Saltzman v. C.I.R.

• Decision Date: 11 December 1997
• Docket Number: D,Nos. 217,910,s. 217
• Citation: 131 F.3d 87
• Parties: -8365, 98-1 USTC P 50,164, 48 Fed. R. Evid. Serv. 483 Eric F. SALTZMAN and Victoria M. Saltzman, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Arnold SALTZMAN and Joan Saltzman, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. ocket 96-4195, 96-4203.
• Court: U.S. Court of Appeals — Second Circuit

Page 87

131 F.3d 87

80 A.F.T.R.2d 97-8365, 98-1 USTC P 50,164,

48 Fed. R. Evid. Serv. 483

Eric F. SALTZMAN and Victoria M. Saltzman, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

Arnold SALTZMAN and Joan Saltzman, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 217, 910, Docket 96-4195, 96-4203.

United States Court of Appeals Second Circuit.

Argued Oct. 3, 1997.

Decided Dec. 11, 1997.

Robert W. Metzler, Tax Division, Department of Justice, Washington, DC (Loretta C. Argrett, Assistant Attorney General, Richard Farber, Department of Justice, Washington, DC, on the brief), for Respondent-Appellee.

Kenneth W. Gideon, Washington, DC (Ruth E. Kent, Wilmer, Cutler & Pickering, Washington, DC, of counsel), for Petitioners-Appellants.

Before: VAN GRAAFEILAND, McLAUGHLIN, Circuit Judges, and COTE, District Judge. ^*

VAN GRAAFEILAND, Circuit Judge:

Arnold Saltzman and Joan Saltzman, his wife, appeal from a decision of the United States Tax Court finding them liable for a gift tax deficiency of $978,960 and imposing negligence penalties totalling $575,953. ¹ For the reasons hereafter discussed, we reverse and remand.

The record in this case fills 10 large packing boxes. Much of it has been ordered sealed. For purposes of this opinion, we see no reason to take the reader through the

entire record, separating sealed from unsealed as we do so. We limit our discussion to two basic issues:

I. Did the Tax Court err in holding that one of two trustees could make a gift of trust property to a non-beneficiary without the knowledge or consent of the trust beneficiaries?

II. Did the Tax Court err in its evaluation of the property in question?

I

Between 1976 and 1981 Arnold Saltzman (hereinafter "Arnold"), who owned almost all the stock of Marian B., Inc. ("MBI") and Newgate Inc. (subsequently merged into MBI), created irrevocable trusts consisting primarily of MBI stock for the benefit of two of his three children, Robert and Marian. Arnold's third offspring, Eric, received his proportionate gift directly and he subsequently purchased Arnold's remaining shares. Portions of Robert's and Marian's shares thereafter were transferred into trusts for Arnold's grandchildren, Xylon and Chloe.

Arnold and his long-time attorney and accountant, Stanley Haber, who died prior to trial, were named co-trustees of the four trusts. All decisions of the trustees were to be made unanimously and in no event was Arnold to have the right and power to act as sole trustee. The trust agreements provided further that "no powers enumerated herein or accorded to trustees generally, pursuant to law, shall be construed to enable the Grantor or the Trustees or any other person to purchase, exchange or otherwise deal with or dispose of the principal or income of the trust for less than an adequate or full consideration in money or money's worth." However, in 1986, Arnold and Haber, who were the directors of MBI, effected such a disposition of the trusts' common stock by means of a recapitalization of MBI, pursuant to which the trusts' common stock was exchanged for preferred stock of a substantially lesser value. The exact amount of the difference in value is the second item in dispute herein. This transaction was accomplished without court approval and without the knowledge of the trust beneficiaries, two of whom were minors. Stating that petitioners' argument that Arnold could not change the beneficiaries or revoke the trusts constituted a "pristine view" of his authority, the Tax Court concluded that "the recapitalization was a gift from Arnold Saltzman to Eric Saltzman in 1986." In thus holding, the Tax Court erred as a matter of law.

In determining ownership of the trust stock that was recapitalized, we must look to the law of New York where the trusts were created and the recapitalization took place. The federal revenue law " 'creates no property rights but merely attaches consequences, federally defined, to rights created under state law.' " United States v. National Bank of Commerce, 472 U.S. 713, 722, 105 S.Ct. 2919, 2925, 86 L.Ed.2d 565 (1985) (quoting United States v. Bess, 357 U.S. 51, 55, 78 S.Ct. 1054, 1057, 2 L.Ed.2d 1135 (1958)). See also United States v. Mitchell, 403 U.S. 190, 197, 91 S.Ct. 1763, 1767, 29 L.Ed.2d 406 (1971) ("In the determination of ownership, state law controls."); United States v. Sterling Nat'l Bank & Trust Companies of N.Y., 494 F.2d 919, 921 (2d Cir.1974) ("The question of whether the bank held property or a right to property of Smith is one of state law, in this case New York's.").

The courts of no other state have emphasized more strongly the duties and obligations of trustees than have the courts of New York. In Judge Cardozo's oft-quoted opinion in Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545 (1928), he summarized them as follows:

Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the "disintegrating erosion" of particular exceptions. Wendt v. Fischer, 243 N.Y. 439, 444[154 Id. at 464, 164 N.E. 545.

N.E. 303] [1926]. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.

In Birnbaum v. Birnbaum, 73 N.Y.2d 461, 541 N.Y.S.2d 746, 539 N.E.2d 574 (1989), the New York Court of Appeals, citing Meinhard, reiterated that "it is elemental that a fiduciary owes a duty of undivided and undiluted loyalty to those whose interests the fiduciary is to protect." Id. at 466, 164 N.E. 545. See also Matter of Lewisohn, 294 N.Y. 596, 608, 63 N.E.2d 589 (1945), where the court said "[t]he rule is inflexible that a trustee shall not place himself in a position where his interest is or may be in conflict with his duty."

The recapitalization was accomplished by Arnold and Haber in their roles as directors of the corporation. However, pursuant to the inexorable dictates of trust law, they also were acting in their capacities as trustees who owed the trust beneficiaries the absolute duty of undiluted loyalty. A trustee cannot "alter his legal position by changing his cloak." Matter of Grace, 42 Misc.2d 214, 217, 247 N.Y.S.2d 695 (N.Y.Sur.1964). Although a trustee, in the course of his administration, may become an officer of a corporation, his duties as a corporate officer do not supplant or mitigate the duties he owes the trust beneficiaries. See Matter of Horowitz, 297 N.Y. 252, 258-59, 78 N.E.2d 598 (1948); Matter of Auditore, 249 N.Y. 335, 342-43, 164 N.E. 242 (1928); Matter of Shehan, 285 A.D. 785, 793, 141 N.Y.S.2d 439 (1955) ("While the trustees elect themselves officers and directors, they actually operate the business as representatives of the estate."). In short, the Tax Court erred as a matter of law in holding that Arnold "did not make the transfer in his capacity as trustee."

Moreover, if, as the Tax Court held, Arnold was the one who made the gift, his act was in clear violation of the trusts' provision that Arnold and Haber, the co-trustees, had to act as a unit. Their powers as co-trustees were undivided and neither could act separately. See Bitker v. Hotel Duluth Co., 83 F.2d 721, 723 (8th Cir.1936); Kane v. Lewis, 282 A.D. 529, 530, 125 N.Y.S.2d 544 (1953); Cooper v. Illinois Central R.R. Co., 38 A.D. 22, 28, 57 N.Y.S. 925 (1899); RESTATEMENT (SECOND) OF TRUSTS § 1942.

Section 288 of the RESTATEMENT (SECOND) OF TRUSTS provides:

If the trustee in breach of trust transfers trust property to a person who takes with notice of the breach of trust, the transferee does not hold the property free of the trust, although he paid value for the transfer.

Comment (a) thereunder elaborates on the scope of the rule as follows:

The interest of the beneficiary in the trust property is not cut off by a transfer by the trustee in breach of trust to a third person who at the time of the transfer has notice that the transfer is in breach of trust, although he paid value for the transfer; and the beneficiary can in equity compel the third person to restore the property to the trust. The third person holds the interest which he acquires by the transfer upon a constructive trust for the beneficiary of the trust.

This is the law of New York. See Renz v. Beeman, 589 F.2d 735, 744 (2d Cir.1978); see also Albright v. Jefferson County Nat'l Bank, 292 N.Y. 31, 40, 53 N.E.2d 753 (1944); Wendt v. Fischer, supra, 243 N.Y. at 444, 154 N.E. 303. The alleged gift from Arnold to Eric was imperfect or inchoate rather than consummate.

In Burnet v. Guggenheim, 288 U.S. 280, 53 S.Ct. 369, 77 L.Ed. 748 (1933), the Court held that the gift statute "is aimed at transfers of the title that have the quality of a gift, and a gift is not consummate until put beyond recall." Id. at 286, 53 S.Ct. at 371. That holding has been followed consistently. See, e.g., Smith v. Shaughnessy, 318 U.S. 176, 181, 63 S.Ct. 545, 547, 87 L.Ed. 690 (1943) ("The separable interests transferred are not gifts to the extent that power remains to revoke the trust or recapture the property represented by any of them[.]") (citing Burnet )); Rev. Ruling 74-365.

Moreover, Burnet is applicable not only where the grantor has expressly reserved the One who receives property as a result of a breach of trust holds the property in constructive trust. This does make him a trustee as that term generally is used. "In the case of a constructive trust, the duty is merely to surrender the property." V SCOTT ON TRUSTS § 462.1...