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Full Opinion
Under the terms of a 1955 separation agreement between petitioner and his wife, petitioner was to transfer appreciated stock in trust; the trust was to be irrevocable; income from the stock was to go in part to the wife for her support and in part to the children while minors, the remainder to the children after the death of the surviving former spouse. The subsequent decree of divorce approved, incorporated, and directed compliance with and performance of the agreement. The agreement itself survived and was carried out. At the time of the transfer, one child was an adult. Petitioner did not report any gain in connection with the transfer; nor did he file a Federal gift tax return. The statute of limitations has run on any income tax due. Several years later, a Delaware court held that a trust had been created. The decision was affirmed by the Supreme Court of the State of Delaware. During the taxable years 1962, 1964, and 1965, petitioner, as trustee of the trust, received distributions of General Motors divestiture stock from duPont and Christiana Securities. In reporting the income under
*141 These two cases were consolidated for trial, briefing, and opinion. In docket No. 2501-69 the respondent determined deficiencies in the trust's Federal income taxes as follows:
| Taxable year | Deficiency |
| 1962 | $ 2,918.54 |
| 1964 | 36,133.75 |
| 1965 | 49,223.50 |
*142 *136 In docket No. 4013-70 respondent determined a deficiency in Federal gift tax against petitioner Preston Lea Spruance and an addition to tax as follows:
| Addition to tax | ||
| Taxable year | Deficiency | 1 sec. 6651(a) |
| 1955 | $ 93,348.21 | $ 23,337.05 |
We must decide four issues, namely:
(1) Whether Preston Lea Spruance, petitioner in docket No. 4013-70, made a taxable gift when he transferred various stocks in trust for the benefit of his wife and children.
(2) Whether Preston Lea Spruance, petitioner in docket No. 4013-70, is liable for the addition to tax under
(3) Whether Preston Lea Spruance, as the trustee-petitioner in docket No. 2501-69, recognized long-term capital gain in the taxable years 1962, 1964, and 1965 under
(4) Whether the statute of limitations bars assessment and collection of any deficiency *137 in income tax due from Preston Lea Spruance, as the trustee-petitioner in docket No. 2501-69, for the taxable year 1962.
FINDINGS OF FACT
Many of the facts have been stipulated by the parties. The stipulation and supplemental stipulation, together with the exhibits attached thereto, are incorporated herein by this reference.
Preston Lea Spruance (herein called petitioner or Lea) was a legal resident of Wilmington, Del., at the time the petitions were filed in these cases. Also the trust of which he was trustee was situated in Wilmington. As trustee he filed U.S. Fiduciary Income Tax Returns for taxable years 1962, 1964, and 1965 with the district director of internal revenue at Wilmington. He did not file a U.S. Gift Tax Return in 1955 on his own behalf.
Petitioner married Margaret Halsey Spruance (herein called Margaret) on June 25, 1932. They lived in Wilmington and acquired property as tenants by the entirety. Four children were born of their marriage. Preston Lea Spruance, Jr., was born on July 14, 1933. Margaret Grandy Spruance was born on September 20, 1935. William Halsey Spruance was born on August 20, 1938. And Alice Lea Spruance was born on June 3, 1945. As of October *138 28, 1955, they were 22, 20, 17, and 10 years of age, respectively.
*143 Lea was born on September 19, 1910, and on October 28, 1955, was 45 years old. Margaret was born on October 10, 1910, and on October 28, 1955, was also 45 years old.
In 1949, Lea made a gift of 3 shares of Christiana Securities Co. common stock to each of his four children; in 1950 he made a similar gift of 2 shares to his children. In both years he filed U.S. Gift Tax Returns covering the gifts. The value of 1 share of Christiana Securities Co. stock in 1955 was $ 14,600.
During 1953, Lea's four children had an aggregate gross income of $ 6,128.48. In 1954, their gross income amounted to $ 6,285.
On November 29, 1951, Lea and Margaret separated. Margaret then instituted an action for separate maintenance in the Court of Chancery of New Castle County, Del., to compel Lea to support her and three of the children who were minors. She asked for a monthly allowance of $ 2,500. Margaret also brought an action for divorce in the Superior Court of New Castle County, Del.
On July 25, 1955, while the above actions were pending, Lea and Margaret entered in a separation agreement resolving "all matters in controversy between *139 them and relative to their marital and property rights and support of said minor children." 2*141 Paragraph 1 of the agreement provides: "In the event the Wife files an action for divorce against the Husband and a final decree of divorce is granted by a court of competent jurisdiction, the Husband shall make the following payments * * * [summarized below]." The last paragraph (paragraph 15) of the agreement provides: "This agreement shall become effective only if and when a final decree of divorce is granted to the Wife by a court of competent jurisdiction." The agreement also provided in part as follows:
1. Lea was to hold separately the following shares of stock:
| Number of | FMV as of | |
| shares | Stock | 10/28/55 |
| 55 | Christiana Securities Co. (common) | $ 803,000.00 |
| 1,137 | E. I. duPont de Nemours & Co., Inc. (common) | 243,460.13 |
| 48 | Wilmington Trust Co. (common) | 8,640.00 |
| 25 | Christiana Securities Co. (preferred) | 3,475.00 |
| 1,058.575.13 |
*144 2. Within 5 days of the receipt of any cash dividends upon any of such shares, Lea was to pay to Margaret a sum equal to such dividend or dividends.
3. Ten percent of all such dividends payable to Margaret was payable for the support of each minor child so long as the child remained a minor; *140 accordingly, since three of the four children were minors as of October 28, 1955, 30 percent would have had to have been allocated among them as child support. As each child reached majority the amount payable to Margaret for her own support increased so that when the youngest child reached majority, all payments to Margaret were "wife support" payments.
4. If Margaret predeceased Lea, he was to pay an amount equal to the amount of any dividends received from the separately held stock in equal shares to the four children. The share of any minor child was to be placed in trust for such child until he or she reached majority. At Lea's death the separately held stock was to pass under his will to the four children in equal shares.
5. If Lea predeceased Margaret, the separately held stock was to be placed in trust and any dividends upon the stock were to be paid to Margaret during her lifetime. Upon her death the shares were to be transferred to the four children in equal shares.
6. Lea agreed to provide funds for the education of the minor children in the event that his mother failed to continue providing funds for that purpose (as she had provided in the past).
In general, the separation agreement is a highly *142 sophisticated, 15-page document that was prepared by attorneys who understood the tax laws as well as the law of trusts. The provisions calling for Lea to "continue to hold separately" the above-listed shares of stock do not clearly enunciate the parties' intention of creating thereby a trust for the benefit of Margaret and the children.
On July 28, 1955, the Superior Court of New Castle County, Del., granted Margaret, in her action for divorce, a decree nisi.
On October 28, 1955, the Superior Court granted Margaret a final divorce decree. The decree absolute reads in part as follows:
That the said Separation Agreement entered into between the parties on the 25th day of July, A.D. 1955, a copy of which is annexed hereto, hereby incorporated herein by reference, is hereby approved, and the parties hereto are hereby directed to comply with and carry out the terms and provisions thereof.
The separation agreement was not merged into the divorce decree but survived it.
Under Delaware law the divorce court did not have the power to vary the terms of the parties' separation agreement. See
*145 On October *143 29, 1955, 1 day after the granting of the decree absolute, Margaret and Lea entered into a supplemental agreement which provided in part as follows:
1. The Husband shall, on or before December 15, 1955, designate the certificate numbers and issue stop-transfer orders revocable only with the consent of the Wife to the companies and their transfer agents so as to effectually stop any transfer of the following stocks in the following amounts: 55 shares of common stock of Christiana Securities Company. 1,137 shares of common stock of E. I. duPont de Nemours & Company, Inc. 48 shares of common stock of Wilmington Trust Company. 25 shares of preferred stock of Christiana Securities Company.
Lea turned over to Margaret during the remainder of 1955 dividends of $ 14,725 that were received on the separately held stock. Lea reported these dividends and claimed an offsetting alimony deduction for an identical amount on his Federal income tax return for taxable year 1955. In addition, on the same return, he claimed a 4-percent dividends-received credit for these dividends. He did not report any gain resulting from a transfer of the separately *144 held stock. Nor did he indicate that a trust had been created by virtue of the terms of the separation agreement.
Lea's 1955 return was examined by an Internal Revenue Service agent. In connection with the examination, Lea gave the agent a copy of the separation agreement but did not supply a copy of the supplemental agreement. The agent made no adjustment to the dividends item, the alimony deduction item, or the dividends-received credit item on the return.
In 1961, the Supreme Court of the United States, having found in a prior decision that E. I. duPont de Nemours & Co., Inc., had violated the Clayton Act, sec. 2,
In 1962, Congress passed Pub. L. 87-403, 76 Stat. 4, adding
The distribution will be treated as a return of capital, and its full fair market value will reduce the basis of the stock with respect to which it is made. If, however, the fair market value of the stock distributed exceeds the basis of the stock with respect to which the distribution is made, then gain is recognized to the extent of the excess and is taxable as any other gain would be. (This is the same as the income tax treatment of distributions made by corporations which have no earnings and profits.) [S. Rept. No. 1100, 87th Cong., 1st Sess., p. 2 (1961).]
*146 Lea's cost basis for the separately held 1,137 shares of duPont stock and 4,400 shares of Christiana Securities stock (this stock split 80 for 1 on March 10, 1961) totaled $ 92,358. The fair market value of the General Motors stock distributed in 1962, 1964, and 1965, with respect to these two separately held stocks, and other facts of interest, are reflected in the following schedule:
| Cost or | |||
| Stock | Shares | Date | other |
| acquired | basis | ||
| duPont | 1,030 | Feb. 20, 1930 | $ 2,503 |
| Do | 4 | Mar. 5, 1948 | 166 |
| Do | 8 | Jan. 3, 1949 | 365 |
| Do | 12 | Mar. 4, 1949 | 551 |
| Do | 21 | Jan. 3, 1950 | 1,289 |
| Do | 8 | Mar. 2, 1951 | 721 |
| Do | 28 | Jan. 2, 1952 | 2,557 |
| Do | 5 | Mar. 7, 1952 | 437 |
| Do | 5 | Mar. 5, 1953 | 474 |
| Do | 10 | Jan. 4, 1954 | 1,065 |
| Do | 6 | Mar. 3, 1955 | 1,040 |
| Christiana Securities[n2] | 4,400 | Jan. 9, 1935 | 81,190 |
| Total | 92,358 |
| GM shares | FMV of | Reduced | ||
| Stock | received | GM stock | Gain | basis |
| 1962 | received | after 1962 | ||
| distribution | ||||
| duPont | 515 | $ 24,559 | [n1] $ 22,056 | |
| Do | 2 | 95 | $ 71 | |
| Do | 4 | 191 | 174 | |
| Do | 6 | 286 | 265 | |
| Do | 10 1/2 | 501 | 788 | |
| Do | 4 | 191 | 530 | |
| Do | 14 | 668 | 1,889 | |
| Do | 2 1/2 | 119 | 318 | |
| Do | 2 1/2 | 119 | 355 | |
| Do | 5 | 239 | 826 | |
| Do | 3 | 143 | 897 | |
| Christiana Securities[n2] | 1,466 2/3 | 80,392 | 798 | |
| Total | 107,503 | 22,056 |
| Reduced | |||
| Stock | Shares | Date | basis after |
| acquired | 1962 distribution | ||
| duPont | 1,030 | Feb. 20, 1930 | |
| Do | 4 | Mar. 5, 1948 | $ 71 |
| Do | 8 | Jan. 3, 1949 | 174 |
| Do | 12 | Mar. 4, 1949 | 265 |
| Do | 21 | Jan. 3, 1950 | 788 |
| Do | 8 | Mar. 2, 1951 | 530 |
| Do | 28 | Jan. 2, 1952 | 1,889 |
| Do | 5 | Mar. 7, 1952 | 318 |
| Do | 5 | Mar. 5, 1953 | 355 |
| Do | 10 | Jan. 4, 1954 | 826 |
| Do | 6 | Mar. 3, 1955 | 897 |
| Christiana Securities | 4,400 | Jan. 9, 1935 | 798 |
| Total |
| GM | FMV of | Reduced | ||
| Stock | shares | GM stock | Gain | basis after |
| received | received | 1964 distribution | ||
| 1964 | ||||
| duPont | 370.80 | $ 29,293 | $ 29,293 | |
| Do | 1.44 | 114 | 43 | |
| Do | 2.88 | 228 | 54 | |
| Do | 4.32 | 341 | 76 | |
| Do | 7.56 | 597 | $ 181 | |
| Do | 2.88 | 228 | 302 | |
| Do | 10.08 | 796 | 1,093 | |
| Do | 1.80 | 142 | 176 | |
| Do | 1.80 | 142 | 213 | |
| Do | 3.60 | 284 | 542 | |
| Do | 2.16 | 171 | 726 | |
| Christiana Securities | 1,466 2/3 | 115,867 | 115,069 | |
| Total | 148,203 | 144,535 |
| Reduced | |||
| Date | basis | ||
| Stock | Shares | acquired | after |
| 1964 distribution | |||
| duPont | 1,030 | Feb. 20, 1930 | |
| Do | 4 | Mar. 5, 1948 | |
| Do | 8 | Jan. 3, 1949 | |
| Do | 12 | Mar. 4, 1949 | |
| Do | 21 | Jan. 3, 1950 | $ 181 |
| Do | 8 | Mar. 2, 1951 | 302 |
| Do | 28 | Jan. 2, 1952 | 1,093 |
| Do | 5 | Mar. 7, 1952 | 176 |
| Do | 5 | Mar. 5, 1953 | 213 |
| Do | 10 | Jan. 4, 1954 | 542 |
| Do | 6 | Mar. 3, 1955 | 726 |
| Christiana Securities | 4,400 | Jan. 9, 1935 | |
| Total |
| Reduced | ||||
| GM | FMV of | basis | ||
| Stock | shares received | GM stock | Gain | after |
| 1965 | received | 1965 | ||
| distribution | ||||
| duPont | 515 | $ 49,472 | $ 49,472 | |
| Do | 2 | 192 | 192 | |
| Do | 4 | 384 | 384 | |
| Do | 6 | 576 | 576 | |
| Do | 10 1/2 | 1,009 | 828 | |
| Do | 4 | 384 | 82 | |
| Do | 14 | 1,345 | 252 | |
| Do | 2 1/2 | 240 | 64 | |
| Do | 2 1/2 | 240 | 27 | |
| Do | 5 | 480 | $ 62 | |
| Do | 3 | 288 | 738 | |
| Christiana Securities | 1,466 2/3 | 145,017 | 145,017 | |
| Total | 199,627 | 196,894 |
Respondent's *147 figure is $ 22,066.
80 for 1 stock split Mar. 10, 1961.
*147 Lea did not report on his individual returns for 1962, 1964, and 1965 any gain pursuant to
On July 31, 1962, Lea requested the district director of internal revenue in Wilmington, Del., for a ruling as to whether the separation agreement dated July 25, 1955, created a trust and as to the proper tax treatment of the receipt of the General Motors divestiture stock. In connection with his request, Lea forwarded a copy of the separation agreement. He did not forward a copy of the supplemental agreement.
In response to the ruling request, the National Office of the Internal Revenue Service, in a technical advice memorandum dated July 23, 1963, stated (1) that a trust was not created for Federal tax purposes and (2) that for purposes of determining the gain realized by Lea on the 1962 distribution of divested General Motors stock, Lea's basis in the separately held stock was his cost or other basis for such stock. In short, his basis in the stock was not stepped-up by virtue of a prior realization of *148 gain; there was no prior realization; and there had been no transfer.
Lea chose not to follow the technical advice memorandum and filed a U.S. Fiduciary Income Tax Return for 1962 reporting the dividends received on the separately held stock amounting to $ 45,396. He attached to the return a copy of the separation agreement but not a copy of the supplemental agreement. He did not report any gain on the distribution of the General Motors divestiture stock.
On February 28, 1964, Lea filed a complaint in the Court of Chancery of the State of Delaware in and for New Castle County seeking a declaratory judgment as to whether the separation agreement created a trust and whether he, as trustee, held the separately held duPont and Christiana Securities stock in trust for the benefit of Margaret and the four children. He also sought instructions as to the disposition of the General Motors divesture stock. The Court held, on October 29, 1965, that a trust was created and that the divestiture stock should be added to the trust corpus. In his opinion, Vice Chancellor Short said:
I * * * am satisfied that the [Agreement] * * * did, in law, create a trust. I so find in spite of defendant's [Margaret's] *149 contention that no trust was intended. While it appears that the agreement was drawn by able counsel who did not see fit to use the ordinary technical terms creating a trust, it is obvious that all of the essential elements of a trust are here present. By the terms of the agreement plaintiff undertook to hold specified property for the benefit of defendant and their children. The intention was obviously to make a present transfer of the equitable estate with reservation of the legal title in plaintiff. The fact that the trust results from an agreement of the parties rather than by declaration of the plaintiff is of no moment. Neither is his subsequent conduct, *148 in the circumstances presented, sufficient to overcome the fact that a trust was created at the time the agreement was made. Whatever tax consequences may follow from plaintiff's course of conduct following the execution of the agreement is not here in issue. [
This decision was affirmed by the Supreme Court of the State of Delaware on July 28, 1966. Noting that there was a supplemental agreement, the Supreme Court relied upon the fact that the stop-transfer *150 orders, provided for therein, prevented Lea from dealing with the separately held stock as his own property:
In the case at bar all the elements exist to create the relationship known as a trust. Lea has set aside certain securities and by stop-transfer orders has made it impossible for him to deal with them as his own property. He has obligated himself to pass on the dividends received on these securities to his former wife and children. He has obligated himself to provide by will for the ultimate vesting of title to these in his children or their issue. In short, the Agreement divests Lea of any beneficial interest in the corpus, represented by the securities separately held, and has transferred that interest to his wife and children. The fundamental elements of a trust relationship thus exist. [
In a statutory notice of deficiency mailed to Lea, as trustee, respondent determined that Lea, as trustee, recognized long-term capital gain under
| Year | Amount |
| 1962 |