First Wisconsin Trust Co. v. Comm'r of Internal Revenue (In re Estate of Bloch)

• Decision Date: 25 May 1982
• Docket Number: Docket No. 2667-78.
• Citation: 78 T.C. 850
• Parties: ESTATE of HARRY BLOCH, JR., DECEASED, FIRST WISCONSIN TRUST COMPANY, PERSONAL REPRESENTATIVE, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

78 T.C. 850

ESTATE of HARRY BLOCH, JR., DECEASED, FIRST WISCONSIN TRUST COMPANY, PERSONAL REPRESENTATIVE, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 2667-78.

United States Tax Court

Filed May 25, 1982.

Decedent was the trustee of a trust established by his father in 1946 for the benefit of decedent's children. The trust agreement vested the trustee with the same rights and powers over insurance policies held by the trust “as he would have as the absolute owner thereof.” As trustee, decedent caused the trust to purchase three insurance policies on his life. Subsequently, decedent as trustee executed assignments of those insurance policies as collateral security for personal obligations and obligations of a corporation in which decedent was an officer, director, and 50-percent shareholder. The assignments were not made for the benefit of decedent's children as beneficiaries of the 1946 trust. Held, decedent did not possess any “incidents of ownership” in the insurance policies within the meaning of sec. 2042(2), I.R.C. 1954, and, therefore, the proceeds of those policies are not includable in decedent's gross estate; the assignment of the insurance policies for decedent's personal benefit and for the benefit of the corporation violated decedent's fiduciary obligations as trustee of the 1946 trust but does not permit inclusion of the policies in his gross estate. Gerald J. Kahn, for the petitioner.

Edward J. Roepsch, for the respondent.

OPINION

FEATHERSTON , Judge:

Respondent determined a deficiency in the amount of $419,942.46 in petitioner's estate tax. After concessions by the parties, the only issue remaining for decision is whether decedent, who was trustee of a trust created by his father, possessed at the time of his death any “incidents of ownership” in three entrusted insurance policies on his life with the result that the insurance proceeds are includable in his gross estate under section 2042(2).¹

1. Basic Facts

All the facts are stipulated.²

Decedent died testate on September 19, 1973. He was survived by his second wife (Noreen), by three children (Robert H., James G., and Richard E.) from his first wife (Ruth), and by two adopted children (Richard and Deborah). At the time the petition was filed, the First Wisconsin Trust Co., with its principal office in Milwaukee, Wis., was serving as sole personal representative of decedent's estate. Decedent's estate tax return was filed with the Midwest Service Center, Kansas City, Mo.

On or about December 2, 1946, decedent's father, Harry Bloch, Sr., as grantor, entered into an agreement with decedent, as sole trustee, establishing the “Robert H. and James G. Bloch Trust” (the 1946 trust). Decedent continued to serve as trustee of the 1946 trust until his death.

On December 7, 1946, Herman Silverstein established an irrevocable trust (the Silverstein trust) naming the decedent as sole trustee. Pursuant to the Silverstein trust agreement, Mr. Silverstein paid $14,389.95 to decedent as trustee, and he placed these funds in the 1946 trust. Under the terms of the Silverstein trust agreement: (1) Mr. Silverstein was to receive a $160-per-month annuity for life; (2) decedent as trustee was required to pay Mr. Silverstein's hospital and funeral expenses; (3) upon Mr. Silverstein's death, any remaining property of the Silverstein trust was to be distributed to the 1946 trust; and (4) decedent personally guaranteed the annuity payments to Mr. Silverstein in the event the Silverstein trust estate was insufficient to make the payments.

Also, on December 7, 1946, Mr. Silverstein designated decedent in his capacity as trustee of the 1946 trust as the sole beneficiary of two insurance policies on Mr. Silverstein's life in the total face amount of $10,000. As a result of the Silverstein transactions, the 1946 trust received a total of $24,389.95 (cash of $14,389.95 and $10,000 on Mr. Silverstein's death) and disbursed for all purposes of the Silverstein trust a total of $33,422.63. The disbursements thus exceeded receipts by $9,032.68.

In addition to receipts from the Silverstein trust transactions, the 1946 trust received funds in excess of $242,000 from several sources, including Harry Bloch, Sr. (the grantor, decedent's father), Harry Bloch, Jr. (decedent), Hannah Bloch (decedent's aunt), Ruth J. Bloch (decedent's first wife), and the Dayton trust. The Dayton trust was established by Myrtle E. Bloch (decedent's mother) on February 25, 1953, and 17 percent of its income was to be distributed to the 1946 trust. At decedent's death, the 1946 trust owed decedent $9,164.51 and owed the Dayton trust $1,000.

By the terms of the 1946 trust agreement, the trustee was to hold the trust estate “for the benefit of Robert H. Bloch and James G. Bloch and any other children of * * * [decedent] now or hereafter born, equally, and their issue, per stirpes.” The trustee was authorized to acquire, among other things, life insurance policies upon the lives of the beneficiaries and any other person in whom they had an insurable interest. During the lifetime of decedent and until the youngest of his sons reached the age of 25 years, the trustee was to use as much of the net income of the 1946 trust as was necessary to pay any life insurance premiums and was to accumulate the balance. The trust agreement provided that the trust would terminate upon the death of decedent or when the youngest of his sons reached the age of 25 years after decedent's death.

The trust agreement vested the trustee with power to manage and control any insurance policies owned by the 1946 trust to the same extent he would have as absolute owner, including the power to pledge them for loans. Decedent's father as grantor of the 1946 trust reserved the right to designate a successor trustee in the event the trustee died or resigned. A successor trustee would succeed to all the rights, powers, and obligations of the deceased or resigned trustee. The trustee was exculpated from liability by reason of any loss or diminution of value in the trust estate, except when the trustee did not act in good faith or with reasonable care.

On or about February 7, 1947, decedent as trustee of the 1946 trust applied to Prudential Insurance Co. of America (Prudential) for two insurance policies on his life, each in the amount of $100,000. On or about February 8, 1947, these two policies, each calling for annual premiums of $1,922 for the first 3 years and $2,261 thereafter, were issued to the 1946 trust in accordance with decedent's application. On October 26, 1953, decedent as trustee submitted an application to Prudential for a policy on his life in the amount of $150,000, and the policy, calling for annual premiums of $3,660, was issued to the 1946 trust in accordance with the application. The Prudential policies gave their legal owner (the 1946 trust) certain rights, including the rights to receive dividends, obtain loans, surrender the policies, change beneficiaries, assign the policies outright or as collateral for loans, and select the mode of settlement of the proceeds.

Beginning February 16, 1967, decedent (in his individual capacity) executed a series of collateral pledge agreements and a personal guaranty in connection with loans made by First Wisconsin National Bank (hereinafter the bank) to Bloch-Daneman Co., a corporation of which he was an officer, director, and 50-percent shareholder. On July 23, 1969, following pressure from the bank for more collateral, decedent as trustee of the 1946 trust executed assignments of the 1946 trust's three Prudential life insurance policies as collateral security for the obligations of Bloch-Daneman Co. to the bank. The assignments were for the personal benefit of decedent, and for the benefit of the corporation, not for the benefit of the beneficiaries of the 1946 trust. The bank did not receive any written authorization from the trust's beneficiaries with regard to these assignments, nor did decedent receive any court approval therefor.

On or about June 30, 1970, decedent decided to liquidate Bloch-Daneman Co. by selling the assets of the business. In order to pay creditors and sell the inventory, decedent borrowed additional sums from the bank on behalf of the corporation and as an individual. All of this indebtedness was secured by the cash surrender value of the three Prudential life insurance policies and decedent's personal guaranty.

As early as October 8, 1971, the bank raised a question as to the propriety of accepting the entrusted insurance policies as collateral for the corporation's indebtedness. Decedent's attorney suggested that the corporate obligation be transferred to decedent's name. However, on December 6, 1971, the bank informed decedent that its attorneys had doubts as to whether the 1946 trust's insurance policies could legally be pledged to secure decedent's note and suggested that he pledge other collateral. Decedent responded by again suggesting that the corporation's name be taken off the note. On October 19, 1972, the bank advised that “our attorneys are of the opinion that a pledge of trust assets to secure personal indebtedness of the administrator could be questioned by the courts” and suggested alternative arrangements. The matter had not been resolved when decedent died.

On January 8, 1974, after decedent's death on September 19, 1973, the bank filed a claim against decedent's estate in the amount of $112,300 (plus interest) with respect to the corporate note of Bloch-Daneman Co. and two personal notes of decedent. The claim was allowed with minor modifications, and the collateral other than the 1946 trust's insurance policies was liquidated and applied on the claim.

On June 4, 1974, the County Court of Milwaukee County appointed Robert H. and James G. Bloch as successor trustees of the 1946 trust. A claim was filed against decedent's estate on behalf of the 1946 trust on the theory that decedent had diverted...