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Docket Number

No. 12582.

Attorney(S)

Temple W. Seay, of Washington, D.C. (Phil D. Morelock, of Washington, D.C., on the brief), for petitioner. F.E. Youngman, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, A.F. Prescott, and S. Dee Hanson, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Judges

Walter Garrett Riddick

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Smart Summary

Case Summary: French v. Commissioner of Internal Revenue

Factual and Procedural Background

Francis Henry French petitioned the United States Court of Appeals for the Eighth Circuit to review a decision of the United States Board of Tax Appeals (now the Tax Court of the United States). The dispute concerned five transfers to trusts in 1938 (Trusts N, O, P, Q) and a transfer of $5,000 on December 30, 1938 to Trust J (Trust J was created in 1932). The Commissioner of Internal Revenue determined, and the Board of Tax Appeals affirmed, that each transfer was a gift of a future interest in property; accordingly, exclusions of $5,000 each under section 504(b) of the Revenue Act of 1932 were denied. The Court of Appeals affirmed the Board's decision.

Legal Issues Presented

Whether the transfers to Trusts N, O, P, and Q (and the income from those trusts) were gifts of present interests in property, entitling the taxpayer to $5,000 exclusions under section 504(b) of the Revenue Act of 1932, or were gifts of future interests for which no exclusions are allowable.
Whether the $5,000 transferred in 1938 to Trust J constituted payment of an obligation (interest on the taxpayer's demand note) or was a gift of a future interest in property.

Arguments of the Parties

Petitioner's Arguments

Although the taxpayer conceded that the corpus transfers to Trusts N, O, P, and Q were transfers of future interests, he argued that the income from those trusts constituted gifts of present interests to the beneficiaries and therefore qualified for the $5,000 exclusion.
The taxpayer maintained that, because a court of equity can control a trustee's discretion and compel distribution in proper cases, the beneficiaries effectively held a present interest in the income.
With respect to Trust J, the taxpayer contended that the $5,000 transfer represented payment of an obligation—specifically, payment of interest on his demand note payable to the trustee—rather than a gift.

Respondent's Arguments

The Commissioner and the Board treated the transfers (including income) as gifts of future interests because beneficiaries did not have an unconditional right to present use, possession, or enjoyment of the income; distribution was dependent on trustee discretion and contingent events.
Regarding Trust J, the Commissioner (and the Board) treated the $5,000 transfer as a gift because the promissory note held by the trustee was given without consideration and was not an enforceable obligation under Iowa law; thus the $5,000 could not be characterized as payment of an obligation.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
United States v. Pelzer, 312 U.S. 399, 61 S.Ct. 659, 85 L.Ed. 913	Definition and treatment of gifts as future interests where donees receive no present right to enjoyment.	Used with Ryerson to establish that Supreme Court precedent leaves no room for classifying such transfers as present interests when no unconditional present enjoyment exists.
Ryerson v. United States, 312 U.S. 405, 61 S.Ct. 656, 85 L.Ed. 917	Same principle as Pelzer regarding present vs. future interests for gift-tax exclusions.	Applied alongside Pelzer to support that gifts lacking present enjoyment are future interests.
Commissioner v. Wells, 6 Cir., 132 F.2d 405	Illustrative circuit authority concerning gifts and interests under the revenue statutes.	Cited as supporting authority for the interpretation that transfers lacking unconditional present enjoyment are future interests.
Welch v. Paine, 1 Cir., 120 F.2d 141	Illustrative circuit authority concerning the characterization of gifts under the statute.	Cited among other circuit decisions affirming the same principle.
Fisher v. Commissioner, 9 Cir., 132 F.2d 383	Circuit authority interpreting trust provisions in the context of gift taxation.	Cited as supporting precedent; court distinguished it later because the trusts there gave beneficiaries immediate use and enjoyment.
Smith v. Commissioner, 8 Cir., 131 F.2d 254	Circuit authority on present enjoyment of trust income.	Cited but distinguished: in Smith the beneficiaries were entitled to immediate use and enjoyment, unlike the trusts here.
Commissioner v. Lowden, 7 Cir., 131 F.2d 127	Circuit authority on characterization of trust interests for gift-tax purposes.	Cited but distinguished for the same reason as Smith and Fisher.
Meginnes v. McChesney, 179 Iowa 563, 160 N.W. 50, L.R.A. 1917E, 1060	Iowa rule that a promissory note given without consideration is not an enforceable obligation.	Applied to conclude the taxpayer's promissory note (the corpus of Trust J) was not an enforceable obligation, so the $5,000 could not be payment of an obligation.
Johnson v. Commissioner, 2 Cir., 86 F.2d 710, 713	Authority cited in connection with treatment of donor obligations and gift character.	Cited as supporting precedent for the treatment of the promissory note and transfers as gifts where the note lacked enforceability.
Gilman v. Commissioner, 8 Cir., 53 F.2d 47, 80 A.L.R. 209	Authority on the treatment of transfers and notes in trust contexts.	Cited to support the proposition that a donor's note given without consideration is not an obligation rendering later payments non-gifts.

Court's Reasoning and Analysis

The court began with the statutory framework: section 504(b) of the Revenue Act of 1932 authorized an exclusion of the first $5,000 of a transfer to any one person except where the gift was of a "future interest in property." The court relied on Treasury Regulations 79 (1936 Edition), Article 11, and Supreme Court decisions (United States v. Pelzer and Ryerson v. United States) to state the controlling legal standard: a future interest includes any interest "limited to commence in use, possession, or enjoyment at some future date or time," and gifts are future interests when the donee has no right to present enjoyment, use, or possession of either corpus or income.

Applying these principles, the court examined the trust instruments. For Trusts N and O (benefiting minor daughters), the trustee had discretion to distribute or accumulate any or all net income during the beneficiaries' legal disability; distribution percentages were specified only after the disability was removed. For Trust P (benefiting the wife), the trustee could in discretion distribute or accumulate income during the first ten years. For Trust Q (benefiting descendants per stirpes), the trustee could distribute or accumulate without time limitation, and distributions to Class 1 beneficiaries could be excluded if a later-born Class 2 beneficiary existed. In all these trusts the trustee's discretion meant beneficiaries did not have an unconditional present right to income; entitlement was contingent on trustee action or future events. The court concluded that these contingencies rendered the gifts future interests under the statute.

The court addressed the taxpayer's argument that a court of equity could force distributions and thus beneficiaries held present interests. The court reasoned that equitable intervention cannot be exercised until the condition giving rise to such intervention occurs; the beneficiaries' right to require distribution remained contingent and dependent on future events, so the existence of potential equitable relief did not convert the gifts into present interests.

Regarding Trust J and the $5,000 transfer, the court examined whether the transfer was a payment of an obligation (interest on the taxpayer's demand note payable to the trustee) or a gift. The court found, applying Iowa law as articulated in Meginnes v. McChesney, that the promissory note constituting the corpus of Trust J was given without consideration and therefore was not an enforceable obligation of the taxpayer. Consequently, the $5,000 could not be treated as payment of an obligation and was instead a gift. Because the trustee had discretion to distribute or accumulate income under Trust J, the transfer likewise constituted a gift of a future interest.

Holding and Implications

Holding: The decision of the Board of Tax Appeals was affirmed.

Implications:

The court upheld the Board's determination that the transfers to Trusts N, O, P, and Q were gifts of future interests; therefore, the taxpayer was not entitled to the $5,000 exclusions under section 504(b) for those transfers.
The $5,000 transferred to Trust J in 1938 was held to be a gift of a future interest (not payment of an obligation) because the promissory note was not an enforceable obligation under Iowa law and the trustee retained discretion to distribute or accumulate income.
No broader or new precedent was established by the court beyond the application of existing statute, Treasury regulation, and cited precedent; the direct effect was to deny the claimed exclusions and affirm taxation of the transfers as gifts of future interests.

Disposition: The Board of Tax Appeals' decision was affirmed.

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FRENCH v. COMMISSIONER OF INTERNAL REVENUE.

RIDDICK, Circuit Judge.

This petition to review a decision of the United States Board of Tax Appeals (now the Tax Court of the United States) presents the question whether certain transfers in trust were gifts of present interests in property for which in the computation of his gift tax the taxpayer was entitled to exclusions of $5,000 each, or were gifts of future interests for which no exclusions were allowable within the meaning of section 504(b) of the Revenue Act of 1932, 26 U.S.C.A. Int.Rev. Acts, page 585. The Board of Tax Appeals approved the determination of the Commissioner that each of the transfers was a gift of a future interest, and the exclusions claimed by the taxpayer were denied.

Five separate transfers of property were made by the taxpayer in the year 1938 to five trusts, known as Trusts N, O, P, Q, and J. Trusts N, O, P, and Q were created by the taxpayer in 1938, and the taxpayer concedes that the transfers of certain securities to these trusts were transfers of future interests in property, but he contends that the income from the trusts constituted gifts of present interests to the respective beneficiaries, and that, in respect to such income, he is entitled to the exclusions claimed. Trusts N and O were each created for "the benefit, support and education of" a named minor daughter, one of whom was seven, and the other, ten years of age at the time the trusts were created and the transfers made. Trust P was created for "the benefit and support" of taxpayer's wife. Trust Q was created for the benefit of the taxpayer's descendants per stirpes, the two minor daughters to take until such time as there might be in existence a child born after the date of the trust.

In each of the trusts N, O, P, and Q, the net income is to be computed as follows: "From the gross income derived from the trust, realized capital gains and taxes and other proper expenses incurred in executing, maintaining and preserving said trust, including a reasonable sum for the trustee's own compensation, shall be deducted; and the income remaining shall be known as the net income."

Distribution of net income in each of the trusts was provided for as follows:

"Trusts N and O.

"So long as a child of mine, who is under legal disability, is an income beneficiary hereunder, the trustee may in its discretion disburse or accumulate all or any part of the net income; but otherwise, and in any event after the disability shall have been removed the trustee shall in each accounting and distribution year distribute to the person or persons then beneficiary or beneficiaries as defined by Section III, until January 1, 1955, not less than one-fourth and not more than all of the net income and thereafter not less than one-half and not more than all of the net income, the amount so distributed being herein termed the distribution income; the amount of income withheld from distribution being herein termed the reserved income, which may be accumulated from year to year; * * * In the Trustee's discretion, the trustee may make distributions of income as and when received or at convenient intervals thereafter or may estimate the income to be available as distribution income during the current accounting and distribution year and make monthly or other periodic distributions, borrowing temporarily from the reserved income, if necessary, to make some of such payments.

"Trust P.

"* * * Until the first day of January, 1948 the trustee may in its discretion disburse or accumulate all or any part of the net income but thereafter the trustee shall in each accounting and distribution year distribute to the person or persons then beneficiary or beneficiaries as defined by Section III, not less than one-half and not more than all of the net income * * *. In the trustee's discretion, the trustee may make distributions of income as and when received or at convenient intervals thereafter or may estimate the income to be available as distribution income during the current accounting and distribution year and make monthly or other periodic distributions, borrowing temporarily from the reserved income, if necessary, to make some of such payments.

"Trust Q.

"The trustee may accumulate all or any part of the net income or may distribute all or any part of the currently accruing net income and accumulated net income for or to the beneficiaries (ascertained as herein provided) proportionately as they would take the principal if the trust were terminated at the moment of income distribution. Disbursements shall be to or for Class 1 beneficiaries [the named minor daughters] unless at any time a Class 2 beneficiary [child of one of the daughters] is, or Class 2 beneficiaries are, in being, in which event Class 1 beneficiaries shall be excluded from income benefits, and such disbursements shall be to or for such Class 2 beneficiary or beneficiaries."

Trust J was created by the taxpayer on June 6, 1932, one-half for the benefit of his wife or surviving widow, and one-half for the benefit of his descendants per capita. The trustee in Trust J was a sister of the taxpayer, and the corpus of the trust was taxpayer's promissory note payable on demand to the trustee or to her order in the sum of $100,000, with interest at the rate of five per cent per annum payable semiannually. On December 30, 1938, the taxpayer "transferred the sum of $5,000 to the trustee of Trust J." The net income of Trust J is defined and is to be distributed as follows: "From the gross income derived from the trust, realized capital gains and taxes and other proper expenses incurred in executing, maintaining and preserving said trust, including a reasonable sum for the trustee's own compensation, shall be deducted; and the income remaining shall be known as the net income. So long as a child of mine, who is under legal disability, is an income beneficiary hereunder, the trustee may in its discretion disburse or accumulate all or any part of the net income; but otherwise, and in any event after the disability shall have been removed, the trustee shall in each accounting and distribution year distribute to the person or persons then beneficiary or beneficiaries as defined by Section III, not less than six-tenths and not more than all of the net income and the amount so distributed being herein termed the distribution income; the amount of income withheld from distribution being herein termed the reserved income, which may be accumulated from year to year; provided that the trustee shall not be required to transfer income withheld from the income account to the reserved income account until the end of the current accounting and distribution year and a reasonable interval thereafter. The trustee may fix the calendar year as the period for accounting and making distributions, or, in his discretion, may fix a year beginning on any other date than January 1st, and may change the accounting and distribution year from time to time. In the trustee's discretion, the trustee may make distributions of income as and when received or at convenient intervals thereafter or may estimate the income to be available as distribution income during the current accounting and distribution year and make monthly or other periodic distributions, borrowing temporarily from the reserved income, if necessary, to make some of such payments."

The Board decided that the transfers in Trusts N, O, P, and Q constituted gifts of future interests in property and that no exclusions were allowable. It also held that the $5,000 transferred in 1938 to Trust J was not the payment of an obligation, as claimed by the taxpayer, but was a gift of a future interest in property, taxable as such without the allowance of the exclusion claimed.

In 1938 when Trusts N, O, P, and Q were created and when the transfer of $5,000 was made to Trust J, the applicable revenue act allowed a taxpayer to exclude the first $5,000 of a transfer made as a gift to any one person in each year, unless the gift was of a future interest in property. Section 504(b), Revenue Act of 1932, 26 U.S.C.A. Int.Rev. Acts, page 585. It is settled beyond question that gifts are of future interest in property, within the meaning of the statute, where the donees, in this case the beneficiaries of the respective trusts, receive no right to the present enjoyment, use or possession either of the corpus of the gift or of the income from it. In determining whether a transfer of property is a gift of a present or future interest in the property transferred, local law is without application. A future interest within the meaning of the revenue act in question includes any interest or estate "whether vested or contingent * * * limited to commence in use, possession, or enjoyment at some future date or time." Treasury Regulations 79 (1936 Edition), Article 11. Unless the donee is entitled unconditionally to the present use, possession, or enjoyment of the property transferred, the gift is one of a future interest for which no exclusion is allowable under the statute. The decisions of the Supreme Court of the United States in United States v. Pelzer, 312 U.S. 399, 61 S.Ct. 659, 85 L.Ed. 913, and Ryerson v. United States, 312 U.S. 405, 61 S.Ct. 656, 85 L.Ed. 917, leave no room for argument to the contrary. And see Commissioner v. Wells, 6 Cir., 132 F.2d 405; Welch v. Paine, 1 Cir., 120 F.2d 141; Fisher v. Commissioner, 9 Cir., 132 F.2d 383; Smith v. Commissioner, 8 Cir., 131 F.2d 254; and Commissioner v. Lowden, 7 Cir., 131 F.2d 127.

It is conceded that transfers of the corpus to each of the Trusts N, O, P, and Q are gifts of future interests, and we think this is true of the income of these trusts. In none of the trusts were the beneficiaries given the present absolute right to enjoyment of the trust income. In Trusts N and O, in which the minor daughters of the taxpayer were the beneficiaries, the trustee was authorized in its discretion to disburse or accumulate all or any part of the net income during the legal disability of the beneficiaries, who were at the time of the creation of the trusts aged, respectively, seven and ten years. In Trust P for the benefit of taxpayer's wife, the trustee was given the authority in its discretion to distribute or accumulate income during the first ten years of the trust; and in Trust Q the trustee was authorized to distribute or accumulate within its discretion all of the net income without limitation as to time, or until the termination of the trust, twenty-one years after the death of the last survivor of taxpayer's wife and daughters. It follows that in neither of these trusts have the beneficiaries acquired the unconditional right to the present possession and enjoyment of the income from the trust. The right to receive income was dependent upon the exercise of discretion by the trustee, and, so far as receipt of income by any of the beneficiaries was concerned, was postponed until the happening of a future event which may or may not have occurred within the lifetime of any of the beneficiaries. The gifts were clearly gifts of future interests.

The taxpayer, conceding the power in the various trustees to accumulate trust income, as he is compelled to do by the plain terms of the trust instrument, contends, nevertheless, that the beneficiaries under the trusts acquired a present interest in the income of the trusts, because the discretion vested in the trustees to distribute or accumulate income is subject to the control of a court of equity, which may, in proper cases, require the trustees to pay over to the beneficiaries. But conceding that the discretion of the trustee is subject to this control by a court of equity in favor of the beneficiaries, the power of the court in this respect can not be exercised until the occasion for its exercise arises. The right of the beneficiaries to require distribution is still dependent upon a contingency, the happening of future events, which may never occur, and the power of the court and the right of the beneficiaries can not come into existence until those events occur. Moreover, there is nothing in this record to indicate, much less to show, that at the time of the transfers in question the need of the beneficiaries for the use of the income of the trusts for the purpose for which the trusts were created was a present need of the character to permit the intervention of a court of equity to control the trustee's discretion.

Nor do the cases of Smith v. Commissioner, Fisher v. Commissioner, or Commissioner v. Lowden, supra, support the taxpayer's argument. All of these decisions were based upon the holding that the beneficiaries under the terms of the trusts in those cases were entitled to immediate use and enjoyment of the income of the trust property. In none of the trust instruments involved in the cases mentioned was there a provision as there is here permitting the trustee in his discretion to pay over or accumulate income.

With respect to Trust J, the taxpayer apparently claimed before the Commissioner and the Board that the $5,000 transferred to that trust in 1938 was not a gift, but constituted payment of an obligation of the taxpayer, namely, the payment of interest on his demand note of $100,000 which constituted the corpus of that trust. The stipulation of facts in the case does not directly support this contention, reciting merely that in the year in question the taxpayer transferred $5,000 to Trust J.

The Board decided and we think correctly that the taxpayer's promissory note payable to the trustee in Trust J was given without consideration and was not, in the hands of the trustee, an obligation of the taxpayer enforceable against the taxpayer or his estate. This is the rule in Iowa where the taxpayer resided and where the note was made and delivered. Meginnes v. McChesney, 179 Iowa 563, 571, 160 N.W. 50, L.R.A. 1917E, 1060; and see Johnson v. Commissioner, 2 Cir., 86 F.2d 710, 713; and Gilman v. Commissioner, 8 Cir., 53 F.2d 47, 80 A.L.R. 209. Since the taxpayer's note was not a valid obligation, the payment of the $5,000 to the trustee as interest upon the note can not be considered the payment of an obligation. It follows that this transfer was a gift of property to the beneficiaries of Trust J. It is unnecessary to consider whether it should be treated as an addition to principal of the trust estate or as income. It was in either event a gift of a future interest in property, because in neither case did the beneficiaries acquire any right to its immediate enjoyment or possession, the trustee having discretion to distribute or accumulate income.

The decision of the Board of Tax Appeals is affirmed.

FRENCH v. COMMISSIONER OF INTERNAL REVENUE