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Peoples Trust Co. v. United States

decided: June 9, 1971.


Ganey, Van Dusen and Gibbons, Circuit Judges.

Author: Gibbons


GIBBONS, Circuit Judge.

The United States appeals from a judgment of the district court in favor of a taxpayer in an action for a refund. The plaintiff-taxpayer is the corporate executor of the estate of Dora Plume. Dora Plume died on May 5, 1964, survived by her husband. Her executor filed an estate tax return claiming a charitable deduction of $273,231.99, which it claimed was the value of a charitable remainder in an inter vivos trust which Dora Plume had executed on June 9, 1960. Her will poured her residuary estate into this trust. The Commissioner of Internal Revenue disallowed the claimed charitable deduction and assessed a deficiency in estate tax of $54,207.03, plus interest. The taxpayer paid the deficiency, filed timely refund claims for tax and interest and brought suit for a refund. The United States moved for summary judgment, which was denied, and the district court entered summary judgment in favor of the plaintiff. 311 F. Supp. 1197.

The June 9, 1960, inter vivos trust named the settlor as trustee for life and reserved to her a life income. It provided, for purposes herein relevant, that upon her death the successor trustee should pay the income to settlor's husband for his life, and upon his death should pay the corpus to certain named charities, each of which qualifies as a charitable recipient under Section 2055 of the Internal Revenue Code of 1954. 26 U.S.C. § 2055 (1964). The trust instrument provided that the trustee could pay or expend for the benefit of her husband "such part or parts or all of the principal of the Trust Estate as it shall judge to be necessary, in its discretion, to provide adequately for the said husband of the Settlor and for his support, maintenance, health and needs."

The United States contends that the value of the charitable remainder is unascertainable and hence not deductible*fn1 because of certain administrative provisions in the trust instrument which would permit the trustee to divert the corpus of the charitable remainder to the noncharitable life beneficiary. These administrative provisions are:

"[Article] 9. Capital gain dividends derived from mutual fund investments shall be considered to be income and shall be paid to the then income beneficiary in the same manner as general income of the Trust Estate.

"[Article] 10. In addition to all other powers granted to the Trustee by law, the Trustee shall have the following specific powers:

13. To retain, sell, invest and reinvest any or all of the Trust Estate in any real estate, mortgages, stocks, bonds or securities of recognized investment rating, which the Trustee in her discretion shall deem wise, necessary or expedient, not necessarily confining herself to legal investments.

F. To do all acts which the Trustee shall deem advisable without seeking the aid of any court, even though such act may not be appropriate for fiduciaries under any statutory or other rule of law or court, but for this power."

The appellant does not contend in this appeal that the dispositive provisions of the trust, including the power to invade corpus to provide adequately for the support, maintenance, health and needs of the decedent settlor's husband, render the charitable remainder unascertainable.*fn2 Rather, it contends that the administrative power to invest in mutual funds coupled with the administrative direction that mutual fund capital gains distributions shall be treated as income gives to the trustee the uncontrolled power to divert corpus from the remainder interest to the life interest. This occurs, appellant urges, because the shareholder of a mutual fund owns a proportionate interest in the fund's undivided aggregate assets. What he pays for his share is determined by that asset value on the date of purchase. That price reflects unrealized capital appreciation of the fund holdings. When the fund subsequently realizes gain on such appreciation and distributes all or part of the realized gain the effect is a partial return of the purchase price which, if treated as income, depletes corpus.

In an economic sense there is no distinction between the purchase of stock in any corporation having appreciated but unsold assets and the purchase of stock in a mutual fund having such assets. If in the former case the corporation should realize on the appreciated asset, that realization, net after payment of the capital gains tax, would be added to earned surplus and would be available for dividends. N.J. Rev. Stat. § 14A:7-14 (1969); National Newark & Essex Banking Co. v. Durant Motor Co., 124 N.J. Eq. 213, 1 A. 2d 316 (Ch. 1938), aff'd 125 N.J. Eq. 435, 5 A. 2d 767 (E. & A. 1939). Such dividends, received as trust income, would theoretically have the same effect on trust corpus as capital gains distributions. Indeed the purchase price of stock of any corporation may at any given time reflect earnings which have not yet been but may in the future be declared as dividends. To the extent that such earned income is reflected in the purchase price the same theoretical effect on corpus occurs when a dividend is later declared and received as trust income. The appellant does not contend that either possibility makes a charitable remainder unascertainable. Rather, it contends that capital gains distributions of mutual funds present a unique problem because under the governing provisions of the Internal Revenue Code there is a strong incentive on the part of fund managers to pay out rather than reinvest realized capital gains.*fn3 Thus, the appellant argues, investment in mutual funds and the treatment as income of capital gain distributions from such funds, presents to the trustee a unique opportunity to increase distributions to a life beneficiary at the expense of a remainderman.

In response appellee contends, (1) that the court should continue to recognize the distinction, for the purpose of determining the ascertainability of a charitable remainder, between dispositive and administrative provisions in a trust instrument; (2) that the trust instrument reflects no intention on the part of the decedent settlor to favor the life beneficiary over the charitable remainderman; and (3) that the New Jersey law applicable to the trust provides sufficient control over a trustee's exercise of discretion that the possibility of the diversions conjured up by the appellant does not really exist.

Appellee's first contention, that we should look only at dispositive and not at administrative provisions, is foreclosed by this court's decision in Estate of Stewart v. Commissioner of Internal Revenue, 436 F.2d 1281 (3 Cir. 1971). There we held that administrative powers could give a trustee such broad discretion to select investments and to allocate receipts between income and corpus that the charitable remainder would become unascertainable. The Stewart trust instrument was governed by New York law, which we held did not impose any fixed and ascertainable standard to control the conduct of the trustee under its broad language. If in the instant case the trust instrument, construed as it would be in ...

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