Lettie Pate Whitehead Foundation, Inc. v. U.S.

• Citation: 606 F.2d 534
• Decision Date: 13 November 1979
• Docket Number: No. 77-1853,77-1853
• Parties: 79-2 USTC P 9706 LETTIE PATE WHITEHEAD FOUNDATION, INC., Plaintiff-Appellee, Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

Page 534

606 F.2d 534

79-2 USTC P 9706

LETTIE PATE WHITEHEAD FOUNDATION, INC., Plaintiff-Appellee Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant, Cross-Appellee.

No. 77-1853.

United States Court of Appeals Fifth Circuit.

Nov. 13, 1979.

Gilbert E. Andrews, Act. Chief, App. Section, M. Carr Ferguson, Asst. Atty. Gen., Tax Div., Ann Belanger Durney, Atty., F. Arnold Heller, Atty., Ernest J. Brown, Atty., U. S. Dept. of Justice, Washington, D. C., for defendant-appellant, cross-appellee.

John A. Wallace, Michael C. Russ, Ralph B. Levy, L. Joseph Loveland, Atlanta, Ga., for plaintiff-appellee, cross-appellant.

Appeals from the United States District Court for the Northern District of Georgia.

Before SIMPSON, TJOFLAT and HILL, Circuit Judges.

SIMPSON, Circuit Judge:

Following the entry of partial summary judgment for the Lettie Pate Whitehead Foundation, Inc. (Taxpayer or the foundation) on stipulated facts by the district court in this suit for refund of excise taxes, the United States appealed and Taxpayer cross-appealed. ¹ We reverse on the government's appeal and affirm as to Taxpayer's cross-appeal.

The first issue presented is whether a private foundation, as defined by section 509 of the Internal Revenue Code of 1954, which is also the sole remainder beneficiary of a trust, is entitled to deduct the trustee's termination fee when computing the foundation's excise tax on net investment income. I.R.C. § 4940. The second issue is whether a private foundation may use the Code section 642(h)(2) unused deductions of the trust in computing the excise tax. A private foundation is not entitled to either deduction under the facts of this case.

The stipulated facts follow. Taxpayer is a charitable organization exempt from federal income tax. I.R.C. §§ 501(a), (c)(3). However, because the foundation is a private foundation, as defined by section 509, it is subject to an excise tax on its net investment income. ² The controversy in this dispute concerns the allowable deductions in computing the section 4940 excise tax.

The foundation was established by the will of the late Conkey P. Whitehead. Mr. Whitehead's will also established a trust; his widow was entitled to the income of the trust during her life and upon her death the foundation was entitled to receive the remainder. The widow's death in April of 1970 spawned the series of events underlying this litigation.

Under Georgia law, a trustee is allowed a distribution fee of up to 3 percent of the value of assets distributed. Ga.Code Ann. §§ 49-223, 108-432, 113-2004. The Georgia Court of Ordinary may set a fee of less than 3 percent, but, to avoid court intervention, Georgia trustees frequently negotiate an agreeable fee. Id. Accordingly, after a period of arms' length negotiations, the corporate trustee and the foundation agreed to a final distribution fee of $300,000, approximately 1.79 percent of the value of the trust assets at the time of the income beneficiary's death.

Most of the trust assets were minority shares of stock in two closely held corporations. Satisfaction of the $300,000 fee directly from trust assets would have required a partial liquidation at less than actual value because there was little, if any, market for the closely held stock. The foundation paid the fee directly in order to avoid a possible disadvantageous partial liquidation. Thereafter all trust assets were distributed to the foundation.

The trust claimed and was allowed by the Commissioner a $307,982 deduction for trustee's fees in its 1970 tax year, $7,982 in cash receipts and disbursements fees and the $300,000 final distribution fee. See I.R.C. §§ 212, 641, 642. The trust's taxable income for the 1970 tax year was less than its deductions and, consequently, $228,659.75 of the deductions were not used by the trust. Generally remainder beneficiaries of a trust are allowed to claim the unused deductions of such a terminated trust in computing their federal income tax. Id. at § 642(h)(2). In this case the foundation claimed the entire $300,000 as a section 4940(c)(3)(A) deduction in computing its section 4940 excise tax for the 1970 tax year. The foundation alternatively claimed that it was entitled to claim the $228,659.75 in unused deductions of the trust as a foundation deduction in computing the excise tax. The Commissioner disallowed the deduction of the entire $300,000 fee and further determined that the foundation was not entitled to deduct the unused deductions of the trust. The foundation paid the deficiency subsequently assessed by the Commissioner, Id. at § 6211, filed a timely claim for refund, Id. at § 6511(a), and, after the statutory six month period, sued for refund in the district court. Treas.Reg. 301 § 6532-I(a)(1) (1956).

The district court ruled that the foundation was not entitled to deduct the entire $300,000 directly under section 4940(c)(3)(A) but that the foundation was entitled to deduct the $228,659.75 in unused deductions of the terminated trust. This appeal and cross-appeal followed.

The excise tax on the net investment income of private foundations was adopted by the Tax Reform Act of 1969. The Congress was concerned that many private foundations were not fulfilling the charitable purposes for which they were granted exemption from income tax. To combat this abuse, Congress added several provisions to the Internal Revenue Code of 1954 imposing excise taxes on certain practices inconsistent with the charitable purposes of private foundations. See I.R.C. §§ 4941 (tax on self dealing), 4942 (tax on undistributed income), 4943 (tax on excess business holdings), 4944 (tax on speculative investments), 4945 (tax on certain expenditures). The § 4940 excise tax was added to put the expense of auditing and enforcing these provisions on the private foundations. S.Rep.No.552, 91st Cong., 1st Sess. 6 Reprinted in (1969) U.S.Code Cong. & Admin.News, pp. 2027, 2032. Technically the tax is an excise and not an income tax because it is imposed on a foundation's investment activities. Id. U.S.Code Cong. & Admin.News at 2053-54; 4 J. Rabkin and M. Johnson, Federal Income, Gift and Estate Taxation, § 59.01C(11) (1977).

The foundation's straightforward argument on appeal is that it paid the $300,000 and that therefore it is entitled to deduct that amount directly under section 4940(c)(3) in computing net investment income. The Code defines net investment income as: "the amount by which (A) the sum of the gross investment income and the capital gain net income exceeds (B) the deductions allowed by paragraph (3). Except to the extent inconsistent with the provisions of this section, net investment income shall be determined under the principles of subtitle A." I.R.C. § 4940(c)(1). Gross investment income is defined as: "the gross amount of income from interest, dividends, rents, and royalties . . .." Id. at § 4940(c)(2). In computing net investment income a foundation is allowed deductions for "all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income." Id. at § 4940(c)(3)(A). The foundation's argument is faulty on two independent grounds.

The trustee fee was clearly not "paid or incurred for the production or collection of gross investment income", Id., of the foundation because it was a distribution expense of the trust having nothing to do with production or collection of any specific item of income of the foundation. The only other allowable deduction pertinent to these facts is for expenses paid or incurred for the "management, conservation, or maintenance of property held for the production of such income . . .." Id. The Supreme Court has held that the payment of similar fees is deductible to a trust as an ordinary and necessary expense paid for the conservation of income producing property. ³ Likewise, in this case the trustee fee was an obligation and deduction of the trust and not of the foundation.

A trust is a juridical entity separate from its beneficiaries. Anderson v. Wilson, 289 U.S. 20, 27, 53 S.Ct. 417, 77 L.Ed. 1004 (1933); United States v. Norton, 250 F.2d 902, 905 (5th Cir. 1958). Consequently, the trustee distribution fees are obligations and deductions of the trust, not of its beneficiaries, even if the term of the trust has ended and even if the fees are paid by the beneficiary. Estate of Drew, 30 T.C. 335, 338 (1958); Agnew v. Commissioner, 16 T.C. 1466, 1468 (1951). The Supreme Court held in Bingham that:

The property did not cease to be held for the production of income (by the trust) because, upon the expiration of the trust and until distribution, the trustees were under an additional duty to distribute the trust fund, or because the trustees, upon distribution, were then accountable to new and different beneficiaries, the residuary legatees, both for the principal of the fund and any income accumulating after the expiry date.

325 U.S. at 373, 65 S.Ct. at 1236. It logically follows that the property could not have been "held" for production of income by the foundation at the same time that it was being "held" for the production of income by the trust. The trust and not the foundation was entitled to deduct the payment of the fee.

The foundation argues that it should be allowed to deduct the $300,000 fee directly under section 4940 even if it was an obligation of the trust. In support of this argument the foundation points to a line of Tax Court cases which allowed deductions under §§ 162, 212 or their predecessors, ⁴ for expenses paid by a taxpayer, even though the expense was the obligation of a third party. James L. Lohrke, 48 T.C. 679 (1967); Cubbedge Snow, 31 T.C. 585 (1958); Charles J. Dinardo, 22 T.C. 430 (1954); Edward J. Miller, 37 B.T.A. 830 (1938); Hennepin Holding Co., 23 B.T.A. 119 (1931). These cases are clearly distinguishable...