Hemphill v. Comm'r of Internal Revenue, Docket Nos. 5150

• Decision Date: 31 January 1947
• Docket Number: Docket Nos. 5150,5151.
• Citation: 8 T.C. 257
• Parties: JANE COOPER HEMPHILL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.RALPH HEMPHILL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

8 T.C. 257

JANE COOPER HEMPHILL, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.RALPH HEMPHILL, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 5150

5151.

Tax Court of the United States.

Promulgated January 31, 1947.

In 1938 petitioner and his wife created irrevocable trusts, of which he was trustee and of which each corpus consisted of 5,000 shares of stock of Aero Industries Technical Institute, Inc. (later merged into Aero-Crafts Corporation). The two minor children of petitioner were beneficiaries, one of each trust. Thereupon, petitioner held a minority of the stock of Industries. Petitioner became president and a director of Aero-Crafts on December 9, 1940. Under an agreement dated November 14, 1941, petitioner was required to resign as such president and director. Later, with the support of minority stockholders, he was reelected president and director. The trust instrument provided that all net income and earnings should be accumulated and added to corpus during the lives of the grantors, or the survivor thereof, and prior to the attainment of the beneficiary's majority. It recited that the trust estate was for the exclusive use and benefit of the beneficiary and that if the beneficiary should require financial aid because of accident, sickness, or other unforeseen emergency, the trustee might use the income or corpus to meet such needs. It further provided that upon the beneficiary's becoming 21 years of age all the net income and earnings should be paid to him until he became 25 years of age, when one-fourth of the trust estate should be distributed. Thereafter, at intervals, fractional parts of the estate were so distributable until he should become 40 years of age, when he would receive the remainder of the corpus and the trust would terminate. The beneficiary was given the absolute power of appointment, from the date on which he should become 18 years of age until the termination of the trust. Should he die before exercising such power, distribution would be made to his sister (or brother, in the case of the trust in which the daughter was beneficiary) or her issue. If she should die without issue, distribution would be made under the laws of succession of California. The trustee was granted the usual broad powers od administration. He kept a strict account of his transactions as trustee. Neither income nor corpus of the estates has ever been used by the trustee for the education, support, and maintenance of the beneficiaries. All income from both trusts has been added to the corpora. Held, that the trust income is not taxable to the petitioners under section 167 or section 22(a) of the Internal Revenue Code. A. W. Hutchinson, C.P.A., for the petitioners.

R. E. Maiden, Jr., Esq., for the respondent.

The respondent determined deficiencies in the income tax of each of the petitioners, Ralph Hemphill and Jane Cooper Hemphill, as follows:

+-------------+
                ¦1939¦$298.59 ¦
                +----+--------¦
                ¦1940¦909.61  ¦
                +----+--------¦
                ¦1941¦222.93  ¦
                +-------------+
                

The sole issue is the taxability of the income from certain trusts created by the petitioners for the benefit of their minor children, Calvin Ralph Hemphill and Audrey Jane Hemphill, respectively.

FINDINGS OF FACT.

The facts were stipulated. Such portions thereof as are material to the issue are as follows:

Ralph Hemphill and Jane C. Hemphill are, and have been at all times herein material, husband and wife, residing either in Los Angeles or Glendale, California. Ralph Hemphill will be referred to hereinafter as the petitioner. Their income tax returns were filed with the collector of internal revenue for the sixth district of California for the years 1939, 1940, and 1941 on the community property basis and disclosed net incomes of $22,774.90, $13,859.31 and $8,919.86, respectively, for each petitioner.

Under date of December 29, 1938, the petitioner and his wife executed two trust indentures naming Ralph Hemphill as trustee, one in favor of their son, Calvin Ralph Hemphill, who was born March 4, 1925, and the other in favor of their daughter, Audrey Jane Hemphill, who was born November 7, 1931. The trusts were identical in form and were declared to be for the exclusive use and benefit of their children. The corpus of each trust was 5,000 shares of Aero Industries Technical Institute, Inc. (now Aero-Crafts Corporation), hereinafter called Industries, a Delaware corporation having its office and principal place of business at 5245 San Fernando Road, Los Angeles, California. All net income was to be added to corpus during the majority by the beneficiaries. In case of accident, sickness, or other unforeseen emergency, the trustee might devote income or corpus to the needs of the beneficiaries. Upon the beneficiary's becoming 21 years of age, all income was distributable to him until he should become 25 years old, when he was to receive one-fourth of the trust estate. Similar conditions controlled the payment of current income and the distribution of the estate at 30, 35, and 40 years of age. At the last named age the entire remainder of the trust estate was to be distributed.

At the age of 18 years the beneficiary was given the absolute power of appointment of the undistributed estate. Should the beneficiary die before receiving final distribution of the corpus and not having exercised the power of appointment, distribution was to be made to his surviving issue, if any, by right of representation, and if no issue survived, to the sister or brother, or issue. If no such issue survived, the trust estate was to be distributed to the heirs at law of the beneficiary according to the laws of succession of the State of California.

The trustee was empowered to hold any property received in the trust as long as he might deem it advisable; to manage, control, sell, exchange, improve, repair, etc., the corpus; to borrow money as he deemed advisable and to mortgage and encumber the corpus; to invest the principal and income in approved securities, except those owned or for sale by him; and to advance his own funds to the trust, to be repaid first out of income or principal. He was also granted all powers and discretions of an absolute owner and was charged with the payment of taxes, fees, and expenses incurred in the administration of the estate.

At the time of the creation of these trusts the petitioner and his wife owned, on a community property basis, 53,500 shares of the capital stock of Industries out of a total of 100,000 shares of the corporation's capital stock outstanding at that date, representing a 53 1/2 per cent ownership therein. Such shares were registered and held in the name of Ralph Hemphill.

Industries was incorporated under the laws of the State of Delaware on January 4, 1937. It was engaged exclusively in the business of a technical trade school for the training of aircraft mechanics and engineers. The petitioner, who had for many years prior to the organization of the corporation been engaged in the operation of technical trade schools such as that carried on by the corporation, was active in the organization of the corporation. During its entire existence, to wit, from January 4, 1937, to July 1, 1941, he was never president or an executive officer, but was a member and the chairman of its board of directors.

At the time of the execution of the trust indentures the petitioner and his wife transferred to each trust 5,000 shares of the capital stock of Industries. This stock represented the sole corpus of each trust and no additions were made to the corpus of either of the trusts during the taxable years 1939, 1940 and 1941, or at any time since then, by either of the grantors.

Aero-Crafts Corporation, hereinafter called Aero-Crafts, was incorporated on December 9, 1940, under the laws of the State of California. It acquired all of the assets and assumed the liabilities of Industries by a merger on July 1, 1941. There was no change in the business operations, Aero-Crafts continuing the school for the training of aircraft mechanics and engineers formerly conducted by Industries. The corporate change was primarily made for the purpose of changing the organization from a Delaware to a California corporation. At the time of the merger the stockholders received five shares of stock in Aero-crafts for each share of stock in Industries. Ralph Hemphill became president and a member and chairman of the board of directors of the new corporation. He held these official positions continuously until November 14, 1941, at which time he resigned all his offices. On June 1, 1942, he was elected president and a member of the board of directors, and, except during the period from November 14, 1941, to June 1, 1942, during which the petitioner held no official position with Aero-Crafts, he has been the active and chief executive officer of the corporation.

During the taxable years 1939, 1940, and 1941, in addition to Ralph Hemphill and the two trusts, there were approximately 300 stockholders of the capital stock of Industries, the average holding of the remaining stockholders being less than 1,000 shares. The capital stock of the corporation issued and outstanding during the taxable years 1939 and 1940 and part of 1941 was 100,000 shares, par value $1 per share. In 1941 an additional 20,000 shares were issued.

At all times material hereto, Aero-Crafts had 600,000 shares of stock outstanding, of which at the time of the merger 180,000 shares were issued to Ralph Hemphill and 25,000 shares were issued to each of the trusts. In addition to Ralph Hemphill and the two trusts, there were approximately 300 stockholders of the capital stock of Aero-Crafts, the average holding of the 300 stockholders being less than 1,000 shares.

On December 29, 1938, the petitioner and his wife held as community property 43,500 shares of Industries. On March 20, 1939, they held 49,800 such shares. Thereafter they held various amounts...