BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION v. United States

• Decision Date: 09 March 1962
• Docket Number: Civ. A. No. 38060.
• Citation: 203 F. Supp. 152
• Parties: BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as Trustee of the Trust created under the Last Will and Testament of Kernan Robson, Deceased, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Northern District of California

203 F. Supp. 152

BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as Trustee of the Trust created under the Last Will and Testament of Kernan Robson, Deceased, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 38060.

United States District Court N. D. California, S. D.

March 9, 1962.

Robert J. Dreher, Dreher, McCarthy & Dreher, San Francisco, Cal., for plaintiff.

Cecil F. Poole, U. S. Atty., Richard L. Carico, Asst. U. S. Atty., San Francisco, Cal., for defendant.

WOLLENBERG, District Judge.

The facts in the above entitled action show that Kernan Robson was a resident of California when he died on January 13, 1956. His will was admitted to probate in the Superior Court of California on February 6, 1956 and the Bank of America was appointed executor of the estate on that same day.

The residue of decedent's estate was left to the Bank of America as trustee, with directions to pay monthly to certain named beneficiaries income earned by the trust, no part to be paid out of principal except to decedent's wife in the trustee's discretion if an emergency arises. The trust is to end December 31, 1977, or, if all of the income beneficiaries die before December 31, 1977, on the death of the last income beneficiary. The principal, at the termination of the trust, is to be paid to certain charitable institutions.

The estate had, for its first fiscal year running from January 13, 1956, the date of death, to October 31, 1956, a distributable net income of $178,109.00, which consisted of capital gains and income earned by the decedent prior to death and ordinary income of $65,470.44 earned by the estate.

On October 15, 1956 the Superior Court for the County of Marin entered a decree of preliminary distribution of the estate. Pursuant to the decree the estate distributed to the trustee assets of the estate, the value of which was in excess of the distributable net income of the estate; however, the property distributed did not include any of the income earned by the estate.

The estate then filed its federal income tax return for its first fiscal year, deducting the sum of $178,109.00 as amounts distributed to a beneficiary of the estate. The trustee filed his first federal income tax return, choosing for the trust's first fiscal year the period from October 15, 1956, the date of the preliminary distribution, to October 31, 1956. The trustee included $178,109.00 in the gross income of the trust and deducted $8,075.00 as depreciation expense and the remainder, $170,034.00, as funds permanently set aside for charitable beneficiaries.

The government disallowed the $65,470.44 of the trust's deduction which was income earned by the estate subsequent to decedent's death, and $8,276.35 which was the amount to go to the Marin County Hospital District, one of the remainder beneficiaries, alleging it did not qualify as a charity within I.R.C. § 170 (c). 26 U.S.C.A. § 170(c).

The trustee paid the tax on these amounts, plus interest, and now sues to recover said sums.

The issues to be decided now are as follows:

(1) Was that portion of the income distributable to beneficiaries by the estate, which was the $65,470.44 earned by the estate, and includable in the first tax return of the trustee in his gross income, income currently distributable to the income beneficiaries of the trust?

(2) If the said amount in question received by the trustee from said estate was not income currently distributable to the income beneficiaries of the trust, was the same gross income permanently set aside by the trust for charitable purposes?

(3) Does the bequest in the testamentary trust of the decedent for the benefit of Marin County Hospital District qualify as a charitable deduction?

It is the government's contention in denying to the trustee the $65,470.44 deduction that, since it was income earned by the estate during the period of administration and no provision was made in the will as to the disposition of any such monies earned, the income beneficiaries under the trust were entitled to it. In re De Laveaga's Estate, 50 Cal. 2d 480, 326 P.2d 129 (1958). And, accordingly, under the theory of the conduit rule the tax liability on such income passes to the Trust even though, in the taxable year involved, the said income was retained by the estate and was not distributed to the Trust and its income beneficiaries until a subsequent taxable year not here at issue.

I.R.C. § 661(a) allows the estate to deduct from its gross income any amount distributed to its beneficiary up to its distributable net income, no matter what assets were actually distributed to the beneficiary. And even though the estate retained the income earned during administration Congress provided that the beneficiary receiving the distribution from the estate include the amount so received in its gross income, up to the distributable net income of the estate I.R. C. § 662(a). This both parties admit.

The government then contends that I.R.C. §§ 661(b) and 662(b) require the application of the conduit theory which, it says, treats the beneficiary (in this case, the trust) as having received the income and the classes of income actually received by the estate, which consisted of income and capital gains earned prior to decedent's death, and income earned during administration, and therefore the $65,420.44, which was earned by the estate during administration, is income earned by the trust and must be distributable to the income beneficiaries.

The government's argument wears thin in two places, however. It is agreed that the terms of the governing instrument and applicable local law prevail to define "income" and to determine whether the income is required to be distributed when the word "income" is in issue and is not preceded by the words "`taxable', `distributable net', `undistributable net' or `gross.'" I.R.C. § 643(b), Regulations § 1.661(a)-2(b). See also Judge Hand's opinion in Johnston v. Helvering (2nd Cir., 1944) 141 F.2d 208 at 210.

It is clear from a...