, generally speaking, the ultimate decision rests with John S. Phipps, who is looked upon by the other members of the family as the head of the family, although that is not a necessary rule. People affected decide on their own affairs. Petitioner participated in discussion of securities as to those of his own personal funds. Practically all of petitioner's personal investments are handled by the Bessemer Trust Co. or Bessemer Investment Co. Petitioner had factual control in the nature of a veto power over the trust involved and its income by reason of the integrated family character of the Bessemer Trust Co. and the necessity of procuring its consent to any trust action.

During the period petitioner was trustee of the trust in question he did not exercise any rights as trustee. In December 1934 he was told *362 by his attorney that it*709 would be advisable for him to resign as trustee and he executed an instrument dated December 6, 1934, which set forth a statement of his resignation as trustee.

Petitioner never bought any securities from or sold any securities to the trustees under the trust in question, nor did he ever borrow any money from or enter into any transaction with the trustees of the trust.

Petitioner's wife had no business knowledge concerning investments; she was not in any position to formulate an investment policy for the trust; she did not participate actively in its management. Occasionally, upon being told about a certain investment, she would ask an employee of the trust company about it, but would rely upon the judgment of the trust company.

For the year 1935 the trust in question received net taxable income amounting to $119,408.84. For the same year two Federal income tax returns on Form 1040 were filed with respect to the property held by the trust, whereby the net taxable income of $119,408.84 was reported by returning $113,360.08 on a form designated "Harriet and Anne Phipps Trust" and the balance of $6,048.76 on a form designated "Harriet and Anne Phipps Income Trust." If petitioner*710 is taxable with respect to the income from the property, he is taxable upon the aggregate of $119,408.84.

The following table shows the dates of the checks on the Bessemer Trust Co. in payment of trust income, the disposition thereof, and the dates on which requests were made:

Petitioner's wife reported the amounts indicated (except the portions thereof which represented tax exempt income) *711 in her Federal income tax returns for the respective years and taxes shown to be due upon these returns were paid. None of the payments so made and none of the income from the securities purchased with such payments were used by petitioner's wife to defray household expenses. Household expenses, which annually aggregated about $60,000, were paid by petitioner's wife with funds furnished by petitioner by means of checks drawn by the wife upon a special account in her name with the Corn *363 Exchange Bank & Trust Co., signed "Harriet Phipps, Special Account."

At the time the trust was executed petitioner and his wife had no understanding between themselves with respect to using the income from the property either for the payment of household expenses or in any other way for the benefit of petitioner. Petitioner did not in any of the years in question personally advise his wife either with respect to the amount of income which she should request to be distributed to her by Bessemer Trust Co., or with respect to the disposition to be made by her of the income which was distributed to her.

The following table reflects in summary the payments made by petitioner's wife from*712 the checking account in which the payments of the trust income she received were deposited:

The Bessemer Investment Co., which was payee of 13 of the checks drawn by petitioner's wife for the aggregate sum of $295,377.64, as indicated above, is a Delaware corporation, all of the stocks and bonds of which, except for qualifying shares, were held by and for petitioner and members of his family. Petitioner did not have a controlling interest in Bessemer Investment Co. by reason of the stocks and bonds thereof owned by him directly and individually. The Bessemer Investment Co. during the period in question, was engaged in the purchase, sale, and holding of securities for itself and for petitioner*713 and members of his family.

On January 1, 1936, the account of petitioner's wife with the Bessemer Investment Co. had a credit balance in her favor of $39,205.93. The following table shows in summary the payments made in the years 1936-1940 by the Bessemer Investment Co. from the account of petitioner's wife:

*364 OPINION.

OPPER: We can not distinguish this case in principle from , which applies to its own facts the theory of , and concludes that the taxpayer there was subject to tax on the income of a trust he had created. We think the same result*714 must follow here.

It has been said that the Clifford principle rests upon a triangular base: Control over the corpus by the grantor, intimate family relationship with the beneficiaries, and the short term of the trust. But the clarification contributed in a number of subsequent decisions makes it evident that the last of the three considerations is in fact nothing but a factor supplemental to the other two. The doctrine may be narrowed to this: That if the grantor has retained the substance of control over the custody and management of the principal of the trust by his own position as trustee or by his control of the fiduciary, cf. , and if at the same time he enjoys a sufficient measure of the financial or even of the noneconomic benefits of the income through its distribution within the intimate family group, , or alternatively through his control of that distribution, direct or indirect, , then the transfer to the trust is at best illusory and the grantor has unsuccessfully attempted "to have his cake*715 and eat it."

The function of the length of the term of the trust is thus no more than to act as an indicator or contributing factor in the determination of the other two criteria. . If the term is short, evidence of control is furnished almost automatically. If the term is long or indeterminable, it may be that other elements of control must be found. ; . And the same may be said of the grantor's position as sole or joint trustee. He may, through a power to influence the trustee's action, be in a position as dominant as though he were technically the trustee himself. ;. The important process is to decipher if we can in an all-inclusive survey of the terms of the arrangement, the relationship of the parties, and the potential as well as actual developments, whether there has in fact resulted an open-handed freeing by the grantor of substantially all of his connection with the trust property on the*716 one hand or a purely perfunctory and superficial release while at the same time the basic elements of control and enjoyment remain. Cf. ; .

The present circumstances may indeed differ considerably from those in the Clifford case. But the principle does not rest within *365 the frame of an instantly recognizable and always identical arrangement of provisions and circumstances. The grantor may ostensibly have surrendered way lawyers are accustomed to consider the legal tools for controlling property. The income may be irrevocably guided to destinations excluding his own pocket. Yet the doctrine of the Clifford case requires the triers of the facts to consider whether, in the light of all the circumstances and with an eye to all the significant relationships, the grantor has so fundamentally separated himself from the control of corpus, the enjoyment of income, and the realization of economic benefits and personal satisfactions connected with the property, that as practical people we can assure ourselves of the reality of any conclusion that the beneficiary*717 enjoys substantially all, and the grantor substantially none, of those advantages of civilized government inhering in the possession of property for which income taxes in the last analysis are exacted. See .

In many situations, to which the present is no exception, this is a difficult and subtle exercise. It may be necessary to arrive at an appropriate solution by resort to analogy and hypothesis. And yet if we fail to do so a result which is evident to the lay mind may fail of recognition by the very bodies which are entrusted with applying in the field of taxation what must be essentially practical and common experience.

Here we have the story of an individual whose asserted motive is the making of periodic gifts to a member of his intimate family. If, while retaining the property producing them, these presents were handed out from time to time by the petitioner, it is clear his income would remain undiminished for tax purposes. But for reasons of which we are not apprised, except that they seem to have stemmed from the legal and technical advice which petitioner obtained, *718 these gifts were made, not by an outright transfer, but by the indirect process of a discretionary trust, with at least the exercise of a joint control lodged in a corporate trustee operated by petitioner's family.

Clearly this family fiduciary was dominated by petitioner, his brothers and sisters. Just as positively, though this is partly inference, the wishes of each as to the fiduciary's transactions respecting a trust established by him would be respected by the others. To every practical degree, therefore, we must consider that petitioner could control the fiduciary's activities to accord with his wishes, even though he may as yet have made no effort to do so, and we have so found as an ultimate fact. "The possession of the power is determinative, not the fortuitous manner of its use." .

Income was payable for the wife's use or for the support of the child, or was to be accumulated, depending exclusively on the discretion of the trustees. In New York, decisions of that nature must *366 be unanimous in the case of multiple trustees, and that, of course, is even more true where there are but two. "It seems to be well*719 established that where the acts of trustees call for exercise of discretion and judgment, the concurrence of all is necessary." ; ; ; affd., .

The wife, therefore, could lay no positive claim to a single penny of the trust income. See . If the corporate trustee of which petitioner had practical control refused to sanction the enjoyment of these benefits by the wife, her capacity to share in the prospective gifts could be limited, reduced, or destroyed. The money could then be spent for the support of petitioner's child, or it could be withheld from both wife and child. "Though lacking legal power to control [the trustee's] discretion, there is little doubt that [the grantor] could have her way in directing the disposition of income between the possible beneficiaries." .

True, so long as the affectionate solidarity of the family was preserved, such a development*720 was unlikely, and in fact we know from the evidence that it has not occurred. But if these contributions flowing indirectly from the petitioner were those which he would in any event have contrived for his own personal satisfaction, there is here no detriment to his position, attributable to the trust arrangements, such as would satisfy the Clifford test. A similar situation applies to the management of the corpus and to the reinvestment of accumulated income. Petitioner's subservient corporation could stalemate, and in fact did arrange and govern these matters.

Thus, so long as the anticipated relationship between petitioner and his wife might prevail we have the very essence of the family's solidarity upon which the principle of the Clifford case fundamentally rests. And if the time arrives when this no longer obtains, the structure and arrangement of the trust is such that petitioner's intervention can be made effective. See He can then control, by indirection, the distribution of the trust income. *721

It can not be said that petitioner has relinquished this control merely because, in addition to the discretionary possibility of the current receipt of income by the wife, she has a substantial right by virtue of her interest in income and principal upon the death of the daughter. That condition did not exist during the year we are considering. Cf. And while such a potential adversity of interest may be significant in applying sections 166 and 167, it is inconsequential in construing section 22(a). But cf. ; affd. (C.C.A., 7th Cir.), . And see *367 . And finally the power of appointment over the principal which was given to the wife was, like all the other trust arrangements when adequately scrutinized, carefully limited and safeguarded so that the grantor failed to relinquish his fundamental interest. For the appointment is confined to claimants who would be the natural objects of the grantor's bounty in any event, his own*722 descendants. We can scarcely conclude that a power so circumscribed, particularly with respect to any desire which the wife might have to benefit her own family and personal concerns where they differed from those of the grantor, can be said to effect a substantial relinquishment of property interests by the husband.

A perhaps not inadmissible test of the extent to which this trust was a mere rearrangement of the family finances on the one hand or an outright disposition in favor of the wife on the other is to consider the probable attitude of the parties, were they in a position of dealing at arm's length or in a situation where their interests were actually adverse. Suppose, for example, that this trust had been occasioned by the imminence of a proceeding for separation or divorce. Can it be imagined for an instant that a wife would be willing to accept, in lieu of alimony or a property settlement, provision whereby all of the income could be withheld from her throughout her daughter's life; where payment of income and control of the investment and maintenance of principal were in the hands of a cotrustee dominated by the husband and his family; and where the sole right with*723 respect to disposition of the principal upon her death would rest in the wife, subject to the frustrating limitation that the appointment could be made only in favor of her husband's descendants? We think it clear that judged by such a test the result must be that this was the kind of trust that would only be established by the husband and would only be acceptable to the wife as an indirect means for the one to make periodical gifts to the other as long as the family relationship existed undisturbed. This seems to us the very crux and core of the Clifford principle and of other cases recently dealing with similar problems.

We do not pass upon the separate applicability of sections 166 and 167, nor upon whether that issue is neatly severable in such cases as this. It might be argued that what we have said adds up to an absence of that adverse interest of the wife which sections 166 and 167 require, see ; ; that as long as the wife's conduct satisfies petitioner, she may have an interest but clearly one which is not adverse; and that if the reverse*724 occurs, she may be an adverse party, but the situation can be so controlled that she has no effective interest. But the doctrine of the Clifford case and the rule of sections 166 and 167 are designed for the same purpose and applicable at times to the same *368 situations. See ;;They are certainly not inconsistent. Suffice it to say here, therefore, merely that all the present circumstances go to show how little this petitioner, like Clifford, can justifiably feel that he was any worse off financially or from the viewpoint of family control after he had placed property of which he was the outright owner in a trust fashioned to carry out his purposes and subject in the last analysis to his ultimate direction; and that as the grantor of property of which control and benefit is in fact retained, we think petitioner has failed to divest himself to a sufficient degree of the advantages and satisfactions of ownership to be freed from the tax on this income.

Reviewed by the Board.

Decision will be entered for respondent.*725

BLACK, dissenting: The majority opinion begins by stating:

We can not distinguish this case in principle from , which applies to its own facts the theory of , and concludes that the taxpayer there was subject to tax on the income of a trust he had created. We think the same result must follow here.

If I could agree that the facts in the instant case are not distinguishable in principle from those present in the Buck case, I would concur in the majority opinion, but it seems to me that the facts in the instant case are clearly distinguishable from those present in the Buck case. In the Buck case the grantor of the trust reserved to himself very large powers of control over the trust income and corpus. Those powers were enumerated by the court as follows:

In 1932 Ellsworth B. Buck, respondent here, conveyed 10,000 shares of William Wrigley, Jr. Company stock to a bank, as trustee, to pay the income to his wife for life and, on her death, to pay the income and ultimately the principal to his children or their descendants. *726 He retained a power "to alter or amend in any respect whatsoever" the provisions relating to the distribution of the income or principal, except that this power could not be exercised so as to revoke the trust, revest title to the principal in him, or direct that the income be paid to him, accumulated for him, or applied to the payment of insurance premiums on his life. In the event that a beneficiary predeceased him, the share held for that beneficiary was to return to Buck. He also retained the powers to remove the trustees, and to direct the trustee how to exercise its powers to retain or dispose of the corpus and to invest or reinvest the proceeds of a sale, and reserved the right to vote any stock or to direct the trustee how to vote it.

In the instant case Howard Phipps, the grantor of the trust, reserved no such powers of control over the income or the corpus of the trust as are enumerated in the above paragraph as being reserved by grantor Buck. In fact, he reserved no powers of control over the trust income or corpus to himself. He was not even a trustee in the taxable year. In 1934, upon advice of his counsel, he resigned as one of the trustee.

*369 The*727 majority opinion recognizes that Howard Phipps, as grantor of the trust, reserved no power of control to himself over the trust income or corpus, but the opinion says in effect that broad powers of management and control were conferred upon the trustees which made them comparable to the powers retained by the grantor in the Buck case; that one of the trustees was the Bessemer Trust Co.; that it was the alter ego of petitioner; hence, the instant case is brought within the ambit of the Buck case. This is a line of reasoning in which I am unable to concur.

The Bessemer Trust Co. was no makeshift corporation created merely to serve the wishes and purposes of petitioner. It was, and is, evidently a very substantial business corporation. It was incorporated under the laws of the State of New Jersey in 1907. According to the findings of fact which are made the basis of the majority opinion, it handles the financial matters of the Phipps family and acts as trustee for trusts created by them. It maintains an investment department which employs the services of various investment counsel firms to recommend changes in investments. It subscribes to other investment services*728 and makes investigations to determine the desirability of securities. Under such circumstances it seems to me that it was the perfectly natural and normal thing for petitioner to make it the corporate trustee for the irrevocable trust which he created in 1932 for the benefit of his wife and daughter. It had ample facilities for experienced management. I see no warrant for our assuming that the Bessemer Trust Co. will act in the administration of its trust in any other manner than a normal and correct trustee would act in discharging fiduciary duties. Assuming that it will so act, and certainly the facts do not show that it has done otherwise down to the present time, then I do not see how it can be said that the instant case is controlled by , and . The cases, in my judgment, are altogether different. It seems to me that the powers granted to the trustees (Bessemer Trust Co. and Harriet Phipps) in the taxable year before us were normal to a discretionary trust - such a trust as is taxable under section 161(a)(4) of the Revenue Act of 1934. The discretionary powers*729 granted to the trustees are enumerated in the findings of fact and need not be repeated here. It seems to me that by no stretch of logic can these discretionary powers to be exercised by the trustees in their fiduciary capacities be compared to the powers which the grantor of the trusts reserved in the Buck and Clifford cases.

I think the facts of the instant case bring it within the ambit of , in which the court, among other things, said:

* * * Where the grantor has stripped himself of all command over the income for an indefinite period, and in all probability, under the terms of the *370 trust instrument, will never regain beneficial ownership of the corpus, there seems to be no statutory basis for treating the income as that of the grantor under Section 22(a) merely because he has made himself trustee with broad power in that capacity to manage the trust estate. * * *

In the instant case the trust is to last until the death of the last survivor of petitioner's wife, Harriet Phipps, and petitioner's daughter, Anne Phipps. Thus to use the language of the court in the Branch case, petitioner*730 "has stripped himself of all command over the income for an indefinite period, and in all probability, under the terms of the trust instrument, will never regain beneficial ownership of the corpus." This being the case, there seems to be no reason to tax petitioner with the income under section 22(a). There are appropriate provisions of the statute which tax the undistributed income to the trust as a separate taxable entity, see section 161(a)(4), Revenue Act of 1934, and tax the distributed income to the wife, the beneficiary who received it, see section 162(c) of the same act. These statutes seem to have been complied with in the taxable year which we have before us. In my judgment, the law requires no more.

The Board followed , in , in which, among other things, we said:

* * * It should be remembered that the trusts involved in the instant case were not short term trusts, as in the Clifford case, but were for the life of the beneficiary named in the respective trusts. The corpus and accumulated income were not to revert to the grantor except upon a remote contingency. Under*731 these circumstances, we do not think , is controlling.

Cf. .

For reasons I have stated above I do not believe that the facts of the instant case bring it within the rule of the Buck and Clifford cases. I, therefore, respectfully dissent from the majority opinion.

MURDOCK, ARUNDELL, LEECH, and TYSON agree with this dissent.