Whittemore v. United States
| Decision Date | 01 November 1967 |
| Docket Number | No. 18577.,18577. |
| Citation | 383 F.2d 824 |
| Parties | Clinton L. WHITTEMORE, Jr., and Anne W. Whittemore, Appellants, v. UNITED STATES of America, Appellee. |
| Court | U.S. Court of Appeals — Eighth Circuit |
COPYRIGHT MATERIAL OMITTED
Harry W. Kroeger, St. Louis, Mo., for appellants; Arthur B. Shepley, Jr., St. Louis, Mo., was on the brief.
Benjamin M. Parker, Atty., Dept. of Justice, Washington, D. C., for appellee; on the brief were Mitchell Rogovin, Asst. Atty. Gen., Tax Div., Dept. of Justice, Lee A. Jackson, Robert N. Anderson, Attys., Dept. of Justice, Washington, D. C., Richard D. Fitzgibbon, Jr., U. S. Atty., and John A. Newton, Asst. U. S. Atty., St. Louis, Mo.
Before VOGEL, Chief Judge, GIBSON and HEANEY, Circuit Judges.
This case presents the question: Are fiduciary fees for the management, conservation or maintenance of that part of a trust or estate consisting of municipal bonds (the interest income which is taxfree) deductible under 26 U.S.C. § 212 (1964)? We reverse the decision of the District Court and hold that to the extent that the municipals produced taxable income or were held for that purpose, the fees, whether measured by the income or the value of the municipals, are deductible and that a reasonable basis for determining the deductible portion is the ratio of taxable to nontaxable income.
In particular, we are concerned with two trusts and one estate. The grantor of the trusts established an intervivos trust in 1910 and a testamentary trust in 1919. After his death, both trusts paid the net annual income to his widow and daughters for their lives.1 The last surviving daughter died in 1958. The assets of the trusts and daughter's estate were distributed in 1959 and 1960 to the children and grandchildren of the last surviving daughter.
The intervivos trust contained assets at termination valued at $2,307,493, of which $705,400, or 30.5%, was invested in municipals. The testamentary trust contained $4,269,239, of which $1,688,870, or 39.5%, was invested in municipals. From 1950 to 1959, the investment in municipals varied from a high of 47.8% to a low of 37.8% in the testamentary trust, and from 40.2% to 30.7% in the intervivos trust. The estate consisted of assets totaling $1,365,345, of which $29,213, or 2.985%, were in municipals.2
The St. Louis Union Trust Company was the common corporate fiduciary for both trusts and the estate. Upon termination of the testamentary trust, a child of the last surviving daughter was co-trustee; and, until his death, he was a co-executor of his mother's estate. He received one-half of the corporate trustee's fees, both annual and termination, for the testamentary trust during the thirteen months he served as co-trustee.3
The fee paid by the intervivos trust, established by agreement, was 2.5% of the yearly income of the trust, and 2.5% of the value of the corpus at termination. The fee paid by the testamentary trust, based on the customary charge of the corporate trustee at the inception of the trust, was 5% of yearly income, and 5% of value of corpus at termination.4 The executor's fee was determined in accordance with Missouri statutory law. Mo.Rev.Stat. § 473.153 (1955). In addition, the estate incurred legal expenses totaling $17,500.5
Total fiduciary fees of $585,730 were paid as follows:
INTERVIVOS TESTAMENTARY
TRUST TRUST ESTATE TOTAL
Annual fees
measured by income
from time to time
collected ......... $ 64,561.05 $198,307.74 $262,868.79
Termination fees
measured by the
value of the
corpus ............ $ 57,263.35 $230,046.30 $35,552.276 $322,861.92
___________ ___________ __________ ___________
TOTALS ...... $121,824.40 $428,354.04 $35,552.27 $585,730.71
Interest income from the municipals was included in total income for the purpose of determining the trustee's annual compensation but consistent with 26 U.S.C. § 103 (1964) was excluded from gross income for income tax purposes. That portion of the annual fee deemed allocable to interest on the municipals was not deducted in computing the annual income tax. The basis of the allocation was the ratio of tax-exempt income to total income. The entire termination fees were taken as deductions from gross income in the years in which each trust terminated. As the fees exceeded taxable income, the beneficiary took the excess deduction against his own income in accordance with the provisions of 26 U.S.C. § 642 (1964).
In auditing the fiduciary and individual returns, the District Director of the Internal Revenue Service refused to permit the taxpayer to deduct any part of the termination fees paid for services of the trustee in administering that part of the corpus invested in municipals. The Director used the ratio of the value of the municipals to the value of the total assets to determine what portion of the fees represented the efforts of the trustee in administering the municipals. In explaining the disallowance, it was stated:
"Since the municipal bonds\' income is tax exempt, the commission charged on these assets would not be deductible under Section 1.265-1(a)-2 of the Regulations which does not allow a deduction for expenses pertaining to exempt income."
A deficiency was assessed and paid. The taxpayer,7 as a beneficiary entitled to the benefit of any excess deduction allowed, filed a timely claim for a refund. Upon disallowance of his claim, an action was commenced in U.S. District Court.8
The District Court sustained the position of the Commissioner of Internal Revenue and held that the Commissioner had properly refused to permit the taxpayer to deduct any part of the termination fee paid for services relating to the municipals:
"* * * plaintiffs would not be entitled to a refund as to any portion of the termination compensation, executor\'s and attorney\'s fees paid in the trusts and the estate allocable to the municipal bonds, regardless of allocation of expenses between production of income and management, consveration or maintenance of property held for production of income, as this is payment primarily for services previously performed, and regardless of what we call it was primarily aimed at producing income. * * *"
The court also stated that even if that portion of the termination fees (based on the value of the municipals) which relate to the preservation of the corpus was deductible, it would not be allowed here because the taxpayer had failed to establish the extent to which the trustee's services related to preservation of the corpus.
The taxpayer contends: that the termination fees were expenses solely for the management, conservation or maintenance of property held for the production of income, and were fully deductible under the provisions of § 212(2) of the Internal Revenue Code without regard to the type of income produced; and that expenses under § 212(2) are not subject to disallowance under § 265(1) of the Code.
He argues, in the alternative, that if the termination fees were not entirely deductible, they were at least partially deductible. In the event that his alternative position is accepted, he urges that the allocation should be based on the ratio of tax-exempt income to total income rather than the ratio of the value of municipals to the value of total assets.
In our judgment, a proper construction of §§ 212 and 265 requires that we reject the taxpayer's principal contention that the entire termination fee is deductible, and the District Court's holding that no part of it is deductible.
(1) Section 212 permits expenses for the production of income, or the management, conservation or maintenance for property held for the production of income to be deducted.
It provides:
The leading case interpreting § 212 is Bingham's Trust v. Commissioner of Int. Rev., 325 U.S. 365, 65 S.Ct. 1232, 89 L.Ed. 1670 (1945). In that case, the Commissioner had argued that administrative and legal expenses incurred in terminating a trust and distributing the corpus to beneficiaries were not deductible under § 212 since the expenses were not for the production of income. The case established that the expenses incurred in disbursing trust assets are within § 212(2) even though such expenses obviously are not incurred with the intent that they will themselves produce income — it is enough that the expense is for the management, conservation or maintenance of property that is held for the production of income. Chief Justice Stone, delivering the opinion of the Court, stated:
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