May v. Comm'r of Internal Revenue

Decision Date08 January 1981
Docket NumberDocket No. 5762-77.
Citation76 T.C. 7
CourtU.S. Tax Court


H and W transferred their entire title and interest in real property used in H's medical practice to an irrevocable trust for the benefit of their children. The trust instrument appointed H and a friend as cotrustees. H leased the property from the trust without a written lease and made monthly payments as rent to the trust. Held the payments by H were ordinary and necessary business expenses under sec. 162(a), I.R.C. 1954. Mathews v. Commissioner 61 T.C. 12 (1973), revd. 520 F.2d 323 (5th Cir. 1975), cert. denied424 U.S. 967 (1976), followed. Dean S. Butler and Henry P. Pramov, Jr for the petitioners.

John W. Harris, Steven S. Heyman and David P. Fuller for the respondent.

EKMAN, Judge:

The Commissioner determined a deficiency of $7,577 in the petitioners' Federal income tax for 1973. Due to concessions by the parties, the only issue for decision is whether the amounts paid as rent by Dr. May in 1973 to an irrevocable trust created by the petitioners for the benefit of their children constituted an ordinary and necessary business expense under section 162(a) of the Internal Revenue Code of 1954.1


Some of the facts have been stipulated, and those facts are so found.

The petitioners, Lewis H. V. and Nancy C. May, husband and wife, maintained their legal residence in Arcadia, Calif., when they filed their petition in this case. They filed a joint Federal income tax return for 1973 with the Internal Revenue Service, Fresno, Calif.

During the taxable year 1973, Lewis H. V. May was a doctor of medicine engaged in the general practice of medicine at 5807 Temple City Boulevard, Temple City, Calif. The doctor had been conducting his practice in a building situated on such property for some years prior thereto. The petitioners owned, as tenants by the entirety, the land and medical building at 5807 Temple City Boulevard (the medical property), which was encumbered by a mortgage.

In 1970, Dr. May contacted an attorney for the purpose of arranging a transfer of the medical property in trust. The attorney drafted a declaration of trust setting forth that the “Trustors,” the petitioners, “have delivered” to Lewis H. V. May and Harlos Gross, as Trustees,” all their right, title, and interest in and to the medical property. In the declaration, the trustees acknowledged delivery of the property to them and agreed to hold the property in trust for the benefit of the petitioners' four children. On January 15, 1971, Dr. May and Mr. Gross executed the declaration as trustees, and petitioners, as trustors, executed the following statement, which was attached to the declaration: We certify that we have read the foregoing Declaration of Trust (Irrevocable), and that it correctly states the terms and conditions under which the Trust Estate is to be held, managed and disposed of by the Trustees. We approve the Declaration of Trust in all particulars, and have requested the Trustees to execute it.” The declaration described the medical property as having a value of $46,504 and encumbered by trust deed notes aggregating $21,619.

The petitioners first became acquainted with Mr. Gross in 1957. Mr. Gross owned the grocery store at which the petitioners shopped, and he became acquainted with the May family. He also participated in various civic organizations with Dr. May. Mr. Gross and his family had, at various times, been patients of Dr. May. Mr. Gross was not related to the petitioners by blood or marriage. Mr. Gross had been a trustee of other trusts and was familiar with the duties of a trustee. He served as trustee of the May trust without compensation.

The declaration of trust creates four separate irrevocable trusts, one for the benefit of each of the petitioners' children. The income is payable currently, except that during the minority of a beneficiary, his share of the income is accumulated until he reaches age 21. The trustees are given the power to apply either income or corpus for the education, maintenance, medical care, or support of a beneficiary but not in discharge of any parental obligation of petitioners. The trustees are required to distribute any accumulated income and corpus to a beneficiary when he attains age 25.

The trust cannot be amended, altered, or revoked by any person prior to termination. In the declaration of trust, the trustors “relinquish, absolutely and forever, all their possession of, or enjoyment of, or right to or income from, the Trust property” and “expressly renounce for themselves, and for their estates, any and all interest, either vested or contingent, including any reversionary interests or possibility of reverter, in the income or corpus of these Trusts.” The declaration of trust further provides that no part of the corpus or income of the trust should ever be used for the benefit of the trustors nor should it be used to pay premiums on insurance policies on their lives or to satisfy their legal obligations. Trustors relinquish all further right to designate, alter, amend, or in any way change the designation of beneficiaries.

Under the declaration of trust, the trustees are given broad powers to manage the trust property, including the powers to lease the property, to make improvements, to borrow money, and to invest trust assets in both low-risk and speculative ventures. The declaration specifically vests the trustees with “all the rights, powers and privileges which an absolute owner of the same property would have.” However, the powers of the trustees are subject “always to the discharge of their fiduciary obligations” and to the exercise of reasonable prudence in making investments. Also, neither the trustors nor the trustees are allowed to deal with or dispose of the corpus or income of the trust for less than an adequate consideration, nor can they borrow all or part of the trust corpus or income without adequate interest or security.

The declaration of trust makes no provisions for resolving disputes which may arise between the two trustees. It designates the individuals to succeed Dr. May and Mr. Gross as trustees, with the limitation that Dr. and Mrs. May shall not serve as trustees at the same time. The original trustees are to receive no compensation, but compensation is to be paid to successor trustees.

The names and birth dates of the petitioners' children are as follows:

                ¦Charles H. V. May   ¦Nov. 30, 1954¦
                ¦Robert Cass May     ¦July 9, 1956 ¦
                ¦Matthew Franklin May¦Feb. 24, 1958¦
                ¦Lewis H. V. May II  ¦Nov. 22, 1960¦

The trustors executed a deed transferring title to the medical property to the trustees. The deed was acknowledged on September 20, 1973, and was recorded in the official records of Los Angeles, Calif., on October 2, 1973. The deed was actually prepared at the time of the execution of the declaration of trust. Although the deed now bears an execution date of September 20, 1973, the original execution date on the deed had been erased.

After January 15, 1971, the petitioners and the cotrustees proceeded as if all the necessary steps had been taken to establish the trust for the medical property. Dr. May was the sole occupant of such property prior to the execution of the declaration of trust, and thereafter, he continued to be the sole occupant of such property. Gift tax returns were timely filed by the petitioners reflecting the gift of their interests in the property. A fiduciary income tax return was filed by the trust for each of the taxable years 1971, 1972, and 1973, in which deductions were claimed for distributions of income to the beneficiaries. From 1971 through 1973, the trust paid the installments on the mortgage on the medical property.

When the declaration of trust was executed, it was understood that the trustees would enter into a lease with Dr. May for the rental of the medical property whereby he would pay all taxes, insurance, utilities, and other operating expenses, and a rental of $1,000 per month. The petitioners' attorney prepared a rough draft of the lease. In April 1972, the attorney left private practice and turned the matter over to another law firm. The lease was never executed. During the taxable years 1971 through 1973, Dr. May paid $1,000 per month to the trust as rent; he also paid taxes and other expenses of the property. Mr. Gross assumed that there was an executed lease and that title to the property had been transferred to the trust, but he made no independent investigation to determine whether a lease had been executed and the transfer completed. However, Mr. Gross testified that he “checked the checkbook about four times a year” and “looked to see if the rent had been paid.” A rental of $1,000 per month net to the trust was a reasonable rental for the medical property.

On their Federal income tax return for 1973, the petitioners deducted the payments made by Dr. May as rent. In his statutory notice of deficiency, the Commissioner disallowed the entire deduction. In explanation thereof, the Commissioner stated that:

The deduction claimed of $12,000.00 for rent on business property paid to a family trust is not allowed because it has not been established that these expenses were incurred or, if incurred, were expended for ordinary and necessary business expense. Therefore, your taxable income is increased by such amount.


The only issue in this case is whether the payments made by Dr. May as rent in 1973 were ordinary and necessary business expenses under section 162(a). In part, that section provides:

There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying...

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