Sultan v. Comm'r of Internal Revenue
| Decision Date | 03 July 1952 |
| Docket Number | Docket Nos. 24513,24514. |
| Citation | 18 T.C. 715 |
| Parties | EDWARD D. SULTAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.OLGA L. SULTAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
The husband-petitioner created a trust for the benefit of his minor son and conveyed to it a 42 per cent interest in his business. The settlor was not a trustee. The trustees became a special partner in a partnership in which the settlor and others were general partners for the operation of the business theretofore conducted by the petitioner as a sole proprietorship. One of the trustees insisted on, and received, the trust's distributive share of profits as soon as they were available for distribution.
1. Held, that the trust was a bona fide partner and that its distributive share of partnership profits was not income of the petitioners.
2. Held, further, that the settlor did not have any rights in the trust corpus or income sufficient to make the income of the trust taxable to him and his wife.
Milton Cades, Esq., and Urban E. Wild, Esq., for the petitioners.
Robert G. Harless, Esq., for the respondent.
The respondent determined deficiencies in income taxes of the petitioners as follows:
+-----------------------------------+
¦Petitioner ¦Year ¦Amount ¦
+----------------+------+-----------¦
¦ ¦( 1944¦$145,292.17¦
+----------------+------+-----------¦
¦Edward D. Sultan¦( 1945¦183,632.00 ¦
+----------------+------+-----------¦
¦ ¦( 1946¦60,694.17 ¦
+----------------+------+-----------¦
¦Olga L. Sultan ¦1946 ¦17,091.57 ¦
+-----------------------------------+
The issue to be decided is whether the distributive portion of partnership income payable to, and paid to, a trust created by the settlor and which became a special partner in the operation of a business was income to the settlor. The settlor's wife is involved only because of the community property law of Hawaii which became effective on June 1, 1945.
The petitioners are, and at all times material to these proceedings were, husband and wife, and residents of the Territory of Hawaii. Their income tax returns were filed with the collector of internal revenue for the district of Hawaii. They have one child, Edward D. Sultan, Jr. (whose name was changed from Edward Dolph Sultan) born December 28, 1927.
Edward D. Sultan, one of the petitioners, and herein usually referred to as the petitioner, has been in the wholesale jewelry or jewelry manufacturing business since he was about 10 years old. In the early part of 1941, he was in the wholesale jewelry business as an individual in Honolulu. That business consisted of dealing in watches, diamonds, silverware, general jewelry lines, and everything associated with a jewelry business.
The petitioner is primarily a salesman. The manager of the business was his brother, Ernest W. Sultan, who received as compensation 25 per cent of the net profits of the business. The petitioner devoted most of his time to selling in the Far East and in the Pacific Islands. Ernest, in addition to managing the office part of the business, made some selling trips prior to 1940. Ernest had no financial interest in the business but was very valuable to it because of his knowledge of the jewelry business.
For some time prior to August 1941, the petitioner had been considering ways of protecting his family in the event of his illness or death, and also of interesting his son in the business. The son, who was 13 years old in 1941, was interested in the study of journalism and not in the jewelry business. The petitioner at that time was almost constantly in the care of doctors. In 1940, while the petitioner was on a trip, his brother Ernest became seriously ill and was away from the office for a few weeks.
Another brother of the petitioner, Gabriel, was a full time salesman of the petitioner's merchandise in California. The petitioner's sister, Marie Hilda Cohen, was in San Francisco, where she and her husband owned a warehouse and they frequently supplied warehouse space for the petitioner's merchandise while it was awaiting shipment to Honolulu. In the early part of 1941, it was difficult to obtain shipping space. The petitioner's sister was a capable business woman.
The petitioner discussed with his brothers and sister possible methods of having his business carried on for the protection of his wife and son and of interesting his son in the business. He also discussed the matter with his wife, with a relative in the United States who was a lawyer, and with counsel in Honolulu. Out of these discussions there was evolved the idea of the creation of a trust and the formation of a partnership. The petitioner knew of one instance in which a jewelry business that was in bad financial shape had been rehabilitated under the management of a trust company. He wanted a trust company as trustee of the trust to be created for his son for the benefit of the advice that it could give and for the management that it could provide in the event that he was not able to carry on the business. He wanted his brothers and sister associated with him in the business for the assistance they could give as they had in the past.
The Bishop Trust Company, Limited, an Hawaiian corporation, conducted a trust company business in the Territory of Hawaii. Its main business was the administration of estates, trusts, guardianships, agency accounts, and it acted as transfer agent, and similar business. In its fiduciary capacity, it often operated businesses in connection with its administration of estates or trusts.
On August 28, 1941, the petitioner Edward D. Sultan created the Edward D. Sultan Trust, naming as trustees Ernest W. Sultan and Bishop Trust Company, Limited. The trust instrument recited the delivery to the trustees of the sum of $42,000 by the settlor, to be used to purchase a 42 per cent interest in a partnership known as Edward D. Sultan Co. Income was to be accumulated until the settlor's son, Edward Dolph Sultan, became 21 years of age, but with discretion in the trustees to pay out not more than $3,600 per year for the maintenance, support and education of the beneficiary. Beginning at age 21, the beneficiary was to receive $300 per month; at age 25 he was to receive a portion of the accumulated income in a lump sum. At the beneficiary's age of 30 years, the trust was to terminate and he was to receive the trust corpus, together with any cash in the estate not in excess of $20,000. Any remaining cash was to be used to purchase an annuity for the beneficiary. If the beneficiary died before age 30, corpus and income were to go to the wife of the settlor or, in the event of the happening of specified events, to the settlor's sister and brothers.
The trust instrument gave the trustees the usual powers to hold and manage the trust property, collect the income, and invest and reinvest. The trustees were not restricted to investments of the type that are permitted by law, with provisos that during the lifetime of the settlor the trustees were to obtain the settlor's consent to investments, and upon the settlor's death they were to be restricted to legal trust investments. However, the trustees could in any event make loans or advances to the partnership without liability for resulting losses. The trust was irrevocable. The corporate trustee was given custody of all money and securities in the trust estate. The settlor reserved the right to transfer additional property to the trust. Under the terms of the trust instrument neither the corpus nor income of the trust was ever to be paid to the settlor. The trust was conditioned upon obtaining court approval for the purchase of a 42 per cent interest in Edward D. Sultan Co., and approval of the trustees becoming a special partner therein. If such approval was not obtained within 60 days, the trust indenture was to be null and void.
On August 30, 1941, a partnership was formed under the name of Edward D. Sultan Co. It was a special partnership. The general partners were Edward D. Sultan, Ernest W. Sultan, Marie Hilda Cohen, and Gabriel L. Sultan. The trustees of the Edward D. Sultan trust were a special partner. The initial capital of the partnership was $100,000. Contributions of capital and partnership interests were as follows:
+---------------------------------------------------------------+
¦Partner ¦Contribution ¦Interest ¦
+----------------------------------+--------------+-------------¦
¦ ¦ ¦( per cent )¦
+----------------------------------+--------------+-------------¦
¦Edward D. Sultan ¦$46,000 ¦46 ¦
+----------------------------------+--------------+-------------¦
¦Ernest W. Sultan ¦4,000 ¦4 ¦
+----------------------------------+--------------+-------------¦
¦Marie Hilda Cohen ¦4,000 ¦4 ¦
+----------------------------------+--------------+-------------¦
¦Gabriel L. Sultan ¦4,000 ¦4 ¦
+----------------------------------+--------------+-------------¦
¦Trustees of Edward D. Sultan Trust¦42,000 ¦42 ¦
+---------------------------------------------------------------+
The partnership was to acquire the assets and carry on the business theretofore conducted by Edward D. Sultan. The general partners actively engaged in the business were to receive compensation for services rendered in such amounts as the general partners might agree on, and such compensation was to be charged as an expense in computing net profits. As long as Ernest W. Sultan was active in the business, he was to receive 25 per cent of the net profits. The remainder of the profits was to be divided in proportion to the capital contributions of the partners. The provision for Ernest W. Sultan to...
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