Brodhead v. Comm'r of Internal Revenue
| Decision Date | 07 July 1952 |
| Docket Number | 29392.,Docket Nos. 29391 |
| Citation | 18 T.C. 726 |
| Parties | THOMAS H. BRODHEAD AND ELIZABETH S. BRODHEAD, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
A trust created by the husband-petitioner for minor children, only one of whom was then in being, became a special partner in a partnership in which the petitioner was the general partner. The next year, when the petitioners had two children, the wife-petitioner created a trust for minor children, which trust purchased the interest of the first trust in the partnership and became a special partner. The trusts' contributions to the partnership originated with the husband. The trusts were long term trusts, irrevocable, and the trustees were independent of the settlors.
1. Held, that the trusts were bona fide partners in the partnership and their distributive shares of partnership income were not income of the settlors.
2. Held, further, that the settlors did not retain sufficient control over, or interest in, the trusts to make the trust income taxable to them.
Milton Cades, Esq., and Urban E. Wild, Esq., for the petitioners.
Charles W. Nyquist, Esq., for the respondent.
The respondent determined deficiencies in income tax for the years and in the amounts as follows:
+----------------+
¦1943¦$42,280.89 ¦
+----+-----------¦
¦1944¦$79,944.90 ¦
+----+-----------¦
¦1945¦$48,666.11 ¦
+----+-----------¦
¦1948¦$1,177.22 ¦
+----------------+
The principal cause of the deficiencies is the inclusion in income of the petitioners of income of successive trusts created by the petitioners— the first by the husband and the second by the wife— each of which trusts became a partner with the husband in a business which the husband had theretofore operated. The propriety of such inclusion is the main issue. If that issue is decided adversely to the petitioners, there is a further issue as to whether the statute of limitations has run against the year 1943.
The petitioners at all times material to these proceedings were husband and wife and residents of the Territory of Hawaii. They filed their income tax returns with the collector of internal revenue for the district of Hawaii.
The petitioners have three children born December 29, 1939, November 19, 1942, and May 1, 1945.
In and prior to 1942 the petitioner Thomas H. Brodhead was engaged as an individual in operating a wholesale merchandise business in Honolulu. The merchandise handled consisted of a great variety of articles which were sold to post exchanges and ships' service stores and included drug items, razor blades, dungarees, shoes, underware, work shirts, shower clogs, pocket knives, candy, gum, and miscellaneous items.
The petitioner Thomas H. Brodhead came from a family of short-lived people on his father's side and he was quite concerned about the length of his own life. Conditions in Hawaii in 1942 were not conducive to a feeling of long life. He was determined to make some provision for his children so that they would have a better education than he had. In September 1942 the petitioners had one child, and were expecting the birth of another. Thomas H. Brodhead's business grew rapidly after the start of World War II, and he wanted some means of having it carried on for the benefit of his children in the event of his death. Also, because of the size to which the business had grown in 1942 he felt that he needed someone to help him with it.
Mortimer J. Glueck had been a personal and business acquaintance of the petitioner Thomas H. Brodhead for a number of years, had kept his books on a part time basis, and had advised him generally. Glueck had a commission business, and in 1942 he was getting too busy with it to be able to assist petitioner Brodhead and advised him to get other assistance. Glueck and Brodhead had many discussions as to what provision the latter should make for his children.
Bishop Trust Company, Limited, in and prior to 1942 conducted a trust company business in the Territory of Hawaii. It is operated as a professional fiduciary, with side issues such as insurance, real estate sales, and brokerage. Its main business is the administration of estates, trusts, guardianships and agency accounts. The normal trust or estate handled by the trust company consists of securities or interests in real estate. However, it has at times administered proprietorships and the controlling shares of incorporated businesses. In the administration of such properties it has operated various businesses including a structural steel mill, a department store, dairies, ranches, a bottling company, and an automobile agency.
In 1942 Glueck and Brodhead sought the advice of counsel, and it was agreed that a trust should be created for the benefit of the petitioners' children and that the trust should become a partner with Brodhead in his business. Brodhead asked Glueck to be one of the trustees so that with his knowledge of the business he could carry it on in the event of Brodhead's death. Brodhead also wanted Bishop Trust Company, Limited, as a trustee for the general assistance and advice that it could give.
On September 30, 1942, the petitioner Thomas H. Brodhead created the Thomas H. Brodhead Trust, naming Mortimer J. Glueck and Bishop Trust Company, Limited, as trustees. Corpus of the trust was stated to be $40,000. It consisted of a one-half interest in the petitioner's business which at that time had a net worth of $80,000. Under the trust agreement, the $40,000 corpus was to be contributed to the capital of a special partnership to be organized concurrently for a 50 per cent interest therein.
The trustees were required to accumulate all trust income during the continuance of the trust, but they had discretion to pay out net income for the maintenance, support, and education of the children of the settlor, or if income was insufficient they could use corpus. All income not used for such purposes was to be accumulated and added to corpus. The trustees were authorized to pay to any child of the settlor any time after attaining age 21, as they deemed proper, such portion of corpus and accumulated income as constituted one share, such share to be determined by considering the trust estate to be divided into as many equal shares as there should be children then surviving or lineal descendants of any deceased child.
The trust was to continue until 20 years after the death of the settlor. The trust property and accumulated income were then to be distributed to the surviving children of the settlor (other than those to whom the distribution of a share may have previously been made) and the issue of any deceased children. If there were no children or issue then surviving, distribution was to be made to those persons, other than the settlor, who would be the heirs-at-law of the last survivor of the children of the settlor.
The trustees could terminate the trust at any time after the termination of the special partnership, in which event distribution was to be made to the settlor's children and issue of any deceased children.
The trustees were given broad powers to invest and reinvest and manage the trust property, but during the life of the settlor they were required to obtain his consent to all investments. After the settlor's death the trustees were to be restricted in making investments to those which trustees are permitted by law to make. However, they could in any event make advances or loans to the special partnership without liability for any loss resulting therefrom.
The settlor reserved the right to transfer additional property to the trust. The trustees were required to furnish annual statements of account to the beneficiaries. The corporate trustee was given the custody of all money or securities in the trust.
The trust was declared to be irrevocable by the settlor. It was provided that in no event should any of the trust property or income be paid to or inure to the benefit of the settlor.
Any alteration, amendment, cancelation, or revocation of any provisions of the trust required the written consent of the trustees and all of the beneficiaries.
A special partnership was formed by a document dated as of September 30, 1942. The petitioner Thomas H. Brodhead was referred to therein and signed the agreement as ‘General Partner.‘ The trustees of the above described trust are referred to and signed as ‘Special Partner.‘ The partnership adopted the name of T. H. Brodhead Co. Its purpose was to acquire the assets and carry on the business theretofore conducted by the petitioner Thomas H. Brodhead. Other purposes are stated including the carrying on of any business that may lawfully be carried on by a partnership.
The initial capital of the partnership was $80,000 which was the book value of the net assets that it acquired. It was agreed that $40,000 was the capital contribution of each of the partners and that each had a 50 per cent interest.
The general partner who was actively engaged in the business was to receive compensation for his services which was to be charged as an expense in computing partnership profits. The remaining profit, or loss, was to be divided in proportion to the capital contributions. Profits attributable to each partner's interest could be withdrawn from time to time as the partners deemed advisable.
The trustees had all the powers, rights, and duties of a special partner as prescribed by designated sections of the Special Partnership Law of the Territory of Hawaii, and were not liable for partnership debts beyond the extent prescribed by law.
Only the general partner had authority to transact the business of the partnership, or incur obligations. He was to establish the policy of the partnership. The special partner could at all times investigate the partnership affairs and advise the general partner as to its management.
The general partner could not assign or mortgage any part of his interest. The special...
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