Chertoff v. Commissioner of Internal Revenue

• Decision Date: 07 April 1947
• Docket Number: No. 10308.,10308.
• Citation: 160 F.2d 691
• Parties: CHERTOFF et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

160 F.2d 691 (1947)

CHERTOFF et al. v. COMMISSIONER OF INTERNAL REVENUE.

No. 10308.

Circuit Court of Appeals, Sixth Circuit.

April 7, 1947.

David Perris, of Cleveland, Ohio (Lawrence M. Rich, of Cleveland, Ohio, on the brief), for petitioners.

I. Henry Kutz, of Washington, D. C. (Sewall Key, Robert N. Anderson and I. Henry Kutz, all of Washington, D. C., on the brief), for respondent.

Before SIMONS, MARTIN and MILLER, Circuit Judges.

MILLER, Circuit Judge.

The petitioners, George J. Chertoff and his wife, Lillian R. Chertoff, filed separate petitions for review of orders of the Tax Court which upheld deficiency assessments of the Commissioner of Internal Revenue in income taxes for the calendar years of 1937, 1940 and 1941 with respect to George Chertoff in the total amount of $22,951.86, and with respect to Lillian Chertoff in the amount of $9,071.55 Under stipulation and order the two petitions for review were filed under and proceed in this one case. The question involved is whether income from separate trusts created by petitioners, with identical provisions, for the benefit of their children was taxable to the petitioners under the rule announced in Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788. Both the Commissioner and the Tax Court held the income from the trusts so taxable.

The facts are stipulated and are briefly stated as follows: The petitioners are residents of Shaker Heights, Ohio, and have three children, Garry, born in 1922, Arlyne, born in 1923, and Gertrude, born in 1925. George Chertoff is a chemist. In 1917, he caused the formation and incorporation of the Synthetic Products Company to which he transferred in exchange for 450 shares of its capital stock a formula which he owned for producing water-repellent powder necessary in the manufacture of rubber paint. Since about 1924, the Company has been a manufacturer of chemicals. On September 15, 1937, the Company had 900 shares of stock outstanding, of which George Chertoff owned 451 shares and Lillian Chertoff 449 shares. On September 15, 1937, George Chertoff executed three indentures of trust, one for the benefit of each child, then under 21 years of age. In all material respects the separate trust indentures are identical. In each trust George Chertoff and Lillian Chertoff were named trustees. In each trust George Chertoff transferred 150 shares of the Synthetic Products Company to the trustees.

On December 12, 1940, Lillian Chertoff executed three indentures of trust for the benefit of Garry, Arlyne and Gertrude respectively, then under 21 years of age. In each trust George Chertoff and Lillian Chertoff were named trustees, and in each instance she transferred 75 shares of stock of the Synthetic Products Company to the trustees. The terms of the trust indentures were in all material respects identical with those executed by George Chertoff in 1937, except that Lillian Chertoff was the settlor.

Each trust was irrevocable. Each trust provided — "The Trustees shall have and hold the corpus and invest the same, receive the income, rents, issues and profits arising therefrom and pay said income over to said (name of child) or his legal guardian without restrictions as to use or purpose, and upon his death to pay over the principal and any accumulation of income to such person or persons and in such shares and lawful estates as the said (name of child) may nominate and appoint by his Last Will and Testament, or other valid written instrument, and in default of the same to pay and transfer the same in equal shares to George J. Chertoff and Lillian R. Chertoff or the survivor of them. * * * The Trustees are Hereby granted the power and authority in their sole discretion to pay to the beneficiary hereunder or his legal guardian from the principal from time to time such sum or sums as said Trustees may deem advisable without restrictions as to use or purpose." Each trust provided that it would terminate (a) as the beneficiary became 30 years of age, or (b) upon the death of the beneficiary prior to his becoming 30 years of age. It was further provided that in the event of either of the trustees dying, resigning, or becoming incapable of acting, the surviving trustee would continue to act, and in the event of the death of the surviving trustee the Executor named in the Will of the settlor would act as trustee. Each trust provided that in the event the beneficiary should alienate or charge either the income or principal, or if by reason of any event happening such income would either wholly or in part cease to be enjoyed by him, then such income would immediately cease and the devise to such person of the principal sum shall be revoked and thereafter the trustees were to pay the principal and income to and for the benefit of the persons who would be entitled thereto under the trust if such beneficiary were dead. The trustees were given the authority, without order of Court, to invest all sums in their possession according to their absolute discretion in such ventures, securities, and real estate as they deemed for the best interest of the beneficiary, irrespective of any statutes, rules or practices of Chancery Courts, with the trustees having absolute discretion as to the terms, conditions and rate of interest in respect to any such investment.

On December 13, 1937, George Chertoff contracted with the Synthetic Products Company to act as its sole and exclusive sales agent for a period of 10 years beginning January 1, 1938. Prior to that date the Company had made its own sales directly. During the years 1938, 1939 and 1940, sales of the corporation's products were made a price slightly in advance of cost to George Chertoff doing business as "Synthetic Products Sales Company." His net profits as such sales agent were $8,985.70 in 1938, $13,810.94 in 1939 and $23,484.44 in 1940, which was in addition to his salary.

On December 11, 1940, the net assets of the Synthetic Products Company were sold to George Chertoff. The corporation then was liquidated. On December 12, 1940, a partnership agreement was executed between George Chertoff, Lillian Chertoff and themselves as Trustees for each of the three children, effective January 1, 1941, and continuing for a period of 10 years unless sooner terminated by death or other cause. George Chertoff contributed to the partnership his skill and experience in the business, the right to the use of the name The Synthetic Products Company, and $10,000 cash. Lillian Chertoff contributed $10,000. The Trustees for each child contributed $10,000. Each contributor became the owner of a one-fifth interest in the partnership. The Articles provided that George Chertoff would devote his entire time to advancing the interest of the partnership, and that as agent of each of the other partners he would have charge of the partnership business, including buying, selling, manufacturing and finances of the firm. His appointment as such agent was terminable at the will of any partner. George Chertoff was to receive for his services the compensation exclusive of his share of the profits equal to 2% of the annual sales of the firm. The sale to George Chertoff and the liquidating dividends were reflected by book entries. Opening entries were also made on the books of the partnership. As of January 1, 1941, the manufacturing and sales end of the Synthetic Products Company were consolidated and were so conducted throughout the taxable year 1941.

The petitioners have treated all the trusts as valid and subsisting trusts. They have never been revoked, and such monies under the terms of said agreements as were collected were retained by the trustees in the respective trusts. Returns were filed for each of the years 1937, 1940 and 1941 with reference to each of the trusts, representing the amounts of income and tax due. There was no income to the trusts in 1938 or 1939. Returns were filed for the partnership after its formation. In making the deficiency assessments referred to, the Commissioner treated the income from the three trusts created by George Chertoff as taxable income to him, and also treated the income from the three trusts created by Lillian Chertoff as taxable income to her.

The Tax Court held that since the beneficiary of each trust would be under legal disability to make a valid appointment during his minority, in the event of his death during minority the trust corpus, with the accumulation of any trust income, would go in equal shares to Mr. and Mrs. Chertoff or in toto to the survivor of them; that the same devolution would result in the event of his death after reaching his majority without having validily exercised his power of appointment, and also in case the trust was terminated by reason of its spendthrift provisions in the absence of a valid exercise of the power of appointment; that the power of the trustees to pay to the beneficiary or his legal guardian from the principal of the trust such sums as the trustee might deem advisable without restriction as to use or purpose enabled the trustee to eliminate the beneficiary's appointee as a remainderman and also to pay to themselves as guardians of the beneficiary during his minority a part or the whole of the principal of the trust, including accumulated trust income, and to devote such payments to any use without restriction, including the carrying on of the business enterprises completely controlled and managed by petitioners to their economic benefit; that during the taxable years involved the beneficiaries were minors and under Ohio Statutes the petitioners were the natural guardians of their minor children with the powers of a legal guardian as to their estates; that insofar as the powers of the management of the trust estates were concerned, they were practically the same as an individual might exercise over his own property and were availed of to serve the economic interest of Chertoff; that the continuance of Chertoff's...