Sloan's Estate, In re

Decision Date15 November 1963
Citation222 Cal.App.2d 283,35 Cal.Rptr. 167
PartiesIn the Matter of the ESTATE of William R. SLOAN, aka Wm. R. Sloan, aka W. R. Sloan, Deceased. Gail St. Aubyn HICKMAN, Anne St. Aubyn Newton, William Sloan Upton, John Roland Upton, Jr., Appellants, v. Margaret Sloan ST. AUBYN, Anna Logan Sloan Upton, Wells Fargo Bank American Trust Company, Respondents. Civ. 20543.
CourtCalifornia Court of Appeals Court of Appeals

Cooley, Crowley, Gaither, Godward, Castro & Huddleson, San Francisco, for appellants.

Brobeck, Phleger & Harrison, San Francisco, for Wells Fargo Bank, the surviving trustee.

Everett S. Layman, Kenneth S. Carey, Everett S. Layman, Jr., Arthur J. Lempert, San Francisco, for respondent income beneficiaries.

TAYLOR, Justice.

This is an appeal by Gail St. Aubyn Hickman, Anne St. Aubyn Newton, William Sloan Upton and John Roland Upton, Jr., some 1 of the remaindermen of a trust created by the will of their grandfather, the late William R. Sloan, from the decree of settlement of the 28th annual account and report of the surviving trustee (hereafter referred to as the 1961 decree), modifying the 19th annual account and report (hereafter referred to as the 1953 decree), as to the allocation of certain oil royalties. The respondents, Margaret Sloan St. Aubyn and Anna Logan Sloan Upton, the daughters of William R. Sloan, are the income beneficiaries; respondent, Wells Fargo Bank American Trust Company, is the surviving trustee.

The testator, William R. Sloan, died on April 14, 1923, survived by his widow, Agnes G. Sloan, and his daughters, Anna and Margaret. Most of the estate was distributed to the trustees named in the will, who were to receive the rents, issues and profits, and income of the property, and to dispose of the same as provided in the will after paying necessary and proper expenses. All of the net income was to go to the widow for life, except for $25 a month to her sister, Anna M. Kiernan. On the death of the widow and her sister, all the net income would go to the daughters (if then living) in equal shares. 2 Anna M. Kiernan died on January 14, 1936, and Agnes Sloan on December 26, 1945. Since the latter date, the two daughters have been entitled to all of the net income of the trust.

Under the will, the trustees had no power to distribute anything to the life beneficiaries except 'rents, issues, profits and income,' after deducting therefrom necessary expenses of administration. The trustees were given the power to sell trust property but required to invest and reinvest the proceeds, or to purchase or acquire other property, all of which was to be held upon the same uses and trusts as the original property.

This controversy concerns only two of the assets of the trust, hereinafter referred to as the Pleasant Valley interests and the Richfield interests. In 1923, 107 shares of stock of Pleasant Valley Farming Company, then appraised at $32,100, were distributed to the trustees. On April 23, 1943, Pleasant Valley distributed to its shareholders economic interests in gas and oil in place with a fair market value of a little over $46,000. Among these was an interest in oil producing lands leased to the Standard Oil Company of California. Between 1943 and October 31, 1951, the trustees received net royalties in excess of $121,000 from the Standard Oil lease. Until the death of the widow in 1945, all such royalties were distributed to her. Thereafter, these royalties were distributed to Anna and Margaret. Depletion in an aggregate of $33,991.39 (27 1/2% of $123,605.03, the gross royalties) was claimed as a deduction by the mother and daughters, in computing their respective federal income taxes from 1943 to October 31, 1951. No depletion was claimed by the trust prior to November 1, 1951.

The Richfield interests consist of mineral rights, including extraction, ingress and egress but not the fee, owned by the testator in certain lands in Cuyama Valley in San Luis Obispo County. These mineral rights were not separately described or referred to in the inventory of the estate or decree of final distribution but were distributed to the trustees by the so-called omnibus clause of that decree. The fair market value of the Cuyama Valley mineral interests on April 14, 1923, was $5,445.25.

Early in 1948, oil was discovered in the Cuyama Valley. About June 19 of that year, the trustees entered into a written contract with Richfield Oil Company for the development of oil and gas from the mineral rights held by the trust. The agreement required the trustees to obtain a court determination of their right to enter into the agreement as the terms of the lease might extend beyond the termination of the trust. 3 The trustees instituted a declaratory relief action in the Superior Court of Alameda County for the purpose of obtaining such a determination At the outset, a question arose as to whether some or all of the royalty income should be retained by the trustees until the termination of the trust. Since this question could not be determined in the declaratory relief action, that suit was abandoned. The trustees then filed their 19th report and account covering the period from October 31, 1951, to July 31, 1952, and asked for instructions as to: 1) their authority to enter into the Richfield agreement; and 2) the proper distribution of the royalties from the Richfield interests and the Pleasant Valley interests.

The Oakland Bank of Commerce was appointed as the guardian ad litem to represent the interests of the minor and unborn remaindermen. The trustees and Anna and Margaret took the position that all of the royalties were income and currently distributable to themselves as the current income beneficiaries and none retained by the trustees. The guardian ad litem, in its objections, took the position that all the royalties were to be retained by the trustees as corpus and only the income from the reinvestment of such royalties should be distributed to Anna and Margaret.

After a full hearing which extended over several days, a decree was entered on May 19, 1953. The decree confirmed the authority of the trustees to enter into the Richfield agreement as follows: Paragraph 28 of the findings of the decree recited that the trustees had the power and authority to execute the Richfield agreement and any other lease '* * * even though such properties are in the nature of wasting assets, provided that the royalty income produced * * * be reasonably apportioned or allocated between the present income beneficiaries and the trustees as hereinafter * * * provided * * *' The trustees were instructed to allocate 72 1/2% of the royalty income from the Richfield and Pleasant Valley interests equally to Anna and Margaret, the income beneficiaries, and 27 1/2% of the royalty income to the trustees as 'retained royalties.'

The trustees were further instructed that all of the 'retained royalties' should be invested and reinvested, the income therefrom to be currently distributed to the income beneficiaries in equal shares. To accomplish this purpose, the trustees were also directed to establish two additional accounts, a 'retained royalties account' and 'income from retained royalties account.' For purposes of distribution of the corpus of the trust upon termination of all or a part thereof, the trustees were ordered to treat the retained royalties in all respects as if they were part of the property distributed to them by the decree of final distribution.

No motion for a new trial was made and no appeal was taken from the decree of May 19, 1953. All parties to this appeal agree that the 1953 decree has become final and res adjudicata. In 1952 and 1953, in accordance with the 1953 decree, the trustees distributed 72 1/2% of the gross royalties to the income beneficiaries and retained the remaining 27 1/2%. 4

The depletion allowance deduction for federal income tax purposes was allocated in the same proportion as the royalties. Thus, in computing net income in their fiduciary income tax returns for 1952 and 1953, the trustees deducted 27 1/2% of the royalties which they had retained as depletion allowance authorized by section 114(b)(3) of the Internal Revenue Code of 1939 (26 U.S.C.A., § 114(b)(3).) Likewise and for the same reason, in computing net income in their personal income tax returns for those years, the life beneficiaries deducted 27 1/2% of the royalties which had been distributed to them. The Alameda court was advised of this in the 21st and 22nd accounts filed by the trustees for the calendar years 1952 and 1953, and approved these accounts and reports.

Upon examination of the tax returns for those years, the Commissioner of Internal Revenue, however, determined that the income beneficiaries were not entitled to take credit for any depletion allowance on the distributed royalties, and that the trustees should have taken all of the depletion allowance. This determination was upheld by the Tax Court (32 T.C. 301 (1959)) and sustained on appeal (Upton v. C. I. R., 283 F.2d 716, Ninth Circuit 1960, cert. den. 366 U.S. 911, 81 S.Ct. 1036, 6 L.Ed.2d 236). The decision of the federal courts was based on section 23(m) of the Internal Revenue Code of 1939 (26 U.S.C.A. § 23(m)), which provides that in case of property held in trust the allowable depletion deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allocable to each. Accordingly, the Ninth Circuit concluded that the will required the trustees to preserve the corpus, as the only things the trustees were authorized to distribute were rents, issues, profits and income.

As to the question of whether the testator intended to include all oil well royalties under income,...

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