McDonald v. Commissioner

*672 These consolidated proceedings involve a redetermination of a deficiency *254 of $ 418,277.16 in estate tax in Docket No. 30556, and the following deficiencies in income tax in Docket No. 22507:

There is also the further question in Docket No. 22506 of the liability of the petitioners as transferees, which liability is conceded in the event any deficiencies in income tax are determined.

The questions for decision are: (1) whether all or any part of the value at the date of death of the assets of a trust designated D. G. McDonald Trust No. 924, Bank of America National Trust and Savings Association, Trustee (hereinafter sometimes called Trust 924), are includible in the gross estate of decedent, D. G. McDonald; and (2) whether the income from that trust is taxable to decedent in any of the periods involved. For 1944 the subsidiary question is raised of *673 the applicability of the 5-year limitation contained in section 275 (c) of the Internal Revenue Code.

Agreed adjustments can be reflected in a Rule 50 computation.

FINDINGS OF FACT.

The stipulated facts are so found and incorporated herein by reference.

Eileen June McDonald and Eileen June McDonald Thompson is one and the same *255 person. She is the duly appointed and qualified executrix of the estate of D. G. McDonald who died on May 16, 1947, a resident of Hastings, Nebraska. As executrix she filed the estate tax return for said estate with the collector at Omaha, Nebraska.

D. G. McDonald filed his income tax returns for 1944, 1945, and 1946 with the collector for the district of Nebraska. His executrix filed an income tax return for decedent for the period January 1, 1947, to May 16, 1947, with the collector for said district. The 1944 return was filed on March 15, 1945, and reported gross income of $ 47,416.65. ² The statutory notice of deficiencies for said periods was mailed to the executrix on January 17, 1949.

The petitioners in Docket No. 22506 are the duly appointed, qualified, and acting trustees of the trust created under the last will and testament of D. G. McDonald, deceased.

D. G. McDonald, hereinafter sometimes called the decedent, was born March 18, 1885. On January 29, 1912, he married Lenore E. McDonald in Kansas. A few months later they moved to Spokane, Washington, where they stayed less than a year. From Spokane the couple went to *256 Kellogg, Idaho, where they remained for about 5 years. Neither had any property at the time of marriage.

After coming to Kellogg the decedent engaged in the general merchandising business and acquired an interest in several stores in Idaho with his brothers. On or about July 1, 1913, the store in Kellogg in which he was interested was consolidated into the J. C. Penney Co. chain (hereinafter called Penney) as store No. 42. As a result decedent acquired 20 shares of Penney classified common stock. Decedent managed the store and from time to time Lenore worked in the store until March 1917, when they moved to St. Paul, Minnesota.

In St. Paul decedent had supervision of a newly opened buying office for Penney and Lenore entertained buyers and their wives at various times. In January 1922 decedent was transferred to New York where he continued as an executive and became a director of Penney until he severed all connections with that company in 1929. During the period in New York decedent received a salary of $ 10,000 per year.

*674 Penney was incorporated in Utah in 1913 and was changed to a Delaware corporation in 1925. Expansion of the chain during the interim was accomplished through *257 what was called the "Three Generation System." Pursuant to that system each store had its own outstanding classified stock. A store would open with three stockholders, one of whom was the store manager. When the store had enough earnings accumulated it could open a second store, again with three stockholders, the manager of the old store, the manager of the new, and one of the other stockholders of the old store. In turn, store number two could open a third, which would then be owned by the managers of the three stores.

A summary of transactions in Penney classified common stock owned by and held in the name of decedent prepared from the Penney books and records follows:

At least 185 of the above shares were purchased by decedent from other individuals.

In 1925 when Penney became a Delaware corporation the 1,135 shares of classified common stock were converted into the following:

*675 On March 5, 1928, decedent sold 35 of his 635 shares of classified common stock to R. J. Wilker. Decedent bought 60 shares of classified common stock from O. Andreasen (Frankfort, Indiana, store) on April 12, 1925, and 30 shares from R. T. Williams (Bristol, Virginia, store) on March 21, 1928. Decedent paid assessments with respect to the Bristol, Virginia, store on June 11, 1928, and January 2, 1930, in the respective amounts of $ 11,499.24 and $ 2,926.05.

On July 7, 1925, decedent purchased 150 shares *259 of unclassified common stock (expansion stock) at $ 1 a share and on January 2, 1926, he acquired 69 shares of unclassified common stock on conversion of 130 of his classified common shares. He then owned 630 shares (411 + 150 + 69) of unclassified common stock which on January 2, 1927, was split 10 for 1. Unclassified common stock was changed in name only to common stock as of January 2, 1927. From January 2, 1927, to January 2, 1929, decedent acquired 1,362 shares of common stock on conversion of 600 shares, all but 90 shares (Bristol, Virginia, store) of his remaining classified common shares. From June 30, 1927, to April 19, 1929, decedent purchased 512 shares of common stock (expansion stock). He then owned 8,174 shares of common stock.

Decedent received rights to subscribe to two shares of common stock at $ 7 for each share of common held and he exercised those rights on July 11, 1929. He then owned 24,522 (8,174 + 16,348) shares of common stock. From January 2, 1926, to January 2, 1929, decedent acquired 441 shares of Class A 6 per cent preferred stock on conversion of 600 shares of his classified common stock.

Exclusive of any common stock attributable to purchases of classified *260 common stock from O. Andreasen and R. T. Williams, respectively, on April 12, 1925, and March 21, 1928, from January 1, 1925, to January 2, 1930, decedent purchased 19,242 shares of J. C. Penney Co. common stock as follows:

J. C. Penney Co. stock rights issued in 1929 were of record May 10, 1929, and expired July 12, 1929. The price the week ending May 10, 1929, was a high of $ 360 and a low of $ 351. The price the week ending July 12, 1929, was a high of $ 123 and a low of $ 123.

*676 About April 15, 1927, the Chemical National Bank took over the transfer work with respect to the Class A 6 per cent Preferred stock of J. C. Penney Co. From July 6, 1925, down to the time Chemical National Bank took over the transfer work, decedent sold 517 shares of J. *261 C. Penney Company preferred stock.

In July of 1929, after the exercise of stock rights, decedent was the owner of 24,522 shares of common stock of Penney Company and 90 shares of classified common stock which were converted into 882 shares of common stock on January 2, 1930.

In November and December of 1929, decedent sold 3,700 shares of Penney common stock, and sold 500 shares in January and March of 1930, leaving a balance of 21,204 shares of Penney common stock owned by him on November 10, 1930.

After going to New York decedent purchased a home in New Rochelle which was sold for between $ 65,000 and $ 75,000 before a new home was built in Bronxville, New York, in 1926 at a cost of $ 450,000. The new home was paid for out of a joint bank account maintained by decedent and Lenore by checks drawn by Lenore. The money in the account was furnished by decedent. The house contained 22 rooms and was serviced by five servants, including a chauffeur and gardener.

In the fall of 1929 the Bronxville home was sold for $ 180,000, and in the spring of 1930 Lenore and the decedent moved to California. Decedent intended to retire.

The McDonalds had two children, a son, Delos, born December 13, 1914, *262 and a legally adopted daughter, Nedra, born October 2, 1925. The family maintained a high standard of living. Delos attended various schools and traveled extensively with his mother. He had a car. For a period his mother took him to Arizona for his health. Nedra attended private schools, took riding lessons, and also traveled with her mother.

After Lenore and the decedent arrived in California, marital difficulties arose between them which led to their separation in September of 1930 and they never lived together again.

On November 10, 1930, decedent created a trust. An instrument entitled Trust No. 924, Declaration of Trust, Bank of America National Trust and Savings Association to D. G. McDonald was executed on November 10, 1930. The Bank of America National Trust and Savings Association was designated trustee and decedent was designated as trustor and he signed as trustor. In a recital, following decedent's signature, and subscribed to by Lenore as "Wife of Trustor" the following was provided:

I, Lenore E. McDonald, wife of D. G. McDonald, the within named Trustor, hereby join in, ratify and approve the foregoing declaration and agreement *677 and each and every condition thereof *263 and the trust thereunder created and declared and hereby assign to the Trustee and waive, for the purpose of said trust, any community or other interest which I might otherwise assert in or to the property made subject to said trust or which shall at any time in the future be made subject to said trust and to the proceeds thereof.

Decedent transferred 12,000 shares of his Penney common stock to the trust. In the trust instrument the trustee acknowledged receipt from D. G. McDonald of 12,000 shares of common stock of J. C. Penney Co. issued in the name of D. G. McDonald and assigned by him for transfer into the name of the trustee. In Article I the trustee was given the power during continuance of the trust to hold, manage, and control the trust funds and estate and to collect and receive the income therefrom and apply the net income to the uses mentioned in the instrument. The trustee, among other powers, also was given the power to do, in general, any and all things which it should deem for the best interest of the trust and which any individual might or could do if the trust estate were held and managed by him for his own use. Article I further provided:

* * * Notwithstanding any *264 of the provisions in this Article I contained, the Trustee shall not, during the lives of the Trustor and Lenore E. McDonald, wife of the Trustor, sell any of the capital stock of the J. C. Penney Co. deposited in this trust by the Trustor without the joint written direction of the Trustor and Lenore E. McDonald, wife of the Trustor, or if either of them shall be deceased, upon the written direction of the survivor.

Article III of the trust instrument provided that the trustor, with the written consent of the trustee, might at any time during the life of the trust deposit with and convey to the trustee, additional property.

Article V of the trust instrument provided that the trustee should pay all of the net income to Lenore E. McDonald, wife of the trustor, until Delos, son of the trustor, attained the age of 21 years, until Lenore remarried, or until Lenore died. When Delos attained the age of 21, if Lenore was still living and had not remarried, the trustee was to pay $ 3,600 a year to Delos and the remaining net income to Lenore.

If Lenore remarried, the trustee was to pay one-half of the net income to Lenore as long as she should live and so much of the remaining one-half of the *265 net income as should be required for the care, education, and maintenance of Delos, until he attained the age of 25 years. In ascertaining the amount required for the care, education, and maintenance of Delos, it was provided the trustee should consult the trustor during the life of the trustor; and when Delos attained the age of 25 years, the trustee was to pay the remaining one-half of the net income to Delos during the existence of the trust.

After the death of Lenore the trustee was to pay so much of the net income as should be required for the care, education, and maintenance *678 of Delos until he attained the age of 25 years. In ascertaining the amount required the trustee was to consult the trustor. When Delos attained the age of 25 years the trustee was to pay all of the net income to Delos. When he reached the age of 30 years one-half of the principal was to be distributed to Delos, and when he reached the age of 35 years he was to receive the entire remaining trust estate.

If not sooner terminated, the trust was to terminate upon the death of the survivor of Lenore and Delos and the trustee was to distribute the entire trust estate to the issue of Delos, per stirpes, or, in *266 the event of no surviving issue of Delos, to the trustor if living, and if not living to the executor or administrator of the trustor.

Article V (f) provided that:

After the death of the Trustor, the Trustee shall pay from the corpus of the trust estate all State Inheritance Tax and Federal Estate Tax which may be chargeable against this estate or against the gifts, benefits and interests accrued or to accrue under the terms of the trust, it being the intention of the Trustor that each and every gift, benefit and interest shall be delivered to and taken by every beneficiary hereunder in full and without deduction on account of said taxes.

Article VI of the trust agreement read as follows:

The Trustor reserves the right, while he shall be competent to act, and while Lenore E. McDonald, wife of the Trustor, shall be living and competent to act, to change or amend any of the provisions of this trust or any of the trusts hereby created, and also to revoke the trust in whole or in part and take out of the trust and remove from the operation thereof any part or all of the trust estate, provided, however, that any change or amendment of the trust shall be made only by written declaration or agreement, *267 subscribed by the Trustor, Lenore E. McDonald, wife of the Trustor, and by the Trustee, and revocation, either partial or as to the whole trust, shall be by notice in writing, signed by the Trustor and Lenore E. McDonald, wife of the Trustor, and delivered to the Trustee. This trust shall not be subject to amendment or revocation after the death of either the Trustor or Lenore E. McDonald, wife of the Trustor.

Article VII of the trust provided that, in the event of the resignation of the trustee, the trustee should convey the trust property to such trustee as the trustor should designate.

In addition to four dividends paid in 1930 of 75 cents each, a dividend of $ 2.50 on the Penney common stock was paid January 31, 1930.

On November 10, 1930, the market quotation for Penney common stock was a high of $ 36 and a low of $ 34.50.

On November 10, 1930, when the trust was created, decedent hoped for a reconciliation with Lenore, but about Christmas of that year Lenore advised him that she was going to get a divorce. Both were represented by counsel.

Acrimonious negotiations concerning a property settlement and the divorce extended over a period of several months in 1931 leading up to a written *268 agreement between Lenore and decedent executed on November *679 30, 1931, and also to amendment, partial revocation, and addition to Trust 924 by instrument dated November 30, 1931. Lenore was present at only two conferences at which decedent was present and that was at the beginning of the negotiations.

On November 28, 1931, Lenore signed a complaint for divorce which was filed on November 30, 1931. The complaint asserted that a property settlement had theretofore been entered into between the parties and prayed that upon the granting of the decree, the property settlement be embodied in and made a part thereof.

On November 30, 1931, both Lenore and decedent signed the property settlement agreement referred to in the complaint. Lenore was designated party of the first part and decedent party of the second part. They signed separately before different notaries public. Relevant portions of the agreement follow:

Whereas, the parties hereto desire to forever settle and adjust their property rights, both present and future, including division of the community property of the parties, and

Whereas, the parties have agreed upon a full and complete settlement of all property rights including *269 support and maintenance of the party of the first part and their children, and

Whereas, each of the parties, in the negotiations between them resulting in this agreement, has retained his or her own separate, independent legal counsel, and has been fully advised in respect thereto by such counsel,

* * * *

2. The parties hereto agree that Trust No. 924, Bank of America, shall be so revised and amended as to permit the withdrawal therefrom of 5,500 shares of the J. C. Penney Co. stock now subject to said Trust, which said 5,500 shares shall be delivered to first party, free from the provisions of said Trust and shall become and be her sole and separate property. That there shall be added to said Trust by second party hereto an additional 500 shares of said J. C. Penney stock of the same kind, as is now covered by said Trust, making a total number of shares remaining in said Trust of 7,000; that said Trust shall be further revised, changed and modified as set forth in the annexed copy of said Trust No. 924, and the amendment, modification and revision of the same; said original Trust being marked Exhibit "A" and said amendment and revision being marked Exhibit "B", attached to and made *270 a part of this Agreement.

The parties agreed that all the household furniture, furnishings, rugs, carpets, drapes, pictures, and objects of art in the possession of Lenore and the two automobiles and all her jewels in her possession, except three certain rugs and a star sapphire, should be her sole and separate property. The star sapphire without the mounting and the three rugs were to be decedent's.

Paragraph 4 of the agreement provides that it "is expressly understood and agreed that the property transferred and conveyed to first party under this agreement, and under said Amended Trust Agreement," now is and henceforth shall be her sole and separate property, and second party relinquishes any interest which he has or hereafter may acquire in and to said property.

*680 In paragraph 6 of the agreement the parties agree that all property of either party owned or thereafter acquired should be his or her separate and sole property and that each relinquished and released any interest which he or she may have had therein under the law, if the agreement had not been entered into. In paragraph 7 it is provided that each of the parties does relinquish, release, renounce, waive, and give up all interest *271 or claim against the person, property, or estate of the other, "including the right of alimony, support, maintenance, and any and all rights of inheritance which shall be a part of the estate of the other, * * * it being expressly understood that included herein is any community right, right of dower, right of homestead, right of former allowance, or any other right or claim * * *" the parties have or may have.

In paragraph 8 it is provided that the agreement shall not operate as a waiver of the right of either party to maintain an action for divorce; that the agreement is made to adjust the obligations and property rights of the parties; and that "if hereafter in any pending action for divorce between the parties hereto, there shall be made any order or decree of the court, it is agreed between the parties that this contract and agreement may be made a part of such order or decree."

In paragraph 9 it is provided that the care, custody and control of Delos and Nedra shall be given to Lenore, subject to the right of decedent to see and visit with the children at all reasonable times and to have custody during school vacations for at least one-half of the vacation period.

Paragraph 10 reads *272 as follows:

It is also understood and agreed between the parties hereto that the income as received by first party from the Amended Trust created for the benefit of said children shall be the sole and separate property of said first party, said first party being hereby released by the second party of any requirements of accounting therefor; it being, however, understood and agreed between the parties to this agreement that the income payable to the first party under and by virtue of said Amended Trust is paid to said first party for the purpose of supporting, educating and maintaining said children, and in consideration thereof said first party does hereby agree to maintain, educate and support said children and does assume full responsibility for their maintenance, support and education, and said payments of income to said first party shall be in full satisfaction of any and all obligations of said second party for the support, maintenance and education of said children.

Paragraph 12 of the agreement reads as follows:

It is understood and agreed that this settlement is made for the purpose of settling, adjusting and disposing of all rights, duties and obligations of support and maintenance, *273 one to the other, of said parties, and of the aforesaid children, it being understood that Delos McDonald is a natural child of the parties hereto and that Nedra McDonald is an adopted daughter. It is also understood that the divorce and/or remarriage of either of the parties hereto shall not alter, vary, or affect the terms of this settlement in any way or manner except as herein provided.

*681 An interlocutory judgment of divorce was filed on December 7, 1931, which contained the following paragraph:

It is Further Ordered, that the property settlement entered into by and between the parties hereto, as evidenced by Exhibit "1" in this cause, is hereby ratified and approved, and that said property as set forth in said Agreement is and shall belong to the parties as set forth therein, and all of their rights as evidenced thereby, is hereby confirmed and approved; that said Property Settlement, together with the original Trust and the Amended Trust is hereby referred to and made a part of this Decree the same as if set forth in full, and it is ordered by the Court that said Exhibit "1" be annexed to and become a part of this Decree in all of its terms and conditions. That defendant pay to *274 plaintiff as set forth in said Property Settlement, the amount specified therein as attorney's fees or for costs.

On November 30, 1931, an instrument entitled "Amendment To Trust, Partial Revocation Of Trust, And Addition To Trust, Trust No. 924" was executed by decedent, Lenore, and the Bank of America National Trust and Savings Association. The instrument provided that under the exercise of the power of revocation in Article VI of Trust 924 the trustee is directed to withdraw from the trust and deliver to Lenore, wife of the trustor, as her separate property, 5,500 shares of the Penney common stock. The trustee delivered 5,500 shares of the Penney common stock to Lenore. The instrument provided that in the exercise of the right to add additional property, the trustor does hereby transfer and convey to the trustee an additional 500 shares of Penney common stock. There is a notation on page 7 of the instrument reading that the 500 shares "is to be delivered later and when received will be held under the terms hereof." The 500 shares were transferred and conveyed by decedent to the trust on February 6, 1932.

The amended trust agreement added the following to Article I of the original *275 agreement:

So long as any of the capital stock of the said J. C. Penney Company is held in this trust, the Trustee shall vote the said stock or shall execute and deliver proxies therefor in accordance with the written directions executed by the Trustor and the said Lenore E. McDonald during their joint lives, and executed by the survivor of them after the death of either, and delivered to the Trustee.

The amended trust agreement also directed the trustee to hold the trust estate without making any physical segregation except as it deemed necessary or advisable, in the proportions of six-sevenths for the benefit of Delos and one-seventh for the benefit of Nedra. The net income of the share held for the benefit of Delos was distributable to Lenore until Delos attained the age of 21 years; thereafter, and until he attained the age of 25 years, $ 3,600 per year was payable to Delos and the remainder to Lenore. When Delos reached the age of 25 the trustee was to distribute all the net income from his share to Delos and since December 13, 1939, it has been so distributed. The net income of *682 the share held for the benefit of Nedra was distributable to Lenore until Nedra attained the age of *276 18 years on October 2, 1943, and since then all the income from her share has been distributed to Nedra.

The principal of the share of the trust estate held for the benefit of each child is to be distributed to the child for whom it is so held upon his or her attaining the age of 35 years. Article V (f) of the trust instrument, as amended, provides that in the event of the death of either of said children prior to receipt of their respective shares of the principal, the share held for such deceased child is to be distributed as follows:

1. If such deceased child leaves issue surviving, to the Executor or Administrator of the estate of such deceased child to be held and distributed as a part of the said estate.

2. If such deceased child leaves a surviving spouse but no surviving issue, one-third (1/3rd) thereof to the Executor or Administrator of the estate of such deceased child, to be held and distributed as a part of the said estate, one-third (1/3rd) thereof to D. G. McDonald, Trustor herein, and one-third (1/3rd) thereof to the said Lenore E. McDonald.

3. If such deceased child leaves neither a spouse nor issue surviving, one-half (1/2) thereof to the said D. G. McDonald, and one-half *277 (1/2) thereof to the said Leonore E. McDonald.

4. In the event of the prior death of either the said D. G. McDonald or the said Lenore E. McDonald, the share of the principal which such deceased would have taken under any of the provisions hereof shall be added to the share of this trust held for the benefit of the other of the said children of the Trustor and held and distributed as a part of such child's share.

Article V (g) of the amended instrument provided:

The share of any deceased beneficiary in any accrued or undistributed net income as of the date of the death of such beneficiary shall be distributed to the beneficiary entitled to the next successive interest hereunder.

Article XI of the trust instrument added by the amendment of November 30, 1931, is as follows:

D. G. McDonald the Trustor, and Lenore E. McDonald, his wife, agree that the provisions of the trust as hereby amended are made pursuant to the terms of a property settlement settling the rights of the parties; that the income to be paid to the said Lenore E. McDonald from the trusts created for the benefit of the said Delos McDonald and the said Nedra McDonald, respectively, shall be considered as full satisfaction of *278 any and all legal obligation of the said D. G. McDonald for the support and maintenance of the said children; that the said payments of income to said Lenore E. McDonald are for the purpose of supporting, educating and maintaining the said children, and that the said Lenore E. McDonald assumes full responsibility of educating, maintaining and furnishing a home for the said children.

Decedent was the grantor, creator and settlor of Trust 924 and it was his property that was transferred to the trust. Lenore, during the taxable years, had no substantial adverse interest in the corpus or income of the trust or in its disposition.