Hays' Estate v. Commissioner of Internal Revenue

• Decision Date: 14 April 1950
• Docket Number: No. 12973.,12973.
• Citation: 181 F.2d 169
• Parties: HAYS' ESTATE et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fifth Circuit

181 F.2d 169 (1950)

HAYS' ESTATE et al. v. COMMISSIONER OF INTERNAL REVENUE.

No. 12973.

United States Court of Appeals Fifth Circuit.

April 14, 1950.

Ernest Kellner, Greenville, Miss., for petitioner.

Lee A. Jackson, Sp. Asst. to Atty. Gen., Theron Lamar Caudle, Asst. Atty. Gen., Ellis N. Slack, Sp. Asst. to Atty. Gen., Charles Oliphant, Chief Counsel, Bureau of Internal Revenue, Charles E. Lowery, Sp. Atty. Bureau of Internal Revenue, Helen Goodner, Sp. Asst. to Atty. Gen., Carlton Fox, Sp. Asst. to Atty. Gen., all of Washington, D.C., for respondent.

Before HOLMES, McCORD, and BORAH, Circuit Judges.

HOLMES, Circuit Judge.

This petition for review involves a deficiency assessment of estates taxes against petitioner. The deficiency resulted solely from the inclusion by the Commissioner in the decedent's gross estate of the value of farm land in Mississippi, which was transferred by decedent to herself as trustee for the benefit of her four children and the heirs at law of any of said children who died during the continuance of the trust. The Tax Court sustained the Commissioner's determination, because it held (1) that the trust instrument required the mortgage debt on the land to be paid by the trustee out of income from the trust estate; (2) that the trustee was given the right to withhold trust income from the beneficiaries; and (3) that the trustee was given the power to terminate the trust. The pertinent undisputed facts are as follows:

In consideration of one dollar and of love and affection, the decedent conveyed said land to herself as trustee. The conveyance was subject to certain mortgage liens that secured debts aggregating $36,636.16. The trust was irrevocable, and the powers of the trustee were to hold, manage, sell, reinvest, and otherwise handle, the land as in her discretion was for the best interest of the beneficiaries. The grantor filed a gift-tax return for the year 1941, which valued the land at $107,636.16 less the amount of the mortgage debts, which equalled a net sum of $70,660.80, paying the gift taxes thereon of $1033.62. There was no accumulated or undistributed income from the trust at the date of her death. Sections 1 and 2 of Item III of the trust instrument are as follows:

"Section 1. The Trustee shall pay the net income of the trust estate or so much thereof as she deems to the best interest of the beneficiaries and to the best interest of the trust, monthly or quarterly, or as often as she deems best, to said benficiaries in equal shares, and the net income not distributed shall remain in and become a part of the trust estate, however, the trustee shall not be required to make any distribution of the net income of the trust estate to the beneficiaries at any time unless and until, in her discretion, the trustee deems such distribution to the best interest of the beneficiaries and of the trust estate.

"Section 2. This trust shall continue until the death of the grantor unless prior thereto the trustee shall deem it to the best interest of the beneficiaries and of the trust estate so to do, and in such event, the trustee may terminate this trust at any time.

"Upon the termination of the trust, either by the death of the grantor or by the trustee prior thereto, the trust estate shall be immediately distributed in kind to the beneficiaries, in equal shares.

"In the event of the death of any one of the beneficiaries during the continuance of this trust, the interest of such beneficiary shall pass to his or her heirs at law under the laws of descent and distribution of the State of Mississippi.

"The beneficiaries of this trust shall have no interest in the trust estate and the income therefrom, except to receive the same as herein provided, and said beneficiaries shall be without power to assign, pledge, encumber or sell their interest in the trust estate and the income therefrom, and the interest in the trust estate and the income therefrom shall never become liable for their debts."

Petitioner concedes that, if the payment of the mortgage notes against the trust property constituted the discharge of a legal obligation of the decedent, the direction that the same be paid by the trust was a reservation by the decedent of the trust income; but she denies that the payment constituted such discharge of a legal obligation, and contends that it did not result in a pecuniary benefit to the decedent, because the land was transferred subject to encumbrances and the trustee was charged with the duty of paying the mortgage notes out of trust income. The Tax Court held that there was nothing in the trust agreement or elsewhere in the evidence to indicate that the grantor intended for the trustee to assume the primary obligation of the mortgage notes. We agree with the petitioner that this ruling was erroneous as a matter of law. The trust instrument expressly provided that the trustee was therein authorized and directed to pay the indebtedness secured by the liens out of the income that might be derived from said lands or in such manner as she deemed to the best interest of the beneficiaries. The record shows that the trustee accepted the trust and acted thereunder throughout the year 1942, and down to the date of her death on November 2, 1943. It is elementary that the grantee in an instrument who accepts such a trust is bound by its obligations, and that the form of the assumption is immaterial provided it casts upon the grantee the burden to pay the indebtedness. The Tax Court conceded that this was the rule in Mississippi.

The indebtedness secured by liens on the land conveyed by decedent to the trust, although originally incurred by her, constituted no charge upon her capital assets after the conveyance. Thereafter, the decedent's liability for said indebtedness was contingent, not only upon the failure of the trust to pay the same, but upon the existence of a deficiency after a foreclosure sale of the land and the application of the proceeds of the sale to the payment of the indebtedness. The possibility of decedent's liability for said debts was so remote that her direction that the trust pay the same did not constitute a reservation of income by her from the land conveyed in trust. Such possibility of liability was too remote to come within the meaning of the statute. 26 U.S.C.A. § 811(d) (1); Dort v. Helvering, 63 App.D.C. 98, 69 F.2d 836; Mellon v. Driscoll, 3 Cir., 117 F.2d 477; Commissioner v. Hofheimer's Estate, 2 Cir., 149 F. 2d 733.

Although the payments made on the mortgage notes benefited the trust, the Tax Court held that they were also for the benefit of the grantor. It said: "The grantor would have been benefited by having her debt paid and the trust by having its property cleared of incumbrances." A part of this statement was based on the assumption that decedent remained primarily liable on the mortgage notes, which was not correct. The grantor conveyed the lands to the trust subject to the mortgage, but she also directed that the trustee pay the mortgage debts. The trustee accepted the trust and thereby became primarily liable for said debts; the mortgagor became a surety with all the consequences flowing from the relation of suretyship. Gilliam v. McLemore, 141 Miss. 253, 106 So. 99, 43 A.L.R. 79.

It is not a general or indefinite benefit but a pecuniary benefit that is necessary for a transaction to constitute a reservation of income, and in this case no pecuniary benefit resulted to the decedent by the trustee's payment of the mortgage notes. A pecuniary benefit means an increase in one's net worth by the receipt of money or property. The payment of the mortgage notes did not and could not increase the decedent's net worth; she received no money; she received no property; none of her property was thereby enhanced in value or released from liens or encumbrances. The payment of the mortgage debts resulted in pecuniary benefit to the trust alone, in that the net worth of its land was increased to the extent of the payments made. There was no legal obligation upon the decedent to discharge this debt except in case of a deficiency being due after there had been a sale of the land upon foreclosure of the mortgage. U. S. v. Kirby Lumber Co., 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131; Edgewater Park Co. v. Standard Bond, etc., Co., 162 Miss. 684, 138 So. 811; McLeod v. Building & Loan Ass'n, 168 Miss. 457, 151 So. 151, 37 Am. Jur. 321.

The second ground on which the Tax Court predicated its decision was that the trustor reserved the right to withhold trust income from the beneficiaries, which resulted in the power to designate who should enjoy the income from the trust estate. Under the trust agreement, income not distributed was to "remain in and become come a part of the corpus of the trust"; and upon...