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Newberry's Estate v. Commissioner of Internal Revenue. Commissioner of Internal Revenue

decided: February 11, 1953.


Author: Hastie

Before GOODRICH, KALODNER and HASTIE, Circuit Judges.

HASTIE, Circuit Judge.

In these petitions for review the taxpayers complain that the Tax Court has improperly applied to the estate of Myrtle H. Newberry, deceased, the provisions of Section 811 (d)(2) of the Internal Revenue Code, 26 U.S.C. ยง 811 (d)(2), that the gross estate shall include any property interest which decedent may have transferred in trust, where, at the time of his death, the enjoyment of that interest was subject to change through exercise by the decedent of a power to alter or revoke. It is admitted that the trusts in controversy gave the decedent until her death such power of alteration. But they were created by transfer of her husband's property under a trust indenture executed solely by him. Nevertheless, the Tax Court, upholding the Commissioner of Internal Revenue, has ruled that in the particular circumstances of this case the decedent may properly be regarded and taxed as the transferor of the trust property within the meaning of Section 811 (d)(2). 17 T.C. 597.

In 1934 both John J. Newberry and his wife, Myrtle H. Newberry, were independently wealthy. Among other holdings, each owned about 50,000 shares of J. J. Newberry Company common stock, then valued at more than $50 per share. The Newberrys were deeply concerned for the future well being of their young children, a son and a daughter, neither of whom had independent means. In 1934 John Newberry created an irrevocable trust of 2500 shares of J. J. Newberry Company common stock for his daughter and a like trust for his son. In 1935 he repeated the process. In each trust he named himself and his wife as trustees and gave Mrs. Newberry alone broad power to alter, amend or terminate the trust, but in no event to revest principal or income in him. Before Mrs. Newberry's death in 1944, this power had been so limited by amendment of each instrument that no more could be done in its exercise than to shift interests among the Newberry issue, spouses of such issue and charities. Other amendments of the trusts were made from time to time but their provisions have no bearing upon this case.

On each occasion when Mr. Newberry executed one of these trusts Mrs. Newberry similarly executed a trust placing 2500 of her shares of J. J. Newberry Company common stock in trust for the same child. In each case she named herself and her husband as trustees and gave him the same powers of alteration as she was granted in the trusts created by him. Each time the husband amended the trusts he had created the wife made identical or equivalent changes in those she had created.

The Tax Court, in its findings of fact, had this to say about the circumstances under which these trusts were established:

"The idea of creating these trusts was first suggested to John J. Newberry by his brother, his business associate. After discussing the matter with his brother, John J. Newberry called in his attorney, with whom he discussed a plan that his brother had suggested. After John J. Newberry had the idea of creating the trusts 'pretty well' fixed in his mind and shortly after he had first discussed it with his attorney he discussed it with his wife. He and she usually talked over matters as important as the trusts. They always handled the affairs of the family mutually. When decedent joined her husband and the attorney in the discussion she said that '* * * if it was a good thing to create these trusts, if John thought it was a good thing to create these trusts for the children, she did, too. She thought it was an excellent idea, and she wanted to do the same thing. She wanted to create the same type of trusts.'

"He suggested the trust idea to her; she was interested right away and thought it was a good plan. Her purpose in creating her two 1935 trusts was the same as his. The decedent never gave any indication that she might not possibly execute the trusts. * * *

"The Newberry children at the time of the creation of the trusts in 1934 and 1935 had no independent means of their own. They were very young and the decedent and her husband did not know what kind of lifemates they might choose. They had a great interest in the children and wished to protect their interest."

In addition, Mr. Newberry was positive in his testimony, and it was in no way rebutted, that he would have created his trusts regardless of whether Mrs. Newberry had decided upon a similar course. He also testified that the property placed in trust represented a small fraction of the wealth of each spouse and that neither of them contemplated any personal benefit or gain from corpus or income of any of the trusts.*fn1 Mr. Newberry testified further and the Tax Court found that powers to shift beneficial interests were incorporated in the trust indentures so as to make sure that no "schemers or ne'er-do-wells" should obtain control of the property in the unhappy event of an unfortunate marriage by either of the children for whose security the trusts were designed.

On this showing the Tax Court reached ultimate factual conclusions that in establishing, and from time to time amending, these trusts "the decedent and her husband were acting as a unit * * * and that the trust instruments were merely part of an interdependent arrangement whereby neither decedent nor her husband would lose control of the amount of the J. J. Newberry Company stock transferred to the trusts until they saw fit to do so". On this basis, the Tax Court ruled that Mrs. Newberry should be regarded as the settlor of the trusts created by her husband as well as the holder of a power to change the enjoyment of the trust estate. Accordingly, the court treated the property in question as part of decedent's gross estate under the requirement of Section 811 (d)(2) that the gross estate include any interests in property over "which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke * * *."

This case decides the taxable status of the trusts in terms created by Mr. Newberry and those only. The narrow question is whether the Tax Court erred in treating Mrs. Newberry as the person who had "made a transfer" of this property in trust within the meaning of Section 811 (d)(2).

Normally taxing authorities and courts administering or applying a statute which taxes to a transferor's estate property he has transferred in trust reserving certain powers to himself have no occasion to go beyond the trust instrument in order to identify the transferor. At times, however, they have gone further. This procedure has been justified as necessary and proper to determine whether the significant shifting of economic interests and the change of dominion and control over property has been different from what the trust instrument itself indicates.*fn2 And if such analysis shows that another than the formal settlor is in reality the transferor, his estate may be taxed accordingly.

The most obviously appropriate occasion for the application of the principle would be presented by a transaction in which one of the formal parties had been essentially a "straw" acting for someone else. Tax consequences, like many other legal and economic consequences of such a transaction, would attach to the real party in interest.*fn3 A like result is clearly proper where, pursuant to a bargain and exchange, one party has given value to another to induce, and in consideration for, the creation of a trust by the second party wherein disposition is made of some beneficial interest as desired by the first party. Indeed, the taxing authorities need do no more than apply considered and accepted doctrine of the law of trusts*fn4 to reach the conclusion that he who pays another for the creation of a trust wherein the payor shall be granted a beneficial interest or a power which he desires may be taxed as one who has transferred property retaining an interest therein. This doctrine has been recognized and applied in a line of cases beginning with Lehman v. Commissioner of Internal Revenue, 2 Cir., 1940, 109 F.2d 99.*fn5 That leading case clearly turned upon the court's reasoning that "the transfer by the decedent's brother, having been paid for and ...

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