La Fargue v. Comm'r of Internal Revenue

• Decision Date: 10 October 1979
• Docket Number: Docket Nos. 5629-75,6259-77.
• Citation: 73 T.C. 40
• Parties: ESTHER LA FARGUE, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

73 T.C. 40

ESTHER LA FARGUE, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 5629-75

6259-77.

United States Tax Court

Filed October 10, 1979.

Pursuant to an overall plan, petitioner established a trust with a nominal corpus of $100. Petitioner's sister, the son of friends, and her lawyer were trustees. Two days later, petitioner transferred various assets to the trust in return for equal annual payments for life from the trust. The annual payment multiplied by petitioner's life expectancy equaled the fair market value of the assets transferred, no allowance having been made for any interest factor. Held, based upon all the facts and circumstances, the transfer of assets was not a sale or exchange for an annuity but a transfer in trust with a reserved interest, with the result that the payments received by petitioner were includable in her gross income under secs. 677 and 671, I.R.C. 1954, to the extent of the lesser of the gross income of the trust or the annual payment, rather than taxable as an annuity under sec. 72, I.R.C. 1954. Harry Margolis, Richard Gladstein, and W. Palmer Kelly, for the petitioner.

John E. Lahart, Jeannette A. Cyphers, and William E. Bonano, for the respondent.

TANNENWALD, Judge:

Respondent determined deficiencies in the Federal income tax of petitioner for 1971, 1972, and 1973 in the respective amounts of $3,576.58, $4,052.04, and $3,912 together with negligence penalties under section 6653(a).¹ The negligence penalties have been conceded by respondent, and capital loss adjustments set forth in one notice of deficiency have been conceded by petitioner. There remains at issue whether certain transactions between petitioner and a trust which she established should be treated as constituting a transfer of property in exchange for an annuity in her favor, with the result that the taxation of the payments received by her should be governed by section 72 and other applicable legal principles, or as creating a trust in which petitioner retained the requisite interest under sections 671 through 677 governing trusts where grantors are treated as substantial owners.

A constitutional objection raised by petitioner is no longer an issue before this Court. This matter was disposed of when the Court granted respondent's motion to strike amendments to the petitions herein.²

The trial of this case was held before Special Trial Judge Aarons. He prepared a report which was served on the parties and to which they have filed certain exceptions. These exceptions have been taken into account by the Court and appropriate weight has been given to the findings of fact recommended by Special Trial Judge Aarons. See Rule 182(c) and (d), and the Note thereto, Tax Court Rules of Practice and Procedure, 60 T.C. 1057, 1149-1150 (1973).

FINDINGS OF FACT

Some of the facts have been stipulated and those facts are so found. The stipulation of facts, supplemental stipulation of facts, and all attached exhibits are incorporated herein by this reference.

Petitioner resided in Los Gatos, Calif., at the time the petitions were filed herein. She filed her Federal income tax returns for the years in issue with the Internal Revenue Service Center, Fresno, Calif.

Anna Bracher Blum, petitioner's mother, died in March 1969 leaving a sizeable estate to her three daughters equally. Petitioner's share amounted to more than $165,000, including stock in a family fruit business (Bracher Fruit Co.), bonds, cash, and other stocks, which was finally distributed in December 1970. Mrs. Blum's death also terminated a testamentary trust created by her husband's will 30 years before. The remainder of the trust was divided equally among petitioner and her two sisters. The final distribution of trust assets to petitioner included bonds and a one-third interest in two parcels of land in San Jose, Calif. One of the parcels was rented to Bank of America for use as a parking lot. The other was an unimproved lot producing no income.

While petitioner was involved in administering her mother's estate, she became concerned about the problems of managing such a large amount of property. Although she had been managing her own property since her husband's death in March 1968, her holdings had not been so extensive. She asked her mother's attorney about the advisability of setting up a trust for her daughter, Emily, and he thought it was a good idea. They did not discuss the matter in detail, since he was from a different city and petitioner did not intend to have him draft the trust documents. During this same period, petitioner was being approached by representatives of life insurance companies who suggested that she purchase an annuity. A friend of her late husband, a securities dealer, also contacted her to discuss an investment plan.

After pondering these alternatives, petitioner tentatively decided to set up a trust and visited her attorney, Harry Margolis. Petitioner and her immediate family had been friends of Mr. Margolis and his family for nearly 20 years, and an informal social relationship existed between them. Petitioner and her husband had executed wills drafted by Mr. Margolis, but they had never been involved in complex matters in which they required sophisticated legal advice.

Since she was aware that she did not fully understand the relative advantages of the suggestions that she had received, petitioner discussed different arrangements with Mr. Margolis and an associate. After these discussions, she again decided to create a trust and, with the help of Mr. Margolis, went about the task of selecting trustees. She was advised that it would be a good idea to have a member of the family as a trustee, someone who was a friend and contemporary of the beneficiary, and someone who was competent in technically handling the assets of the trust. To fill these roles petitioner chose Maxine Gardner (her youngest sister), Daniel Hawkes (son in a family close to both the La Fargues and the Margolises), and Mr. Margolis. Of the three, only Mr. Margolis was at all experienced in trust administration.

The plan involved two steps: first, creating the trust with a nominal corpus; second, executing a contract with the trustees for annual payments to petitioner in exchange for a large portion of the inherited property.

Petitioner and the chosen trustees executed a trust agreement dated February 10, 1971. Petitioner caused to be delivered $100 to the trustees as the initial corpus. The trust agreement consisted of two parts, a general “Master Trust Agreement” and a “Trust Agreement” with specific terms which modified or deleted portions of the master agreement to meet the needs of petitioner. The specific portion of the document provided as follows:

TRUST AGREEMENT

This Trust Agreement is entered into this 10th day of February, 1971, by and between ESTHER MARIE LA FARGUE of Los Gatos, California, as Trustor, and MAXINE LOUISE GARDNER, DANIEL HAWKES and HARRY MARGOLIS, as Trustees.

Attached hereto and made a part thereof as if fully set forth herein is a “Master Trust Agreement” consisting of a one (1) page index and thirteen (13) pages of content. Said “Master Trust Agreement” shall apply fully in all respects except as specifically, by reference, hereinafter deleted, modified, (Articles I, IV and V)(5), (sic) or otherwise rendered inapplicable.

ARTICLE I

Trustor has delivered to Trustees the sum of ONE HUNDRED DOLLARS ($100.00) as the initial corpus of this Trust.

(The Court notes that there is no ARTICLE II or III.)

ARTICLE IV

The beneficiaries of this Trust shall be Emily Anne La Fargue, daughter of the Trustor; the issue of Emily Anne La Fargue; and, all blood relatives of Esther Marie La Fargue and Emily Anne La Fargue. Issue shall become beneficiaries immediately upon birth. The term “issue” shall include anyone legally adopted by Emily Anne La Fargue effective immediately upon the judicial confirmation of the parent-child relationship. Persons, other than those specifically referred to above as beneficiaries, may become beneficiaries only upon the exercise of the Special Limited Power of Appointment hereinafter provided.

ARTICLE V

(2) This is not an accumulation trust.

(5) A Special Limited Power of Appointment is hereby granted to Emily Anne La Fargue as to the total assets of the Trust. * * * The persons and/or organizations which are proper subjects of this Power include:

1. The legal spouse of Emily Anne La Fargue;

2. All blood relatives of all beneficiaries named specifically in this instrument and/or designated as such by the operation of this Power;

3. (Charitable, etc., organizations);

4. (Any other person or organization so long as such recipient would not cause the Power to be defined as a general power of appointment.)

This Power shall take effect only after the death of the survivor of Esther Marie La Fargue and Emily Anne La Fargue. This Power may be exercised by Will or Deed. Should Emily Anne La Fargue not exercise this Special Limited Power of Appointment, then the Trust shall come to an end thirty days after the death of the survivor of Emily Anne La Fargue and Esther Marie La Fargue, and all the assets of the Trust shall, at that time, be distributed equally among all blood relatives selected within the second degree of consanguinity. Emily Anne La Fargue shall have the power to grant additional Special Limited Powers of Appointment to any of the beneficiaries of this Trust upon terms and conditions not inconsistent with this Trust Agreement.

The master trust agreement, to which the specific agreement was referenced, provided that the trust was irrevocable and unamendable and further provided in pertinent part, as follows:

ARTICLE IV

DESIGNATION AND DESCRIPTION OF TRUSTOR, TRUSTEE AND BENEFICIARIES

The Trustor, Trustee and Beneficiaries of this Trust shall be set forth in the instrument of which this is a part. The Trustor and Trustee are expressly excluded, both directly and indirectly, from...