McFaddin v. Commissioner of Internal Revenue

• Decision Date: 14 April 1945
• Docket Number: No. 11064.,11064.
• Parties: McFADDIN v. COMMISSIONER OF INTERNAL REVENUE (three cases). WARD v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fifth Circuit

148 F.2d 570 (1945)

McFADDIN v. COMMISSIONER OF INTERNAL REVENUE (three cases). WARD v. COMMISSIONER OF INTERNAL REVENUE.

No. 11064.

Circuit Court of Appeals, Fifth Circuit.

April 14, 1945.

J. M. Combs, of Beaumont, Tex., and Percy W. Phillips, of Washington, D. C., for the taxpayers.

Hilbert P. Zarky, Sewall Key, Robert N. Anderson, and Robert Koerner, Sp. Assts. to the Atty. Gen., Samuel O. Clark, Jr., Asst. Atty. Gen., and J. P. Wenchel, Chief Counsel, Bureau of Internal Revenue, and Charles E. Lowery, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., for respondent.

Before HUTCHESON, HOLMES, and McCORD, Circuit Judges.

HUTCHESON, Circuit Judge.

Taxpayers, married persons living in Texas, beneficiaries of the McFaddin trust, a trust of Texas property established and managed in Texas, returned as community all the income they had received from the trust in the tax years in question, 1938 and 1939. Disagreeing with the taxpayers in respect of several matters, including (1) their claim that all of the income from the trust was community property, and (2) that profits from the sale of an addition known as Central Gardens should be returned not as ordinary income but as capital gains, and if not, should be returned as community, the commissioner determined deficiencies accordingly. The Tax Court agreed with the commissioner on these two matters and with taxpayers on the others, and redetermined the deficiencies accordingly. Taxpayers are here seeking relief from the findings and order.

The issue of whether the profits from Central Gardens are returnable as ordinary income or as capital gains may be shortly disposed of by saying that the decisions¹ have settled it that property, subdivided and sold as Central Gardens was here, is regarded as sold in the business of the taxpayer and the profits from such operations are regarded as ordinary income.

As to the alternative claim that if these profits are to be regarded as profits of a business and, therefore as ordinary income, the income must then be regarded as community, we think it sufficient to say, that while a case might arise where the character and extent of the community efforts and outlays were such that the profits from the subdivisional sale of separate real estate might be properly regarded as something other than the mere proceeds of the sale of separate property, and therefore, community property, the evidence makes out no such case here. All that appears is that the property was subdivided into an addition and sold by the agent, who having an exclusive agency for, and being in entire charge of, the sales, did all advertising at his own expense and was paid a commission of 25 per cent on all sales. Neither the trustees nor any of the taxpayers had anything to do with the management of the property except that the trustees contributed some moneys to lay out the property and grade the streets. Under these circumstances to say that the profits were "obtained * * * by the toil, talent, thrift, energy, industry or other productive faculty"² of a member of the marital community so as to convert into community the profits of the sale of separate property would be to run a good and sound theory into the ground.

The main question, whether the evidence offered by the taxpayers was sufficient to overthrow the commissioner's determination that the income taxed to them as profits of separate property was in law and in fact separate, requires more ample treatment. Here, as in the Tax Court, taxpayers insist that all the income in question was community, because all the properties of the trust were beneficially owned not by their separate but by their community estates.³ Here, as in the Tax Court, taxpayers insist in the alternative that if all was not community property, that part of it was which came from property acquired by the trustees with funds in part community and in part separate but so inextricably confused and commingled as that under Article 4619 of the Texas Statutes,⁴ they and the property purchased with them must be deemed to be community property.⁵

A subordinate contention of the Taxpayers is that the commissioner, having segregated the gross income from the property into that which he held to be community and that which he held to be separate, wrongly allocated all charges against the gross income to the part of the income which he had determined to be community and none of them against that part which he treated as separate income.

The Tax Court, in an opinion⁶ fully setting out the facts as to the creation and operation of the trust, rejected the taxpayers' first contention that the beneficiaries acquired their interest in the trust by onerous title. It found to the contrary that the trust was created by the father of the beneficiaries, joined by his wife, with a specific donative intent toward his children, and that their interest in all of the property originally granted in trust was their separate property acquired, within the constitutional definition, by gift. The taxpayers' alternative contention, that part of the income was community because from property acquired afterward by the trustees by the use of commingled funds, was disposed of by the Tax Court upon the ground that the rights of the beneficiaries did not attach to the gross income but only to the distributable net, and that the gross income the trustees had used to purchase additions to the trust was not, and could not be, community income. The subordinate point, allocation of all charges to community income was disposed of by the Tax Court upon the ground that the evidence of the taxpayers had failed to show that the commissioner's allocations were wrong.

We agree with the Tax Court that the facts that the lands were conveyed to the trust subject to named debts and liens and that the trust was charged with the payments to Mrs. McFaddin are without effect to overcome the clearly manifested donative intent of the settlors so as to convert what would otherwise be a gift of separate property into a conveyance upon onerous consideration of community property.⁷ We, therefore, agree with its conclusion that the oil royalties and bonuses derived from, and the profits from sales of, the properties originally conveyed in trust to the separate beneficial interests of the taxpayers came to them as separate property and are taxable as separate income.⁸

Upon the taxpayers' alternative contention, however, that part of the sums taxed to it as separate income were derived from property acquired by the trust in such manner as to make it their community property, the matter stands quite differently. The theory of the Tax Court that none of the commingled property with which the after-acquired property was purchased was community property because, under the terms of the trust instrument, gross income was treated as corpus, the rights of the beneficiaries did not attach to gross income but only to the distributable net income, and the gross income used by the trustees was, therefore, not community property, will not at all do. The taxpayers were the beneficial owners of the trust properties, and every part and parcel of them, including income from them, belonged beneficially to them, either as separate or as community property, in the same way that it would have belonged to them had the property been deeded to the taxpayers and operated by themselves.⁹ The greater part of the normal income from the...