Flitcroft v. CIR

• Decision Date: 28 February 1964
• Docket Number: No. 18628.,18628.
• Citation: 328 F.2d 449
• Parties: Will FLITCROFT and Agnes D. Flitcroft, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

328 F.2d 449 (1964)

Will FLITCROFT and Agnes D. Flitcroft, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 18628.

United States Court of Appeals Ninth Circuit.

February 28, 1964.

Ernest R. Mortenson and Eugene Harpole, Pasadena, Cal., for appellants.

John B. Jones, Acting Asst. Atty. Gen., Meyer Rothwacks, Earl J. Silbert and Michael I. Smith, Attys., Dept. of Justice, Washington, D. C., for appellee.

Before CHAMBERS and HAMLEY, Circuit Judges, and JAMESON, District Judge.

JAMESON, District Judge.

This petition for review, involving income taxes for the years 1954, 1955 and 1956, presents the question of whether the income of three short-term trusts set up by taxpayers in behalf of their minor children was includible in taxpayers' gross income under the provisions of section 673(a) of the Internal Revenue Code of 1954.¹

Petitioners, husband and wife, were partners in a business enterprise known as Western Hydraulic and Service Company.² In June, 1952, Richard H. Miers made an audit of the partnership's books. During the following month he was engaged to keep the books and records of the partnership. Thereafter petitioner Will Flitcroft and Miers from time to time discussed the advantages which petitioners might derive by creating trusts for the benefit of their two minor children and including these trusts in the partnership. At a meeting in November, 1952, attended by petitioners, their children, aged 10 and 12 years, Miers, and an attorney recommended by Miers, it was decided to create a ten year trust for each of the children and to form a new partnership composed of petitioners and the two trusts, each owning a 25 percent interest. Miers was to be appointed sole trustee.

Petitioners executed an agreement dated December 31, 1952, dissolving the existing partnership. Petitioners and Miers, as trustee, executed two trust agreements, referred to herein as trusts A and B, each dated January 1, 1953, providing that the trusts would cease and terminate on January 6, 1963.³ Each agreement named one of the petitioners' children as beneficiary.

At the same time petitioners and Miers, as trustee for each of the trusts, executed an instrument entitled "Agreement of Partnership". It provided that the name of the partnership should be Western Hydraulic & Service Company; that the partnership should begin January 1, 1953, and end December 31, 1962; that the capital contributions should consist of the assets, subject to the liabilities, shown on an attached statement; and that each partner owned an undivided one-fourth interest.

In March or April, 1953, petitioners acquired a 60 percent interest in a parcel of real estate which later became the partnership's new business location. A 10 year lease agreement was executed between petitioners, owners of 60 percent, and John O. Best and wife, owners of 40 percent, as lessors and the partnership as lessee, beginning October 1, 1953, and ending September 30, 1963. On October 1, 1953, petitioners formed a third trust, C, with petitioners' two children as beneficiaries, and Miers as trustee. This trust was to run from October 1, 1953 until October 6, 1963. Petitioners conveyed, by quitclaim deed, their 60 percent interest in the property to this trust and also assigned to it their interest as lessors.

On April 15, 1954, petitioners, individually, filed federal income tax returns for 1953, each return reporting the gifts to the respective trusts. Petitioners also filed gift tax returns with the State of California for the year 1953, reporting the gifts to the trusts. Petitioners' attorney received a letter dated June 29, 1954, from the office of the Controller of the State of California, Chief Inheritance Tax Attorney, which stated:

"We have examined the trusts executed by the above named donors * * * taxpayers, and are wondering whether at the time of the execution, they had in mind Section 2280 of the Civil Code.⁴

"It appears to us that in view of this section, the trusts are revocable, and that no gift tax is due. May we have your thoughts on this point?"

Petitioners' attorney replied on July 21, 1954, as follows:

"When the trusts were prepared and executed by the Donors * * * taxpayers consideration was not given to the effect of Section 2280 of the Civil Code.

"It was and is the intention of the Donors * * * taxpayers that the Trusts should be irrevocable and therefore I will prepare and have signed by them (and furnish you with a true copy), an amendment to the Trust Indentures making the Trusts irrevocable and waiving any rights the Donors * * * taxpayers might have to revoke the same under said Section 2280.

"I trust this will remedy the situation and the Trusts will then qualify for gift tax purposes."

Taxpayers and Miers executed an amendment, dated July 30, 1954, to each of the three trust agreements, which provided:

"WHEREAS, it has been called to the attention of the trustors that, under Section 2280 of the Civil Code of the State of California, said trust may be revocable because it is not by its terms made expressly irrevocable; and

"WHEREAS, it was, always has been and is the expressed intention of First Parties * * * taxpayers that said trust should be irrevocable.

"Now, THEREFORE, IT IS MUTUALLY AGREED between the parties hereto as follows:

"There is hereby added to Article 7 on Page 4 thereof the following:

"This trust is by the trustors, hereby expressly made irrevocable."

This amendment was recognized as effective retroactively to the dates of the trust agreements by the office of the Controller of the State of California, Inheritance and Gift Tax Division, and on September 10, 1954, a notice and determination of gift tax for the year 1953 was issued to petitioners. The amendment was not so recognized by the Commissioner of Internal Revenue.

On December 1, 1954, an amendment was executed whereby Frederick L. Botsford, an attorney, became co-trustee with Miers of the three trusts. On November 7, 1958, Miers and Botsford, as trustees, and petitioners' children, through a guardian ad litem, filed a complaint in the Superior Court of the State of California against the petitioners and Robert A. Riddell, District Director of Internal Revenue,⁵ seeking a declaratory judgment of plaintiffs' rights under trust agreements A and B, as amended. It was alleged that Riddell contended the trusts were revocable, refusing to recognize the amendments as effective. Defendant Riddell removed the action to the United States District Court for the Southern District of California, Central Division, where the action was dismissed as to him for lack of jurisdiction. On appeal, the dismissal was affirmed by this court. 9 Cir., Botsford v. Riddell, 283 F.2d 298.⁶

The remaining parties stipulated for remand to the Superior Court of the State of California. That court, on November 13, 1961, entered a judgment on the pleadings wherein it was

"* * * ORDERED, ADJUDGED, AND DECREED that the Trust Agreements, dated January 1, 1953, executed by the defendants Will Flitcroft and Agnes D. Flitcroft, as trustors, and by the plaintiff Richard H. Miers, as trustee, * * * be and they hereby are reformed in accordance with the express intent of the trustors and trustee so that the following sentence is added to the first paragraph of each of said Trust Agreements: `This Trust is irrevocable.\'

"IT IS FURTHER ORDERED AND DECREED that said Trust Agreements were irrevocable upon their date of execution January 1, 1953, and the respective rights and obligations of the parties arising from said agreements shall be governed accordingly."

At the trial before the Tax Court petitioner Will Flitcroft testified that it was his understanding when the trusts were executed that "it was a trust that could not be broken in ten years time". (R. 84.) Miers, the trustee, testified that it was the intention to make each of the three trusts irrevocable. (R. 193, 194.) There is no evidence of any contrary intention.

In its opinion (Footnote 1, R. 234), the Tax Court said, "The evidence here shows that the transactions were not shams, that the independent trustees controlled the trust corpus, and that petitioners recognized the trusts as partners and gave public notice of such recognition by the filing of a Certificate Of Business Fictitious Firm Name listing the trusts as partners"; and that when the partnership agreement and trust agreements are read together, "there is clearly a transfer of the trust corpus of the two individual trusts to the trustee and the designation of the trust corpus is clear."⁷

The primary question for determination is the effect of (1) the provisions of California Civil Code § 2280, (2) the amendments to the trust agreements executed July 30, 1954, and (3) the judgment of the Superior Court of the State of California reforming trusts A and B in accordance with the express intention of the trustors and trustee, and decreeing that the trusts were irrevocable from their date of execution, January 1, 1953.

The Tax Court held that the trusts were revocable trusts under California law until their amendment on July 30, 1954; that the trusts were at no time irrevocable for a period of ten years;⁸ that the trusts' income was includible in petitioners' tax income since petitioners "had a reversionary interest in the corpus at the inception of the irrevocable trusts which would take effect within ten years commencing with the date of transfer to the irrevocable trusts"; that there was no reason for the action in the Superior Court of California except for its "effect upon the Federal Tax question", and that in this limited sense the judgment of the California court was collusive and not binding upon the federal courts in determining tax liability.

It is clear that the trustors and trustee intended to create irrevocable trusts⁹ in compliance with the provisions of section 673(a), IRC of 1954, and they would be so recognized except for the provision of California...