Security-First National Bank v. United States

• Decision Date: 29 February 1960
• Docket Number: No. 992-59-Y.,992-59-Y.
• Court: U.S. District Court — Southern District of California
• Parties: SECURITY-FIRST NATIONAL BANK, as Executor of the Estate of Alice C. D. Riley, Deceased, Plaintiff, v. UNITED STATES of America, Defendant.

181 F. Supp. 911

SECURITY-FIRST NATIONAL BANK, as Executor of the Estate of Alice C. D. Riley, Deceased, Plaintiff, v. UNITED STATES of America, Defendant.

No. 992-59-Y.

United States District Court S. D. California. Central Division.

February 29, 1960.

Brady, Nossaman & Walker, Joseph L. Wyatt, Jr., Los Angeles, Cal., for plaintiff.

Laughlin E. Waters, U. S. Atty., Robert H. Wyshak, Asst. U. S. Atty., Los Angeles, Cal., for defendant.

YANKWICH, District Judge.

By this action Security-First National Bank, to be referred to as Bank, as executor of the estate of Alice C. D. Riley, deceased, to be referred to as decedent, seeks to recover income taxes and interest erroneously or illegally assessed or collected for the calendar and taxable years 1953 and 1954 in the aggregate amount of $483.57 for the year 1953 and $5,153.02 for the year 1954.¹ In the main, the facts are not in dispute. Indeed, most of them are stipulated.

I.

Conceded Facts.

Harrison B. Riley died on or about June 15, 1944, leaving a Will dated December 4, 1943, and leaving as his surviving widow Alice C. D. Riley, the decedent, represented by plaintiff. Mrs. Riley died August 9, 1955.

On or about July 7, 1944, the will of Harrison B. Riley was admitted to probate in the Superior Court of the State of California, in and for the County of Los Angeles, in proceedings entitled "In the Matter of the Estate of Harrison B. Riley, Deceased", No. 233648. The will of Harrison B. Riley provided, among other things:

"Three—I give and bequeath to my much loved wife, Alice C. D. Riley, of said Pasadena, all of my estate and the income thereof, to have and to hold for the duration of her natural life, and with power to sell and dispose of the same or any part thereof absolutely and to transfer an indefeasible title to the purchasers thereof.

"Four—I also devise to my said wife the power to consume such part of the capital of my said estate as she may from time to time find to be necessary for her support, comfort, health and service.

"Five—Subject and subordinate to all of the foregoing provisions, I give, devise and bequeath the remainder of my said estate in whatever form it may consist at the decease of my said wife to my devoted children: Donald Riley of Chicago, Illinois, and Dorothy Riley Brown of Pasadena aforesaid, in the following proportions, to wit: To said Donald, one-third of said remainder and to said Dorothy, two-thirds of said remainder."

On or about August 2, 1946, the State court in said proceedings No. 233648 entered a decree entitled "Order Settling Final Account and For Distribution of Estate". Distribution was so effected to Alice C. D. Riley in 1946. The rights of Mrs. Riley under the will and order of distribution continued through the taxable years 1953 and 1954.

On March 10, 1954, Mrs. Riley filed a fiduciary income tax return, Form 1041, for the calendar year 1953, reporting net capital gains of $2,260.86. On April 15, 1955, Mrs. Riley filed a fiduciary income tax return, Form 1041, for the calendar year 1954, reporting net capital gains of $32,400.08. The capital assets sold in the years 1953 and 1954 which resulted in the capital gains and losses claimed for those years were assets (securities) which were, in both instances, part of the principal of the life estate created by the will and order of distribution in the estate of Harrison B. Riley. Claims for refund for the years 1953 and 1954 were duly and seasonably filed on January 11, 1957, and rejected.

In addition to these facts, it was either stipulated or proved in the record that Mrs. Riley's practice of filing fiduciary returns as a legal life tenant under the name of "Harrison B. Riley Trust" was begun in 1947. The first of them was prepared by W. V. Carroll of Chicago, Illinois, a personal friend of Mrs. Riley and other members of her family and her business and investments adviser. Mr. Carroll prepared the return upon the advice of counsel recommending that such a fiduciary return be filed on the theory that

"regardless of whether Mrs. Riley established a trust recognizable as such under the substantive law of California, it did establish a fiduciary relationship and a trust which will be recognized for income tax purposes."

It is the contention of the Bank that under the Internal Revenue Code of 1939² and the regulations relating to it,³ and the corresponding Section of the Internal Revenue Code of 1954,⁴ as to which the 1939 regulations apply, and a decision of the Court of Appeals for the Ninth Circuit,⁵ the decedent was not taxable as a trustee, in either year.

II.

Principles Involved.

In considering the matter we should remember the admonition given by a great Justice of the Supreme Court, that we should eschew "slavery to forms or phrases",⁶ and that of another great Justice that

"taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed—the actual benefit for which the tax is paid."⁷

Since the inception of income taxation the courts have uniformly held that the object of the Congress was "to use its power to the full extent."⁸ And for this reason the courts have held that the Government is not confined to the traditional classification of interests or estates, but that, on the contrary,

"It may tax, not only ownership, but any right or privilege that is a constituent of ownership. Nashville, C. & St. L. Ry. Co. v. Wallace, 288 U.S. 249, 268, 53 S.Ct. 345, 77 L.Ed. 730; Bromley v. McCaughn, 280 U.S. 124, 136, 50 S.Ct. 46, 74 L. Ed. 226. Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis. A margin must be allowed for the play of legislative judgment."⁹

These principles have been adhered to consistently and the courts have upheld as taxable "all gains except those specifically exempted."¹⁰

Profits derived from sale of capital assets have been held, in the absence of other considerations, to be taxable in the hands of the person entitled to the income from the property.¹¹ The application of this principle brought into play the consideration to be given to State law in the creation of certain rights and the rule adopted is that the legal rights and interests are created by the State but their taxability is determined by federal law.¹² This is important because, while at times the federal Government, in the matter of taxation, may disregard entities, as understood by State Law,¹³ the individual rights created by the State must, in the light of the principles just declared, be taken into consideration. These principles are of great importance in this case. For in determining whether the Bank's decedent was properly taxed as a fiduciary we must determine the nature of the estate which her husband created for her by will. The third clause of the will, already quoted, might, if it stood alone, indicate that she was given full dominion over the estate with power to dispose of it in its entirety and to transfer "an indefeasible title". However, the fourth and fifth clauses are of a character which have been held uniformly in California to create merely a life estate.¹⁴

III.

Life Estate Holders as Fiduciaries.

The California cases also hold that the duty of the holder of the life estate to protect the rights of those in remainder are

"a duty in the nature of a trust constituting him an implied or quasi trustee for the remaindermen."¹⁵ (Emphasis theirs.)

In tax matters the trend in the federal courts is to apply the designation "fiduciary" to many relationships involving trust and confidence, whether they are such under State law or not. Illustrative are: A corporation retaining dividends declared pending determination of the stock's ownership, in litigation between stockholder and alien custodian, was held to be a "fiduciary" holding them in trust.¹⁶ So was the receiver of a corporation to whom securities were turned over by a member of the stockholders' committee pending a decision as to the persons entitled thereto.¹⁷

Where an estate was condemned by a City and the life tenant chose to take a portion of the award in lieu of an income for life and the remainder of the award was placed in custody of a City official to hold for the remaindermen, the City official was held to be a fiduciary required to make a return on the earnings of the funds held by him for the remaindermen.¹⁸

In another case in which the Government sued an Indian allottee's heirs to cancel an allotment, the receiver appointed to lease lands for oil and gas purposes was held to be a fiduciary.¹⁹

Significantly, here the decedent chose to designate her position as that of a fiduciary. And the principle is applicable that a taxpayer who chooses a method for transacting business is held accountable for the tax consequence of his choice.²⁰

IV.

No Unfettered Domain.

If we apply the principles just discussed to the facts before us, the conclusion is inescapable that the life tenant did not have such unfettered dominion over the property as to make the capital gain resulting from the sale of the securities taxable in her hands as owner.²¹ For she was (a) liable for waste of the estate;²² (b) she could have been required to give security to prevent waste;²³ and (c) she could not will the estate or give it away without consideration.²⁴ And herein lies the distinction between the situation presented here and that which the Court of Appeals had before it in the Cooke case.²⁵ The instrument which that Court had under consideration there gave to the life tenant much broader powers than the one before us. It is printed in the margin.²⁶

These clauses, the majority held, were so broad that the life tenant could not be impeached²⁷ if she wasted the estate or sold it for inadequate consideration (a) and (c). No security for preservation of the estate could be required of...