United States v. BANK OF AMERICA NATIONAL TRUST & SAV. ASS'N

• Decision Date: 17 January 1964
• Docket Number: No. 18144.,18144.
• Citation: 326 F.2d 51
• Parties: UNITED STATES of America, Appellant, v. BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION, a national banking association, as trustee of the Trust created under the last Will and Testament of Kernan Robson, deceased, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

326 F.2d 51 (1963)

UNITED STATES of America, Appellant, v. BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION, a national banking association, as trustee of the Trust created under the last Will and Testament of Kernan Robson, deceased, Appellee.

No. 18144.

United States Court of Appeals Ninth Circuit.

December 10, 1963.

Rehearing Denied January 17, 1964.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, L. W. Post and Harold C. Wilkenfeld, Tax Division, Department of Justice, Washington, D. C., Cecil F. Poole, U. S. Atty., and Richard L. Carico, Asst. U. S. Atty., San Francisco, Cal., for appellant.

Dreher, McCarthy & Dreher, and Robert Dreher, San Francisco, Cal., for appellee.

Before BARNES and DUNIWAY, Circuit Judges, and KUNZEL, District Judge.

DUNIWAY, Circuit Judge.

The United States appeals from a judgment in favor of the taxpayer in an action brought by the latter in the district court to recover taxes unlawfully collected, following denial of a claim for refund. The decision of the district court is reported at 203 F.Supp. 152. We conclude that the judgment must be affirmed in part and reversed in part.

The facts are stipulated and, so far as material, are as follows: Appellee is trustee of a trust created under the last will and testament of Kernan Robson, deceased. It also was executor of the will of the decedent. The decedent died on January 13, 1956, a resident of California, and the will was probated in the Superior Court of that state, in and for the County of Marin. On October 15, 1956, the probate court made a decree of preliminary distribution under the terms of which certain property of the estate, specifically described, was distributed to the trustee. All of the property distributed by this decree was corpus of the estate.

The will of the decedent creates a trust under which the trustee is required to hold all of the corpus and pay the income to certain named beneficiaries. Upon termination of the trust, which must be not later than December 31, 1977, all of the corpus of the trust is to be paid to certain institutions, each of which is concededly a tax-exempt charitable or religious organization.

The executor adopted a fiscal year beginning on the date of the death of the testator, January 13, 1956, and ending on October 31, 1956. During that fiscal year the estate had net income of $178,109. The value of the assets distributed under the decree of preliminary distribution of October 15, 1956 exceeded this amount. A portion of this income was "income in respect of the decedent," but $65,420.44 was income received during the course of administration subsequent to the death of the testator.

In its income tax return, the executor reported that the entire $178,109 was distributable, and treated it as income deemed to have been distributed under the provisions of sections 661(a) and 663(a) (1) of the Internal Revenue Code of 1954. The parties are agreed that, under these sections and section 662, the executor was required to treat the distribution as a distribution of income, even though all of the property actually distributed was corpus under state law.

The trustee, in accordance with sections 662(a) and 663(a) (1) of the Internal Revenue Code, included in its first fiduciary income tax return for its fiscal year (October 15, 1956 to October 31, 1956), as part of its gross income, the entire sum of $178,109. It also included dividends and interest received during that period in a sum a little over $10,000. The treatment of this latter sum is not here in question. In reporting its taxable income, the trustee deducted the net of the $178,109 (after depreciation and expenses), or $170,034, purporting to act under section 642(c) of the Internal Revenue Code. This subsection authorizes deduction by a trust of "* * any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid or permanently set aside for a purpose specified in section 170(c) * * *." Section 170(c) defines charitable contributions and it is conceded that all of the residuary beneficiaries of the trust, for which the corpus must be retained by the trustee, are charitable organizations within the meaning of section 170(c). There is a problem, later discussed in this opinion, as to whether one of the gifts is exclusively for charitable purposes.

The District Director of Internal Revenue concluded that $64,420.44 of this deduction should be disallowed, and it is the disallowance of this item that is here in issue. The ground of the disallowance was that this sum was not gross income permanently set aside for charitable purposes pursuant to the terms of decedent's will. The district court disagreed and the United States assigns error. Essentially, the theory of the United States is that since the $64,420.44, which was admittedly gross income of the estate, is deemed to have been distributed to the trustee, and is deemed to be income of the trust under the sections heretofore cited, it must be treated as income distributable by the trustee to the income beneficiaries, who are individuals and not charitable corporations or organizations, and that, since such income was not distributed to them, it is taxable in the hands of the trustee.

The difficulty with this position is that there is nothing in the Internal Revenue Code that so provides. It is clear, and it is admitted, that under California law, and under the terms of the will, all of the assets that were in fact distributed to the trustee during the period in question were corpus, and that the trustee was required to hold them as corpus for ultimate distribution to the charitable beneficiaries. It could not, under California law, distribute any part of them to the individual income beneficiaries. The Internal Revenue Code makes local law applicable as the basis on which to determine what is "income" of a trust. Section 643(b) states in part: "* * the term `income', when not preceded by the words `taxable', `distributable net', `undistributed net', or `gross', means the income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. Items of gross income constituting extraordinary dividends or taxable stock dividends which the fiduciary, acting in good faith, determines to be allocable to corpus under the terms of the governing instrument and applicable local law shall not be considered income. * * *" The regulations (section 1.651(a)-2) provide "* * * The determination of whether trust income is required to be distributed currently depends upon the terms of the trust instrument and the applicable local law * * *." The cases also recognize that, in determining what is distributable income, what is not distributable income, and what is corpus, the trustee and the government are bound by the governing instrument and the local law and the income is to be taxed accordingly. See, for example, Johnston v. Helvering, 2 Cir., 1944, 141 F.2d 208; Bryant v. Commissioner, 4 Cir., 1950, 185 F.2d 517; Gallagher v. Smith, 3 Cir., 1955, 223 F.2d 218.

This rule has been changed by sections 661 and 662 to this extent only,...