Morris Trusts v. Commissioner

*20 Respondent determined deficiencies against petitioner in the following amounts:

*21 These deficiencies arise out of respondent's determination that certain trusts created by 10 trust instruments executed by E. S. Morris and Etty Morris on September 11, 1953, constituted two trusts for Federal income tax purposes, rather than 20 trusts as reported. Each notice of deficiency contained the following statement explaining the determination: "It is determined that you constitute a single trust for federal income tax purposes under the provisions of sections 61, 642, 643, 6012 and other applicable provisions of the Internal Revenue Code." After the petitions and answers were filed, respondent filed amended answers alleging that the Estelle Morris Trusts Nos. 401 through 410 and the B. R. *51 Morris Trusts Nos. 401 through 410 together constituted a single trust for Federal income tax purposes for all the years in question and praying that this Court sustain the resulting deficiencies.

The issues presented for decision are: (1) Whether each of the 10 declarations of trust executed by E.S. Morris and Etty Morris on September 11, 1953, created 1 trust or 2 trusts for Federal income tax purposes; and (2) whether, depending on the resolution of issue (1), the trusts created by the 10 declarations of trust are taxable as 1 or 2 trusts as respondent contends, or as 10 or 20 trusts, as petitioner contends, or as some other intermediate number.

FINDINGS OF FACT

Some of the facts have been stipulated and the stipulations and exhibits ^1*52 thereto are incorporated herein by reference.

Nathan Schwartz (hereinafter referred to as petitioner) is the trustee of the Estelle Morris Trusts Nos. 401 through 410 and of the B. R. Morris Trusts Nos. 401 through 410. He was a legal resident of Beverly Hills, Calif., at the time the petitions in these cases were filed. Federal income tax returns for each of the 20 trusts were filed with the district director of internal revenue at Los Angeles, Calif., for each of the years here involved.

E. S. Morris was a successful corporate executive engaged primarily in the furniture-manufacturing business. He also engaged in some real *22 estate investment activities over a period of about 25 years. *53 For a number of years prior to his death in December 1956, E. S. Morris made gifts to his children and grandchildren. Some of these gifts took the form of trusts, established by him and his wife, Etty Morris, for each of their 11 grandchildren. E. S. Morris left an estate valued in excess of $ 500,000.

Barney R. (B. R.) Morris is the son of E. S. and Etty Morris. B. R. Morris and Estelle Morris are husband and wife and in September 1953 had two children: Karen, then age 11, and Richard, then age 8. B. R., Estelle, Karen, and Richard Morris are now living, and B. R. and Estelle have no other children.

On September 11, 1953, E. S. and Etty Morris executed, as trustors (grantors), 10 written instruments, each designated "Declaration of Trust." Each declaration of trust was identical in form, except as to the period for accumulation of income, and the date the trust was to terminate.

There are no number designations, as such, in the trust instruments, but after they were executed they were given number designations, namely, 401 through 410. The trusts were also sometimes further designated Estelle Morris Trusts Nos. 401 through 410 and B. R. Morris Trusts Nos. 401 through 410. These *54 trusts are sometimes herein collectively referred to as Morris Trusts.

The declarations of trust provide that the trustee is to accumulate the income from the trust estate for the life of the primary beneficiaries, Barney R. Morris and Estelle Morris. The trustee is required to distribute income and principal to the primary beneficiaries upon written request of the primary beneficiaries and a showing by the primary beneficiary that he is unable to maintain his accustomed standard of living. The trustee is given the discretionary power to distribute current or accumulated income and principal, in case of emergency, to any beneficiary or issue of any beneficiary.

Each declaration of trust contains the following provisions concerning the construction and administration of the trust estate:

(A) DESIGNATION OF PROPERTY

The Trustee shall apportion the Trust Estate into two (2) equal shares, each of which shall be a separate Trust; one of which shares shall be held, managed and distributed for the benefit of BARNEY R. MORRIS, and the other of which shares shall be held, managed and distributed by the Trustee for the benefit of ESTELLE MORRIS, both of whom are hereinafter referred to as the "Primary *55 Beneficiaries."

* * * ^**70

(E) POWERS OF THE TRUSTEE

* * * *

*23 (25) Though it is the intention of the Trustors that the two shares created by the Trustors for the benefit of the Primary Beneficiaries, and all of the shares created for the benefit of the lawful issue of the Primary Beneficiaries, shall each constitute a separate Trust, nevertheless, for the sake of convenience in acquiring, holding, and managing such shares, the Trustee shall not be required to partition any property of this Trust received by him, but may hold or sell the same jointly for all shares according to their respective interests therein, and similarly, the Trustee may pool or combine the principal of all shares in making investments or re-investments, and the Trustee may hold or sell the same jointly for all shares according to their respective interest therein, assigning or apportioning to each share its interest therein, all as the Trustee, in his discretion, may determine.

Upon the death of a "primary beneficiary" prior to termination of the trust, his or her share is to be added to the share of the surviving primary beneficiary. After the death of both "primary beneficiaries," the trustee is to apportion the share *56 or shares then existing equally among the surviving issue of the "primary beneficiaries," each share thereby created, to constitute a separate trust.

Paragraphs (B)(6)(a), (b), (d), and (e) of each declaration of trust contain provisions concerning the period of accumulation of income and the time for termination of the trust, and provide as follows:

(B) DISTRIBUTION OF INCOME AND PRINCIPAL

(6) Upon the death of both of the Primary Beneficiaries, the Trustee shall apportion the share or shares then existing into as many equal shares as there may be lawful issue surviving the Primary Beneficiaries, per stirpes, each of which shares shall be a separate trust, and which shall be held, managed and distributed by the Trustee for the benefit of each of such issue, as follows:

(a) As to each share, in the event that both of the Primary Beneficiaries have died prior to the expiration of     years from the date hereof, the income from such share shall be accumulated until     years have elapsed from the date hereof and added to the principal of such share until the termination of this Trust as to such share, as hereinafter provided.

(b) As to each share, upon the expiration of the aforesaid    *57 year period, or upon the death of both of the Primary Beneficiaries after the expiration of said     year period, all of the net income of said share shall be distributed to the beneficiary thereof in monthly or other convenient installments, but not less frequently than annually, provided, however, that in no event shall the beneficiary thereof receive an amount in excess of the sum of Two Hundred Fifty Dollars ($ 250.00) per month, and any income in excess of the distribution herein provided, shall be accumulated and added to the principal of such share, until the termination of this Trust as to such share.

* * * *

(d) As to each share, upon the date when the beneficiary thereof attains his or her     birthday, such share shall be distributed to such beneficiary, and upon such distribution, the Trust as to such share shall terminate.

*24 (e) As to each share, in the event of the death of the beneficiary thereof prior to the termination of this Trust as to such share, such share shall be held in trust for the benefit of the living issue then surviving of the beneficiary, per stirpes, and shall be distributed when each of such issue attains his or her 21st birthday, and in the event such *58 beneficiary leave no issue, then such share shall be divided and augment equally the shares of the other lawful issue of the Primary Beneficiaries then surviving, per stirpes, provided, however, that in the event that at such time any of the other lawful issue of the Primary Beneficiaries have not attained his or her     birthday, and is a beneficiary under this Trust, the portion of such share to which such other lawful issue of the Primary Beneficiaries shall be entitled, shall be added to and become a part of the principal of the share held for such issue, and upon such distribution, as aforesaid, the Trust as to such share shall terminate.

Different figures were inserted in the blanks left in the quoted paragraphs as follows:

Each trust is irrevocable and gives the trustee broad investment powers. E. S. Morris was designated trustee in each of the declarations of trust and served in that capacity until his death in December 1956. Thereafter, Etty Morris served as trustee of each of the trusts until she resigned in January 1959. *59 Etty Morris died in March 1959. Leon Kent succeeded Etty Morris as trustee and served until February 1963. Nathan Schwartz succeeded Leon Kent and since February 1963 has been trustee of each of the trusts. Although the declarations of trust provide for trustee's fees, no such fees have been paid since the creation of the trusts.

At the time the trusts were created, E. S. and Etty Morris made initial cash gifts to the trusts, as follows:

These gifts were made on September 11, 1953, by 10 separate checks, each of which was drawn on the personal bank account of E. S. and Etty Morris, and each was made payable to E. S. Morris, trustee, for *25 trusts Nos. 401 through 410, respectively. In addition to the cash gifts, E. S. Morris made loans to the trusts on September 11, 1953, as follows:

These loans were evidenced by promissory notes signed by E. S. Morris, trustee, and payable to E. S. Morris individually. The gifts and loans to the trusts were made from the funds of E. S. and Etty Morris, and trust funds were not *60 provided by anyone else.

On September 17, 1953, 10 separate bank accounts (one for each of the numbered trusts) were opened in the name of E. S. Morris, trustee, and the gifts and loans were deposited therein. Ten sets of printed checks were prepared, one for each account, and each bore the name of the trustee and the individual number of the respective trust.

At all times since the creation of these Morris Trusts in 1953, separate books of account and records have been kept for each numbered trust, 401 through 410. Separate bank accounts have been maintained, separate checks have been used, and separate bank statements have been received for each of the numbered trusts. No separate books and records were kept within each numbered trust for the B. R. Morris and Estelle Morris Trusts.

In each year since the inception of the trusts, 20 separate tax returns -- 10 returns for Estelle Morris Trusts Nos. 401-410 and 10 returns for B. R. Morris Trusts Nos. 401-410 -- have been filed. Separate annual financial statements have been prepared for each numbered trust by Samuel Pop & Co., certified public accountants.

The principal activities of the Morris Trusts since their inception have been *61 the investment in real property and the acquisition of trust deed notes and land sales contracts at discount. At no time have the Morris Trusts been active participants in any operating venture in which B. R. Morris was involved. B. R. Morris and Estelle Morris have never received any sums of money from the trusts nor do they expect to. The trusts have not made loans to each other or otherwise commingled their assets and funds.

At or about the time the Morris Trusts were created, multiple trusts also were created by friends or associates of the Morris family.

On or about September 11, 1953, John S. and Anna S. Zuckerman executed, as trustors, 10 written instruments, each designated "Declaration of Trust." There are no number designations contained in the trust instruments themselves, but after they were executed they *26 were given number designations, namely, 301 through 310. These trusts are sometimes herein collectively referred to as Zuckerman Trusts. The primary beneficiaries of the Zuckerman Trusts, 301, 303 through 308, and 310 are Edward K. Zuckerman, son of John S. and Anna S. Zuckerman, and Ola Zuckerman.

The books and records of trusts Nos. 303 through 310 (the books and *62 records of trusts Nos. 301 and 302 are no longer in existence) indicate that on or about September 11, 1953, John S. Zuckerman made contributions and loans to the Zuckerman Trusts as follows:

On September 1, 1953, Samuel Hayden and Katie Hayden executed, as trustors, 10 written instruments which were designated "Barney B. Hayden Family Trusts Nos. 1 through 10," respectively. These trusts were also sometimes referred to as 201(H) through 210(H). Barney B. Hayden was the primary beneficiary of each of these trusts.

On the same date, Samuel and Katie Hayden also executed, as trustors, 10 written instruments which were designated "Rose Hayden Furstman Family Trusts Nos. 1 through 10." These trusts were also sometimes referred to as trusts Nos. 201(F) through 210(F). Rose Hayden Furstman was the primary beneficiary of these trusts.

Also on September 1, 1953, Samuel and Katie Hayden executed, as trustors, 10 written instruments designated "Yetta Hayden Mintz Family Trusts Nos. 1 through 10," respectively. These trusts were also referred to as trusts Nos. 201(M) through *63 210(M). Yetta Mintz was the primary beneficiary of these trusts. Trusts 201(H) through 210(H), 201(F) through 210(F) and 201(M) through 210(M) are sometimes herein collectively referred to as Hayden Trusts.

Samuel and Katie Hayden are husband and wife, and Barney B. Hayden, Rose Hayden Furstman and Yetta Hayden Mintz are their children.

The books and records of the "Hayden Trusts" indicate that Samuel and Katie Hayden made equal contributions to each series of trusts on September 1, 1953, totaling as follows:

*27 On September 11, 1953, Hattie Levi executed, as trustor, 10 written instruments designated "Trusts Nos. 1 through 10." The trusts were also sometimes referred to as trusts Nos. 101 through 110, or the Levi Trusts. S. Charles Lee and Miriam Lee, husband and wife, are the primary beneficiaries. Hattie Levi is the mother of S. Charles Lee. The books and records of trusts Nos. 101 through 110 indicate that on or before September 11, 1953, Hattie Levi made the following contributions to the trusts:

All the trust *64 instruments creating the Zuckerman, Hayden, and Levi Trusts were similar to the instruments used in creating the Morris Trusts.

In 1953, and for many years prior thereto, B. R. Morris was engaged in the purchase, subdivision, and development of real estate. These activities were conducted primarily through various corporate entities in which B. R. Morris had an interest. Grandview Building Co. (Grandview), a corporation owned equally by B. R. Morris and E. K. Zuckerman, was the principal company through which B. R. Morris conducted his business activities. E. K. Zuckerman and B. R. Morris entered the real estate business together in about 1943, and jointly conducted their business activities until about 1960. They were primarily tract homebuilders and, by 1953, they had constructed approximately 6,000 homes.

In the latter part of 1952, Grandview retained Engineering Service Corp. (Engineering) to study the feasibility of developing certain properties known as the Johnson Ranch. The Johnson Ranch consisted of approximately 1,500 acres of land, divided into two tracts, located in the southwest area of Los Angeles County, Calif. One tract, known as Johnson Ranch *65 No. 1, included approximately 800 acres of land located in three sections: (1) The northeast, northwest, and southwest quarters of section 14, Township 3 South, Range 14 West, Los Angeles County, Calif. (hereinafter referred to as section 14 or section 14 property); (2) section 11; and (3) practically all of a section located due north of section 11. The second tract, known as Johnson Ranch No. 2, was located approximately 2 1/2 miles west of section 14.

*28 Early in 1953, B. R. Morris and E. K. Zuckerman, through entities in which they had an interest, acquired in association with others approximately 700 or 800 acres of the Johnson Ranch from an eastern syndicate. Among those associated with B. R. Morris and E. K. Zuckerman in acquisitions in section 11 of Johnson Ranch No. 1, and in Johnson Ranch No. 2, were S. Charles Lee and Samuel Hayden, business associates primarily engaged in industrial development. At the same time, Grandview acquired for approximately $ 971,000,117 acres in the northern part of section 14 for Van Ness Building Co., a partnership in which Grandview was a partner. S. Charles Lee and Samuel Hayden had no interest in Grandview or Van Ness.

On August 14, 1953, *66 Van Ness requested Engineering to prepare a sketch dividing part of the section 14 property and to prepare legal descriptions thereof. Pursant to that request, Engineering submitted a sketch, dated September 14, 1953, dividing the property into 42 parcels; namely, parcels 1-13, 14A-25A, 14B-25B, C, D, and 26-28.

On September 17, 1953, the Morris, Zuckerman, and Hayden Trusts acquired the following parcels of section 14 property for the following prices:

The Levi Trusts, i.e., trusts Nos. 101-110, acquired parcels 2, 8, 11, 17A, 17B, 18A, 18B, 23A and 23B, and one-fourth undivided interests *29 in parcels 5, 26, 27, 28, C, and D. It is not known which Levi Trust acquired which parcel or the amounts paid.

The section 14 property acquired by the Morris Trusts was carried on their books and records as being owned by trusts Nos. 401, 402, etc. There was no further breakdown between the B. R. Morris Trusts and Estelle Morris Trusts.

A substantial portion of section 14 was less than 47.5 feet above sea level and was subject to periodic flooding. This portion had been declared by an ordinance of Los Angeles County to be unfit for human habitation, which meant that no building permit for residential buildings could be issued in that area. The 117-acre tract purchased by Grandview for Van Ness was largely outside of the area subject to flooding, although a portion located in the southwest corner of this tract was subject to flooding. This tract was also subject to drainage problems, separate and apart from the flooding of section 14.

After the acquisition by Grandview *68 of the 117-acre tract, Engineering continued to perform services for Grandview in the development of its section 14 property. The work done by Engineering was necessary to the development of the 117-acre tract even though it involved and sometimes benefited section 14 property located outside the tract.

Beginning in the latter part of 1953 and continuing into 1955, Engineering performed various services on section 14 property, unrelated to the 117-acre tract, owned by various Morris, Zuckerman, Hayden, and Levi Trusts. This work was performed primarily in the northwest and southwest quarters of section 14 and included: (1) Preparation and submission of tentative maps to the City of Gardena and others; (2) revision of tentative maps; (3) preparation of plans and presentations to the City of Gardena regarding requests for zoning changes; (4) preparation of plans for residential and industrial development; (5) negotiations with the City of Gardena relating to building and inspection fees and street locations; and (6) preparation of engineering studies and plans for grading, filling, and drainage. These activities enhanced the value of the various trust properties, yet the trusts did *69 not pay any portion of the costs of this work.

Between June 17, 1954, and March 22, 1956, the Morris, Zuckerman, and Hayden Trusts sold their interests in the section 14 property. ² Some of the sales were to corporations or partnerships owned or controlled by the primary beneficiaries of the various trusts. The following *30 is a schedule of these sales, the purchasers, and the proceeds (to the nearest dollar) when known: