Wyly v. U.S.

Decision Date30 November 1981
Docket NumberNo. 80-2138,80-2138
Citation662 F.2d 397
Parties81-2 USTC P 9797 Sam E. WYLY, et al., Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Ray, Anderson, Shields, Trotti & Hemphill, George E. Ray, Troy Murrell, Dallas, Tex., for plaintiffs-appellants.

Martha Joe Stroud, Asst. U.S. Atty., Dallas, Tex., John F. Murray, Acting Asst. Atty. Gen., Gary R. Allen, Gilbert S. Rothenberg, Tax Div., U.S. Dept. of Justice, Washington, D.C., for defendant-appellee.

Appeal from the United States District Court for the Northern District of Texas.

Before POLITZ and RANDALL, Circuit Judges, and GORDON *, District Judge.

RANDALL, Circuit Judge:

This case presents four issues for review. The first deals with the deductibility to each taxpayer under I.R.C. § 267 of losses on securities sold by the taxpayer to a trust established by the taxpayer's parents for the benefit of the taxpayer's children under the circumstance in which the trust instrument, taken in conjunction with the Texas Probate Code, provides that if all the primary beneficiaries die without issue prior to the termination of the trust, the trust corpus and undistributed income would be paid to the taxpayer, as the heir-at-law of the primary beneficiaries. The remaining three issues concern the constitutionality and deductibility of the minimum tax imposed by I.R.C. § 56 and the classification for purposes of the minimum tax of certain legal and management fees incurred by each of the taxpayers in connection with his investment activities. The district court decided each of these issues adversely to the taxpayers. We affirm.

I. THE FACTS

On May 28, 1970, the parents (Charles J. Wyly and Flora Evans Wyly) of the taxpayers, 1 Charles J. Wyly, Jr. and Sam E. Wyly, executed the instruments necessary to create two trusts for the benefit of their minor grandchildren. The primary beneficiaries of Trust No. 1 were the four children of Sam E. Wyly; and the primary beneficiaries of Trust No. 2 were the four children of Charles J. Wyly, Jr. Each of these trusts was funded with a $100 payment by the taxpayers' parents. Arty B. Smith, a certified public accountant who served as the taxpayers' family tax advisor and financial consultant, was named as trustee of each of the trusts. On the same day that the trusts were established, the taxpayers sold stock and municipal bonds to the trusts, sustaining some losses as a result. In return, Smith, as trustee, executed promissory notes payable to Sam E. Wyly and Charles J. Wyly, Jr. in the principal amounts of $5,072,077 and $3,460,590, respectively.

Before the trust instruments were executed, Smith sought tax advice from a Dallas law firm concerning the applicability of § 267 2 to the contemplated transactions. In a letter dated May 27, 1970, the law firm advised Smith that § 267(b)(6) would not disallow the taxpayers a loss on the sale of securities to the trusts so long as "neither Sam Wyly nor Charles Wyly (Jr.) will have any interest in the trust, either expressly or by virtue of some provision appointing them as remaindermen or some provision providing for distribution to the heirs-at-law of the children...." The firm also advised that § 267(b)(7) would not disallow the loss "(i)f neither Sam Wyly nor Charles Wyly (Jr.) has any interest (either expressly or by virtue of some provision appointing them as remaindermen or some provision providing for distribution to the heirs-at-law of the children) in any other trust of which Mr. Charles J. Wyly, Sr. is a grantor (either because he created the other trust or because he made contributions to the other trust)...." Despite this advice, paragraph 4(c) of each of the trust instruments provided that the trust assets would be paid to the heirs-at-law of the taxpayer's children (according to Texas law) if none of the children or their issue were living at the termination of the trust. Section 38(a) of the Texas Probate Code (Tex.Prob.Code Ann. (Vernon 1956)) provides that if a person dies intestate and without issue, his estate will pass "to his father and mother, in equal portions." Thus, each of the taxpayers herein would have been entitled to the corpus and accumulated income of the trust established for the benefit of his children if all of his children had died without issue.

The taxpayers paid Smith's firm in excess of $187,000 in management fees during 1970. The fees were paid for the management, conservation and maintenance of investments held by the taxpayers for the production of capital gain income. Approximately $3,000 of $25,000 in legal fees incurred by the taxpayers during the same period was paid for services incurred in connection with certain federal tax litigation. The balance was paid for the defense by the taxpayers of a stockholders' derivative suit, for securities and tax planning advice and for general legal services incurred in connection with corporate aquisitions for investment purposes.

On his tax return for the year ended December 31, 1970, each of the taxpayers claimed losses with respect to his sale of securities to the trust established for the benefit of his children. As a result of these losses and other deductions, the reported taxable income of each taxpayer was reduced to zero in each instance, although each taxpayer reported minimum tax liability. On audit, the Internal Revenue Service (the "Service") disallowed the claimed losses on the sale of the securities pursuant to § 267 and asserted an increase in the minimum tax liability of each of the taxpayers. The taxpayers paid the additional taxes determined to be due, and following denial of their refund claims, brought suit seeking recovery of all the taxes paid by them for 1970.

At trial, the taxpayers made four basic arguments in support of their claim for a refund. First, they argued that § 267 did not operate to bar the deduction of the losses sustained by them in connection with their sales of securities to the trusts. Second, they argued that the minimum tax was unconstitutional and that, consequently, they did not have to pay the minimum tax liability determined to be owing by the Service. Third, they argued that even if the minimum tax was constitutional, the tax constituted a deductible excise tax. Finally, they argued that certain legal and management fees paid in connection with their investment activities should not be deducted from their investment income in determining their minimum tax liability.

The district court rejected each of these contentions. The court held first that the taxpayers were the beneficiaries under the terms of the trusts established by their parents for the benefit of their children and that, as a result, §§ 267(b)(6) and (b)(7) precluded deduction of the losses sustained by the taxpayers when they sold the securities to the trusts. In addition, the district court held that the minimum tax was constitutional and was not a deductible excise tax. Finally, the court concluded that the legal and management fees paid by the taxpayers in connection with their investment activities were required to be subtracted from their investment income for purposes of determining their minimum tax liability. From that decision, the taxpayers bring this appeal.

II. DEDUCTIBILITY OF LOSSES

On appeal, the taxpayers argue that the district court erred in concluding that each of the taxpayers was a beneficiary of the trust established by his parents for the benefit of his children. The taxpayers concede that pursuant to paragraph 4(c) of each trust instrument, there is a remote possibility that the corpus of the trust estate would revert to the taxpayer. Each of the taxpayers points out that in order for this possibility to come to pass, all four of his children would have to predecease him, leaving no descendants. The taxpayers argue that the actuarial probability that this circumstance would occur is very remote, and that such an actuarially insignificant chance should not be used to defeat the deductibility of the taxpayers' losses under the facts of this case. The taxpayers analogize the situation under § 267 to that under I.R.C. § 2055, which allows a deduction for charitable bequests from a decedent's gross estate. If the charitable transfer is dependent upon the performance of some act or the happening of a precedent event in order that it might become effective, no deduction is allowable unless the possibility that the transfer will not become effective is "so remote as to be negligible." Treas.Reg. § 20.2055-2(b)(1) (1958). The taxpayers note that various revenue rulings and judicial interpretations define when a transfer is "so remote as to be negligible" for purposes of § 2055. For example, Rev.Rul. 70-452, 1970-2 C.B. 199, has set forth a 5% test in determining whether an interest is considered so remote as to be negligible. Under this ruling, the charitable remainder interest in an irrevocable trust subject to invasion to make fixed payments to the life tenant is not deductible under I.R.C. § 2055 where the probability that the transfer to the charity will not occur is greater than 5%. The taxpayers also analogize the situation under § 267 to that under I.R.C. § 170, which allows a deduction for charitable contributions made by individuals and corporations. Treas.Reg. § 1.170A-1(e) (1972) provides in relevant part that "(i)f an interest in property passes to, or is vested in, charity on the date of the gift and the interest would be defeated by the subsequent performance of some act or the happening of some event, the possibility of occurrence of which appears on the date of the gift to be so remote as to be negligible, the deduction is allowable." The Tax Court in Briggs v. Commissioner, 72 T.C. 646 (1979), denied a deduction under § 170 on the ground that the possibility of a breach of one or more conditions subsequent to a charitable transfer and a resulting reentry by the...

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