Funk v. Commissioner of Internal Revenue

• Decision Date: 25 September 1947
• Docket Number: No. 9341.,9341.
• Citation: 163 F.2d 796
• Parties: FUNK v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

163 F.2d 796 (1947)

FUNK v. COMMISSIONER OF INTERNAL REVENUE.

No. 9341.

Circuit Court of Appeals, Third Circuit.

Argued April 10, 1947.

Decided September 25, 1947.

James S. Y. Ivins, of Washington, D. C., and George A. Donohue, of New York City, for petitioner.

Sewall Key, Acting Asst. Atty. Gen. and J. P. Wenchel, of Washington, D. C. (Helen R. Carloss and Melva M. Graney, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before GOODRICH, McLAUGHLIN, and KALODNER, Circuit Judges.

KALODNER, Circuit Judge.

This appeal is taken from a decision of the Tax Court (six judges dissenting) in two consolidated cases. While the principal inquiry involved in the litigation relates to the scope of the petitioner's powers under certain trust instruments, the pressing question for our determination is whether the Tax Court may take judicial notice of its records in another case involving the same trusts but not the same taxpayer so as to make a critical fact finding in the instant litigation.

A further question of law is to what extent the courts of New Jersey will exercise control over the trustee of a New Jersey trust.

The Tax Court ruled that the petitioner was the owner of all the income of four trusts created by her husband and therefore taxable under Section 22(a) of the Internal Revenue Code, 26 U.S.C.A. Int. Rev. Code, § 22(a), despite the fact that part of the trust income was accumulated and added to the corpus during all the tax years involved (1938-1941) and that during three of the four tax years substantial portions of the tax income were disbursed to the settlor husband.

The Tax Court¹ found the facts as stipulated by the parties. Insofar as here pertinent, they are as follows:

On March 1, 1929, petitioner's husband organized Erwin Park, Inc., a Delaware corporation, as his personal holding company. He transferred to it a substantial part of his property and became entitled to all of the capital stock of Erwin Park; such property was set up on the books of the corporation at a value of $6,603,439.32. At the beginning of 1938, the authorized capital stock of Erwin Park consisted of 500 Class A shares, 1,000 Class B shares, and 500 Class C shares. Petitioner's husband and one of the members of a firm of accountants and tax consultants were, and continued to be, the corporation's board of directors. Dividends were to be declared and paid at such time and in such amounts as the directors in their absolute discretion should determine, except that of all dividends paid during any calendar year, 5% had to be paid on Class A stock, 15% on Class B stock, and 80% on Class C stock. Voting power was vested exclusively in the holders of Class B stock, of which petitioner's husband owned all the outstanding shares. Four hundred and ninety-nine and four-fifths of the 500 shares of Class A stock constituted the corpus of three trusts which petitioner's husband had set up for each of their children.

On December 29, 1936, petitioner's husband set up four identical irrevocable trusts designated as trusts A, B, C, and D. The corpus of each trust consisted of 125 shares of Erwin Park Class C stock. Petitioner was made the trustee of each trust. The trusts are to exist during the lifetime of the husband. Upon the death of the husband, the trusts will terminate and the principal and undistributed income will be paid to such persons whom the husband may appoint by will, or, in default of appointment, to the children of petitioner and her husband, or to the issue or heirs of such children.

Each trust provided that the trustee should have the power:

"First. During my lifetime to hold, manage, sell, invest and reinvest the same, to receive the income thereof and to pay therefrom all taxes, assessments, and other charges and expenses accruing thereon from year to year and properly chargeable thereto, and all expenses incident to the trust hereby created, and in her discretion to pay all or a part of the net income annually to me, or to herself, in accordance with our respective needs, of which she shall be the sole judge, and to accumulate and add to principal the balance of such income, if any. Any income so accumulated and added to principal by the Trustee shall become a part of the corpus of the trust and may not thereafter be distributed by the Trustee. (Emphasis supplied.)

* * * * *

"Third. Upon the death or resignation of the Trustee she shall have the right by will or other instrument in writing to appoint a successor Trustee who shall have the same powers as the Trustee appointed hereby."

The Trustee was also given the usual broad powers of management over the trust corpus, including the power of changing investments and registering the securities in her own name. All stock dividends must be added to principal, and all cash dividends, except liquidating dividends, are to be treated as income.

Petitioner accepted the trusts, received the stock certificates and placed them in a safe deposit box to which she alone had access.

On December 29, 1936, petitioner and her husband exchanged letters relating to trusts A, B, C, and D. The letter from petitioner's husband reads:

"As you know, I have to-day made you the Trustee of four trusts designated as Trusts A, B, C, and D, the property transferred to each trust consisting of 125 shares of capital stock of Erwin Park, Inc. Under the terms of these trusts you are to have discretion annually to divide the income between us or to accumulate and add it to the principal of the trust.

"My objective in setting up the trusts in this way is to provide substantial amounts of income which you may dispose of according to the circumstances which you find to exist at the end of each year. No one can foretell with certainty what those circumstances will be, and it is my desire to put you in a position to exercise your own judgment as to how such circumstances shall be met, to the extent of the income arising from these trust funds.

"It is your legal right and duty to exercise this discretion each year as may seem best to you, and in the exercise of this discretion you are not subject to my control or to the control of any other person."

The reply of petitioner was:

"I have read your letter of to-day with reference to the four new trusts which you are setting up, of which you have made me Trustee.

"I understand that at the end of each year I am to decide whether I will pay the income which I have received as Trustee to you or to myself or divide it between us or accumulate and add it to principal. I am to do any or all of these things in such amounts and in such proportions as I see fit.

"I understand that the effect of these trusts is to place upon me the duty of deciding how the money shall be disposed of and that in making this decision I am not subject to your control or that of any other person."

In each of the taxable years Erwin Park issued dividend checks in favor of petitioner, as trustee, on the Class C stock held by each trust. The checks were deposited to her account as trustee. As trustee, petitioner filed fiduciary income tax returns and paid the tax due on the dividend income received by each of the trusts in the respective amounts of $3,400, $12,000, $12,400, and $13,400, for the years 1938, 1939, 1940, and 1941. In the year following the year receipt of the dividends petitioner disposed of the net dividend income from each trust.²

Petitioner did not discuss the question of the distribution of the trust income with anyone. She exercised her own discretion and was the sole judge of how the net income was distributed.³

The Tax Court premised its forementioned ruling that the petitioner was taxable under Section 22(a) on the ground that she was the sole owner of all the trust income and that any disbursements of income to her husband were in the nature of gifts. It rejected her contention that the trust provisions fall within Section 161(a) (4) and (b), 26 U.S.C.A. Int.Rev.Code, § 161(a) (4), (b), providing taxability to fiduciary of trust income which, in the discretion of the fiduciary, must be either distributed to the beneficiaries or accumulated. In doing so it also disregarded petitioner's urging that the trust income was not disbursed or credited to her or her husband in the taxable year when earned and received by the trust, but was accumulated until a later year.

The crux of the Tax Court's ruling against the petitioner was its factual finding that since her "husband was a man of great wealth" and as such had "no need for the trust income during the taxable years," it was therefore "inconceivable that the husband * * * could successfully have complained in a court of equity in New Jersey that the trustee elected to pay all of the income to herself",⁴ and as a consequence petitioner had such absolute control over all the trust income so as to constitute her sole owner thereof.

It is conceded by the Government that the Tax Court went beyond the stipulated facts in making the factual finding as to the "needs or financial position of the taxpayer's husband." The Government frankly admits that this critical fact finding was culled by the Tax Court, via judicial notice, from the record, in the case of Funk v. Commissioner, 3 T.C. 1292, in which it was held that the petitioner's husband was not taxable on the entire income of the trusts.

Although agreeing that the stipulated facts of the present case do not refer to the needs or the financial condition of the petitioner's husband, the Government refers us to the testimony of petitioner herself before the Tax Court in the Wilfred J. Funk litigation as incontrovertably establishing that neither she nor her husband had needs and that the trust income was hers to take or distribute as she willed. Excerpts from her testimony in that action are appended to the Government's brief, but this is purely voluntary reprint on its part, without proper authentication or documentation. The Government's position...