2. That Decker
Farms Number 2, a co-partnership, of Jack R. Decker, H. Wayne Decker,
and Ashby S. Decker entered a voluntary appearance in this matter and
disclaimed any and all interest to or claim upon the real property in
issue here; and that Harold W. Brereton and Nica W. Brereton, his wife,
and Wayne Decker and Evelyn S. Decker, his wife, having been regularly
served, and failing to appear and answer have been declared in default.
That there is no indication in the record of service by publication upon
"all other persons unknown, claiming any right, title, estate, lien
or interest in the real property described in the complaint adverse to
plaintiff's ownership or clouding plaintiff's title thereto."
3. That Salt
County assessed drainage district taxes against the real property
described as follows:
165.48 feet South from the center of Section 34, Township 3 South, Range
1 West, Salt Lake Base and
; thence South 150 feet; thence West 186.5 feet; thence North 150 feet;
thence East 186.5 feet to beginning.
the amount of $3.62 for the year 1951.
defendant, Wayne Decker, under a warranty deed dated December, 1953,
from Jack R. Decker, H. Wayne Decker, and Ashby S. Decker and recorded
December 31, 1953, in Book 1057, page 261, of the official records of
the Salt Lake County Recorder, acquired title to that portion of the
subject property described as follows:
165.48 feet South from the Northeast corner of the Southwest 1/4 of
Section 34, Township 3 South, Range 1 West, Salt Lake Base and
, and running thence South 82.74 feet; thence West 170 feet; thence
North 82.74 feet; thence East 170 feet to the place of beginning.
5. That on
August 16, 1954, in the office of the Salk Lake County Recorder, notice
of a federal income tax lien against defendant Wayne Decker dated August
16, 1954, for the years 1942, 1943, 1944, 1945, 1946, and 1947 in the
total amount of $158,064.95 was duly filed for record against defendant
defendant Wayne Decker is the father of Jack R. Decker, H. Wayne Decker,
and Ashby S. Decker. That Jack R. Decker is the husband of LeJeune
Decker and that Wayne Decker is the father-in-law of LeJeune Decker.
That Jack R. Decker is an attorney licensed to practice in the State of
and that as such he acted for his father in connection with his father's
tax and other legal matters. That Wayne Decker had health problems which
had led him to turn all his business affairs over to Jack R. Decker and
to rely upon his son's professional and personal assistance concerning
property and tax matters. That by virtue of the above relationship
through a blood relationship, a professional relationship, and a
business relationship Jack R. Decker was intimately aware of Wayne
Decker's financial and tax status, and that Jack R. Decker stood in a
fiduciary capacity with his father.
sometime prior to May 22, 1956 Jack R. Decker, having theretofore been
informed by the defendant that he saw no way to avoid letting his
property go to the government received a telephone call from his father
telling him that the property the father, Wayne Decker, owned which is
described in Finding 4, was to be sold by Salt Lake County for
delinquent drainage district taxes. The evidence does not disclose what
beyond this was said on that occasion, but the Court believes that
probably something further was said on this or other occasions between
Wayne Decker and Jack R. Decker concerning a plan that might permit
retention of the property in the family but free of the income tax lien.
Jack R. Decker testified in his deposition, on the contrary, that the
purpose of having the property bid in as far as he was concerned was to
induce the government to "execute" upon it. It seems probable
that whatever the real reasons were, it was not believed likely that the
property could be cleared of the tax lien without a substantial payment,
but that the absence of other bidders at the sale due perhaps to the
record tax lien, the failure of the government to check and follow up
the status and its lien in view of the tax sale, and the long period of
time which elapsed before the matter was brought to a head, crystalized
the determination of plaintiff and her husband to retain the property
free of the lien. Notwithstanding uncertainty in the record in the
latter respects, it admits of no doubt that Jack R. Decker and his wife,
LeJeune Decker, discussed the matter and determined between them upon a
plan of action with respect to said property, and that Jack R. Decker
was the dominant factor in the formulation and the execution of this
8. That on May
22, 1956, the real propinvolved herein was conveyed to the plaintiff
LeJeune Decker by tax deed from Salt Lake County, Utah, dated May 22,
1956, and recorded June 4, 1956, in Book 1315, page 374, of the Official
Records of the Salt Lake County Recorder. Consideration for the
conveyance was $4.44 delinquent drainage district taxes, penalties,
interest, and costs. That said property is of the reasonable value of in
excess of $4,000.
LeJeune Decker did not buy as an independent purchaser at a tax sale
but, being unsophisticated in business affairs and land transactions,
her actions in bidding and buying at Salt Lake County tax sale were
directed by her husband and perhaps others in the hope, or for the
express purpose of defeating the income tax lien of the United States,
which hope or purpose also motivated the failure of Wayne Decker and
Jack R. Decker to pay said drainage district taxes.
10. That Jack
Decker was present with LeJeune Decker at the tax sale when she
purchased the land in question, and it is a reasonable inference that he
directed her actions in respect to such sale. That the plaintiff,
LeJeune Decker, in buying the property was agent for her husband Jack R.
11. That the
said Wayne Decker, and his agent and attorney Jack R. Decker, under the
circumstances had the duty to pay said drainage district taxes. That if
the purchase of said property by LeJeune Decker was not with Wayne
Decker's knowledge, express direction and collusion, it was in substance
and reality the act of Jack R. Decker in breach of the fiduciary duty
owed by him to represent his father and to perform his legal duties in
neither the defendant, Wayne Decker, nor the defendant United States of
redeemed from the tax sale.
13. That since
May 22, 1956
, plaintiff or persons claiming under her, having paid all the general
and other state taxes on the property described in Finding of Fact 1
14. That the
defendant, Wayne Decker, had stipulated with the government on January
16, 1956, and on a subsequent occasion on August 16, 1957, which
stipulation replaced the previous one and which remained in force until
about the time of the commencement of this action that:
proponent expressly waived; "The benefit of any statute of
limitations applicable to the assessment and/or collection of the
liability sought to be compromised, and agrees to the suspension of the
running of the statutory period of limitations on assessment and/or
collection for the period during which this offer is pending, or the
period during which any installment remains unpaid, and for 1 year
foregoing Findings of Fact the Court makes the following:
1. That this
Court has jurisdiction of this quiet title action by virtue of 28
C. §2410, and that the Court has jurisdiction of the parties.
2. That the
plaintiff, LeJeune Decker, in buying the property was acting under the
direction of and as agent for ther husband Jack R. Decker. That the said
Wayne Decker and his agent and attorney Jack R. Decker, under the
circumstances, had the duty to pay said drainage district taxes; and
that if the purchase of said property by LeJeune Decker was not with
Wayne Decker's knowledge, express direction, and collusion it was the
act of Jack R. Decker in breach of the fiduciary duty owed by him to
represent his father and to perform his legal duties in the premises.
That in any event the property in question is held in trust by LeJeune
Decker for the father-in-law Wayne Decker. See Hadlock v. Benjamin
Drainage District, 89 Utah 94, 53 P. 2d 1156 (1936), 106 A. L. R.
876; and Free v. Farnsworth, 105 Utah 583, 144 P. 2d 532 (1943);
see also Paxton v. Paxton, 80 Utah 240, 15 P. 2d 1051 (1932).
3. That the
acquisition of said property by the plaintiff, either in collusion or as
an act in breach of a fiduciary duty, was an act which would not cut off
the preexisting federal income tax lien. Hadlock v. Benjamin Drainage
District, supra; Free v. Farnsworth, supra.
4. That no
statute of limitations has run against the lien of the United States.
Mertins, Law of Federal Income Taxation, Vol. 10, §57.41, pp. 80-81. Phillips
v. Commissioner of Internal Revenue [2 USTC ¶743], 283
589, 51 S. Ct. 608, 75 L. Ed. 1289 (1931).
5. That the
lien of the defendant,
United States of America
, against the property described therein continues in full force and
6. That except
for the property covered by the lien of the
the title of plaintiff should be quieted as against all named
judgment should be entered declaring that the lien of the United States
against the land described hereunder be determined prior to and superior
to the claims of plaintiff, with the exception of a first lien in favor
of the plaintiff for the $4.44 which was the amount of her expense at
the County tax sale and interest on that amount at the rate of 6% to
date. That the decree herein should further provide in the absence of
other agreement between the parties for foreclosure of said liens by
sale of the following described real property pursuant to 28 U. S. C.
2410 and other provisions of law:
165.48 feet South from the Northeast corner of the Southwest 1/4 of
Section 34, Township 3 South, Range 1 West, Salt Lake Base and
; and running thence South 82.74 feet; thence West 170 feet; thence
North 82.74 feet; thence East 170 feet to the place of the beginning.
a distribution of the proceeds of said sale shall be made by the United
States Marshal giving first preference to the $4.44 expense of the
plaintiff, LeJeune Decker, together with 6% interest, and the remainder
of the sale price shall be paid to the Secretary of the Treasury or his
delegate to be applied in partial satisfaction of the lien against Wayne
That costs of
suit should be awarded to the
as against LeJeune Decker.
the United States of America shall within fifteen days prepare, serve
and lodge with the Court a proposed form of decree consistent herewith,
for settlement by the Court after notice to the plaintiff, unless
counsel can stipulate for approval as to form.
United States of America
, Plaintiff-Appellant v. United Banks of
, as Trustee of the Trust Created by the Last Will of Carl J. Martinson,
and William Arthur Martinson, Defendants-Appellees
U. S. Court of Appeals, 10th Circuit, No. 75-1273, 542 F2d 819, 10/6/76,
Reversing and remanding District Court decision, 75-1 USTC ¶9218
[Code Sec. 6321]
Lien for taxes: Trust assets: Vested interest: "Property"
subject to lien.--Under state law, the taxpayer's interest in a
trust was a vested interest subject to complete defeasance. Accordingly,
the case had to be reconsidered by the District Court, which had held
that the interest was contingent and thus did not qualify as
"property" or a "right to property" belonging to the
taxpayer at the time of attachment.
Shepherd, James L. Treece, United States Attorney, Denver, Colo., Scott
P. Crampton, Assistant Attorney General, Gilbert E. Andrews, Crombie J.
D. Garrett, Karl Schmeidler, John G. Manning, Department of Justice,
Washington, D. C. 20530, for plaintiff-appellant. Gene W. Reardon,
Reardon, Reardon and Reardon, 2150 First Nat'l Bank Bldg., Denver,
Colo., for defendants-appellees.
Chief Judge, and BREITENSTEIN and MCWILLIAMS, Circuit Judges.
The issue as
posed by the parties is whether the taxpayer's interest in a trust fund
established by his father's will constitutes "property" or
"rights to property" to which a federal tax lien may attach
under Section 6321 of the Internal Revenue Code of 1964. As will be
developed, we view the issue before us to be much narrower. In any
event, the trial court held that the taxpayer's interest under his
father's will did not constitute either "property" or
"rights to property" under Section 6321, and accordingly
granted the trustee's motion for summary judgment. The Opinion and Order
of the trial court is reported as P-H 1975 FED. TAXES (35 Am. Fed. Tax
R. 2d) ¶75-449 (D. Colo. Jan. 17, 1975). The
now appeals the dismissal of its action.
This is a
civil action instituted by the
against the United Banks of Denver, as trustee of the several trusts
created under the last will of Carl J. Martinson, to foreclose an
Internal Revenue tax lien of $142,540.81, plus interest, upon all
property and rights to property belonging to the taxpayer, William
Arthur Martinson, Carl's son. The section of the Code under which the
brought this proceeding appears at 26
C. §6321 and reads as follows:
Lien for taxes
any person liable to pay any tax neglects or refuses to pay the same
after demand, the amount (including any interest, additional amount,
addition to tax, or assessable penalty, together with any costs that may
accrue in addition thereto) shall be a lien in favor of the United
States upon all property and rights to property, whether real or
personal, belonging to such person.
Aug. 16, 1954
, c. 736, 68A Stat. 779. (Emphasis added.)
deficiency which formed the basis of the present action arose out of
unpaid income tax by the taxpayer, William Arthur Martinson, for the
years of 1950 and 1951. The taxpayer was later indicted for willful tax
evasion in 1959. By that time the taxpayer had disappeared, sometime
during 1957, and has not been seen since. Whether he was dead or alive
at the date this proceeding was instituted was not known. However, for
the purposes of the summary judgment hearing before the trial court, it
was assumed that the taxpayer was still alive. In other words the basis
for the trial court's ruling was that, even assuming that the taxpayer
be still alive, his interest under his father's will was not
"property" or a "right to property" under 26 U. S.
C. §6321, and hence was not subject to a tax lien foreclosure
proceeding. The underlying facts are not in dispute.
father, Carl J. Martinson, died in 1969 leaving a will which had been
executed in 1959. In his will the father, after making two minor
bequests of $1,000 each, devised and bequeathed his home and furnishings
to his widow, Mabel Martinson, and then devised and bequeathed the
remainder of his estate to the United Banks of Denver, as trustee, to be
held under the terms of several trusts established by the will.
Three-eighths of the residue of the estate was to be held in the Mabel
Martinson Fund for the use of Mabel, who, incidentally, is the
further provided that should Mabel predecease her husband, two-thirds of
the property which would have gone into the Mabel Martinson Fund should
go into a trust to be known as the William Arthur Martinson (the
taxpayer) Fund. Alternatively, the will provided that should Mabel
survive her husband, on her (Mabel's) death three fourths of the balance
then held in the Mabel Martinson Fund should go to the William Arthur
Martinson Fund. In this latter connection the provision relating to the
William Arthur Martinson Fund reads as follows:
Three-fourths (3/4ths) to my Trustee herein named, IN TRUST,
NEVERTHELESS, which Trust shall be known as the "WILLIAM ARTHUR
MARTINSON FUND", it to pay to my son, WILLIAM ARTHUR MARTINSON,
from the income and from so much of the principal as may be necessary,
the sum of One Thousand Dollars ($1,000.00) a month for so long as he
lives or until said fund is fully paid to him; provided, however, in
event my son, WILLIAM ARTHUR MARTINSON, does not survive me, or
surviving me, dies before receiving the balance of the distribution of
principal and income, then one-third (1/3rd) thereof shall be and become
a part of the "CARL DAVID MARTINSON FUND" hereinabove
provided, one-third (1/3rd) thereof shall be and become a part of the
"CHARLES MARTINSON FUND" hereinafter provided, and one-third
(1/3rd) thereof shall be and become a part of the "ANTHONY
MARTINSON FUND" hereinafter provided.
Carl, the taxpayer's father, died in 1969, and Mabel, Carl's wife,
survived him. Mabel, under applicable
law, renounced the will and elected to take the share allowed her by
law as the surviving widow. COLO. REV. STATS. §153-5-4 (1963). In
connection therewith the state probate court attempted to "equally
compensate" the several trust funds created under Carl's will for
the "losses" caused by Mabel's election. At the time the state
probate court refused to accelerate William's interest under his
father's will. In this latter regard the state probate court decreed as
dominant intent of the Testator was to postpone the enjoyment of the
William Arthur Martinson Fund . . . until the death of Mabel Martinson,
and therefore, the gift . . . should be distributed to the Trustee named
respect to the three-eighths (3/8) of the income derived from the
property held in the trust . . . and belonging to the William Arthur
Martinson Fund, the Court finds that it should not be distributed but
shall be accumulated until the death of Mabel Martinson, and further
finds that there shall be no acceleration of the enjoyment of the
principal and no payments made from the principal or income of the
William Arthur Martinson Fund except as above provided until the death
of Mabel Martinson.
indicated, Mabel Martinson was living and residing in
as of the commencement of the present proceeding, and apparently remains
alive as of the present time. It was in this general setting that the
trial court concluded that William's (the taxpayer's) interest in the
trust created in his name under his father's will did not constitute
"property" or a "right to property" under 26 U. S.
C. §6321, inasmuch as Mabel still survived, and that such being the
case, William's interest was contingent on his outliving his
court reasoned that William's interest in the trust fund was contingent,
not vested, and being contingent, was therefore beyond a creditor's
reach under local
law. Additionally, the trial court held that the taxpayer's interest
being only contingent did not "as a matter of federal law"
qualify as "property" or a "right to property" as
those terms are read in 26 U. S. C. §6321. It was on this general basis
that the trial court granted the trustee's motion for summary judgment
and entered judgment for the trustee.
It is agreed
that the "property rights" of the taxpayer in the instant case
are to be determined as a matter of local Colorado law and that once
William's rights have been thus determined, then resort should be made
to federal law to ascertain whether such constitute "property"
or "rights to property" within the meaning of the federal tax
lien statute. Aquilino v. United States [60-2 USTC ¶9538], 363
509 (1960) and United States v. Bess [58-2 USTC ¶9595], 357
As applied to
the instant case, the foregoing indicates that the trial court quite
properly looked to Colorado law to determine the precise nature of
William's (the taxpayer's) interest in the trust created in his favor
under his father's will. As indicated, the trial court concluded that
law William's interest was contingent, i. e., he had no right to
receive any monies from the trust unless he survived his stepmother,
On appeal we
were uncertain as to whether under Colorado law William's interest in
the trust created in his favor under his father's will is a future
interest subject to a condition precedent or a vested remainder subject
to complete defeasance on the happening of a condition subsequent.
Accordingly, pursuant to the provisions of Colorado Appellate Rule 21.1,
we certified that question to the Colorado Supreme Court. The Colorado
Supreme Court accepted such certification and in an adversary proceeding
in that court, which included additional briefing, held that under
law William's interest in the trust in question is not a future
interest subject to a condition precedent, and therefore contingent, but
on the contrary the taxpayer's interest is a vested interest subject to
complete defeasance. See In Re Question Submitted by the
Court of Appeals for the Tenth Circuit, 553 P. 2d 382 (
determination by the trial court in the instant case that William's
interest was contingent was the keystone of its entire ruling. The
subsequent determination by the Colorado Supreme Court that William's
interest was not contingent, but vested, requires that the case be
remanded to the trial court for reconsideration.
Colorado Supreme Court announced its ruling on our certification, the
trustee filed in this Court a request to file a supplemental brief. In
such supplemental brief the trustee sought to raise a matter which had
not heretofore been presented to this Court and had not been passed on
by the trial court. In such circumstance, the request to file a
supplemental brief is denied. The matter sought to be thus raised should
first be considered by the trial court.
reversed and case remanded for further consideration.
Samuel D. Magavern, As Executor and
Trustee of the Last Will and Testament of Margaret C. Duncan, Deceased,
United States of America
U. S. Court of Appeals, 2nd Circuit, Docket No. 76-6111, 550 F2d 797,
2/24/77, Affirming District Court decision, 76-2 USTC ¶9670, 415 F.
[Code Secs. 6321, 6323, 6331, 7421 and 7426--result unchanged under '76
Tax Reform Act]
Lien for taxes: Levy: Beneficiary's trust interest: State law.--A
divided Court of Appeals sustained a District Court decision that, under
the terms of a trust and applicable state (New York) law, a delinquent
taxpayer had a property right in the income and principal of the trust,
and that the property in the hands of the trustee was therefore subject
to a valid federal tax lien and to a levy based thereon. Although the
taxpayer-beneficiary was not entitled to the income or principal pro
rata, or to any other specific allocation, he had an enforceable
claim on a "reasonable sum" for his "maintenance and
care," and could not be excluded entirely from a trust
distribution. (One Circuit Judge dissented on the grounds that the
trustee's "good faith" payment of a nominal amount, or even of
zero dollars, would satisfy the trust requirement, which was therefore
meaningless; and that the beneficiary's property right was a
non-transferable "blended trust" interest, which neither the
federal government nor any other creditor could reach.) The District
Court was found to have properly applied as authority a decision of the
highest court of the state (
Court of Appeals) in a comparable case, rather than an ex parte
decision of a lower state court with respect to the trust involved in
the instant proceeding.
Magavern, Charles B. Draper, Magavern, Magavern, Lowe, Beilewich &
Dopkins, 20 Cathedral Park, Buffalo, N. Y. 14202, pro se. Richard J.
Arcara, United States Attorney, Buffalo, N. Y. 14202, Scott P. Crampton,
Assistant Attorney General, Alfred S. Lombardi, Gilbert E. Andrews,
Ernest J. Brown, Department of Justice, Washington, D. C. 20530, for
, OAKES and TIMBERS, Circuit Judges.
arises out of the efforts of the Internal Revenue Service to satisfy an
outstanding tax assessment by levying on what it asserts is the
taxpayer's interest in a testamentary trust established by his mother.
The dollar amount being contested is relatively small, the parties
having stipulated that the Government seeks to acquire only
approximately $2,300. The legal issues confronted, however, are
I. Thomas W.
Doran ("Doran"), the taxpayer herein, was deficient in his
federal tax payments for various amounts during 1965, 1966 and
1968-1971, resulting in the assessment against him of federal taxes and
interest in the aggregate amount of $112,753.51. On
November 7, 1974
a total of $108,303.96, plus penalties and interest, remained unpaid. 1
As might be expected, the Government began to seek assets against which
it could levy to satisfy this large unpaid assessment.
against which the Government proceeded is the trust at issue here.
Margaret C. Duncan, Doran's mother, had died in 1965 leaving the residue
of her estate in trust for her husband, her son, Doran, and the children
and grandchildren of Doran. In each of the years from 1968 to 1973,
Doran had received small monetary amounts from the trust. 2
December 5, 1973
, the Government served a notice of levy under §§ 6321 and 6331 of the
Internal Revenue Code ("Code"), 26
C. §§ 6321 and 6331, on the trustee of the trust, appellant herein,
Samuel D. Magavern. The levy purported to cover "all property and
rights to property" belonging to Doran. However, the trustee
refused to honor the levy on the ground that under the terms of the
trust, Doran had no rights in the trust property.
June 27, 1974
, the trustee commenced a proceeding in the Surrogate's
Court of Erie County
, seeking to determine the validity and effect, if any, of the notice of
levy on Doran's beneficial interest in the trust. The Government
appeared specially in the Surrogate's Court, arguing only that the
Surrogate had no jurisdiction to affect the levy. On December 27, 1974
the Surrogate filed a decision holding that he did not have jurisdiction
to "vacate, annul, cancel or discharge" the levy, but that
pursuant to his continuing jurisdiction over Margaret Duncan's Last Will
and Testament he could decided whether or not the trust beneficiaries
had any property rights in the trust. Accordingly, he proceeded to hold
that by the trust's terms the trustee had complete and sole discretion
to withhold the income from any individual member of the family group,
and that as a consequence Doran had no property rights in the trust. In
re Will of
, 80 Misc. 2d 32, 362 N. Y. S. 2d 788 (Surr. Ct. Erie Co., 1974).
On August 23,
1974, while the Surrogate's Court proceeding was still pending, the
trustee commenced the instant action in the Western District of New York
seeking, pursuant of §7426(a) of the Code, 26 U. S. C. §7426(a), to
enjoin enforcement of the levy. Upon announcement of the Surrogate's
decision, the trustee moved for summary judgment on the basis of the
Surrogate's finding that Doran had no right to property in the trust,
and the Government cross-moved for enforcement of the levy. The district
June 8, 1976
, rendered its decision, reported in [76-2 USTC ¶9670] 415 F. Supp.
217. It reasoned that under
law the trust instrument by mandatory language requires the trustee to
pay at least some income to each of the beneficiaries, including Doran,
so that Doran had a right to the trust property which was subject to
levy. Moreover, the district court held that the contrary decision of
the Surrogate's court, though it must be afforded proper regard, was not
binding on a federal court. Judgment was entered for the Government in
the stipulated amount, and the trustee timely brought this appeal.
Internal Revenue Code contains several sections dealing with the use of
federal tax liens to collect unpaid taxes. See Plumb and Wright, Federal
Tax Liens (2d ed. 1967). Section 6321 3
provides that a lien shall attach in favor of the United States on all
property and rights to property of any person who, after demand,
neglects or refuses to pay federal taxes for which he is liable. Section
provides that any person in possession of property or rights subject to
levy must surrender them upon demand of the Secretary or his delegate.
long-established, and conceded by both parties to this case, that in
asserting its federal tax lien, the Government must look to state law
for a determination of what legal rights and interests, if any, comprise
"property and rights to property" to be attached. Aquilino
v. United States [60-2 USTC ¶9538], 363
509 (1960); United States v. Durham Lumber Co. [60-2 USTC ¶9539],
522 (1960); United States v. Bess [58-2 USTC ¶9595], 357
51 (1958). As the Supreme Court stated in Aquilino:
threshold question in this case, as in all cases where the Federal
Government asserts its tax lien, is whether and to what extent the
taxpayer had 'property' or 'rights to property' to which the tax lien
could attach. In answering that question, both federal and state courts
must look to state law, for it has long been the rule that 'in the
application of a federal revenue act, state law controls in determining
the nature of the legal interest which the taxpayer had in the property,
. . . sought to be reached by the statute.' Morgan v. Commissioner
[40-1 USTC ¶9210], 309
78, 82." 363
at 512-13 (footnote omitted).
parties here agree that the question before us is thus whether or not
law Doran had a property interest or right to property in the trust
established by his mother.
the parties' agreement as to the authority of
law does not insure accord as to what that applicable law is, or how the
federal courts should discover it. The trustee strongly urges upon us
that the decision of the Surrogate's Court is binding on the federal
courts. He suggests that under
law the Surrogate's Court, the court which originally probated Mrs.
Duncan's will, has continuing, exclusive jurisdiction over her estate,
including construction of her will. He concludes that the Surrogate's
interpretation of the trust instrument must be considered an in rem
judgment binding for all purposes, in effect prohibiting any varying
interpretations of the language of the will by federal courts.
Supreme Court has conclusively rebutted the trustee's argument. In Commissioner
v. Estate of Bosch [67-2 USTC ¶12,472], 387
456 (1967), the Court decided two cases concerned with the effect a
federal court should give to a decision by a lower state court. In Bosch,
the state court holding concerned the validity of a decedent's release
of a power of appointment over a
trust. The taxpayer had filed a petition in the Supreme Court of New
York to obtain a decision on the validity of the release, which if
declared invalid could have qualified the corpus of the trust for the
federal tax marital deduction, 26 U. S. C. §2056. The state court held
the release a nullity and the United States Tax Court looked on that
decision as binding. A divided panel of this court affirmed, [66-2 USTC
¶12,412] 363 F. 2d 1009 (1966), but the Supreme Court reversed. The
Court explained that a lower state court decision was a significant
factor for a federal court in ascertaining state law, but federal
tribunals should not consider lower state court decisions binding where
the highest state court has not spoken on the point. As Mr. Justice
Clark stated, speaking for the Court:
the application of a federal statute is involved, the decision of a
state trial court as to an underlying issue of state law should a
fortiori not be controlling. This is but an application of the rule
of Erie R. Co. v. Tompkins, [304
64 (1938)], where state law as announced by the highest court of the
State is to be followed. This is not a diversity case but the same
principle may be applied for the same reasons, viz., the
underlying substantive rule involved is based on state law and the
State's highest court is the best authority on its own law." 387
case decided in Bosch further confirms the point. The Supreme
Court there affirmed the opinion of this court in Second National
Bank v. United States [65-2 USTC ¶12,352], 351 F. 2d 489 (1965),
where this court had expressly upheld a federal district court's finding
that "decrees of the Connecticut Probate Court . . . under no
circumstances can be construed as binding and conclusive upon a federal
court in construing and applying the federal revenue laws." 351 F.
2d at 494, aff'g in part [63-2 USTC ¶12,167] 222 F. Supp. 446,
457 (D. Conn. 1963).
tries to avoid the consequences of the holdings in Bosch by
suggesting that the instant case is distinguishable because here the
Government appeared in the Surrogate's Court. But the Government only
appeared specially, solely to contest that court's jurisdiction. It did
not in any way address the merits of the trustee's claim and did not
become a party to the proceedings. Indeed, the Surrogate recognized the
limited purpose of the Government's appearance in ruling that he had no
jurisdiction to affect the tax levy. 80 Misc. 2d at 33-34, 362 N. Y. S.
2d at 790. We are bound by the reasoning in Bosch, and we
conclude that the decision of the Surrogate that Doran had no property
rights in the trust was not binding on the district court.
also provides guidance for a federal court faced, as was the district
court, with a state law question on which the highest state court has
not yet ruled. The directive of the Supreme Court is that
there be no decision by [the highest state] court then federal
authorities must apply what they find to be the state law after giving
'proper regard' to relevant rulings of other courts of the State. In
this respect, it may be said to be, in effect, sitting as a state
district court, a decision by the highest court of New York on the issue
before it being lacking, was thus required to sit "as a state
court" to decide the case as might a state tribunal, giving proper
consideration to the ruling of the Surrogate's Court. Though the
question is not without some doubt, we feel that the district court
properly decided the merits here.
part of Mrs. Duncan's trust provision reads as follows:
This Trust shall be held and administered for the benefit of the family
group consisting of those from time to time living of my husband,
MATTHEW DUNCAN, my son, THOMAS W. DORAN, his children and the issue of
his children. My Trustee shall pay over or use, apply and expend
whatever part or all of the net income or principal (even to the point
of exhaustion thereof), or both, thereof he shall deem proper or
necessary in order to provide comfortable support, maintenance and/or
education (at any level) to the individual members of the said family
group. My Trustee shall not feel bound, in making such payments, uses,
applications or expenditures, to observe any rule or precept of equality
as between the individual members of said family group."
the meaning of these phrases is far from clear, the first sentence sets
out in mandatory terms the trustee's duty to pay over: he "shall
pay . . . whatever part or all of the net income or principal . . . to
the individual members of the said family group" (emphasis
added). The plain meaning of this primary sentence is to direct some
payment to each beneficiary. The following sentence grants the
trustee discretion to divide such payments unequally among the
beneficiaries, but it does not give him the authority to deny a
particular beneficiary anything at all. The trustee's discretion is not
to determine who gets something, but rather to decide how much each is
to be given. To interpret otherwise would allow the subordinate
sentence, designed only to explain the permissible relativity of the
payments, to swallow entirely the mandatory directive language.
Court of Appeals has on only two occasions interpreted trust language at
all similar to that presented here. The trustee relies heavily upon Hamilton
v. Drogo, 241 N. Y. 401 (1926), in which the Court of Appeals held
that a beneficiary of a testamentary trust did not have any right to
income which a creditor could attach. But the will in that case
expressly granted to the trustee uncontrolled discretion to use the
trust income "for the maintenance and support or otherwise, for the
benefit of all or any one or more exclusively of the other or others
of him my said son" (emphasis added).
The Court of
Appeals stressed the importance of this express instruction in
discussing the Drogo case in Sand v. Beach, 270 N. Y. 281,
284-85 (1936). In Sand, the trustee was directed to pay the trust
income "either direct and in person to my nephew . . . or for the
use and benefit of my said nephew and those defendant upon him. . .
." The court reasoned that this directive gave the trustee
discretion to distribute income either to the nephew directly or for the
benefit of the nephew and his dependents. But absent clear language
giving the trustee the choice of withholding all income from the nephew,
he could not choose to deny the nephew any income at all.
district court found after a reasoned consideration of both these cases,
the facts in the instant case are more akin to Sand than they are
to Drogo. The trustee under the
will "shall pay over" what amounts he deems proper "to
the individual members of the . . . group." The trustee is bound to
distribute some trust income to each of the beneficiaries for their
"comfortable support, maintenance and/or education." Nothing
in the will, either expressly or by reasonable implication, allows an
entire deletion of any beneficiary. Nor is the trustee's own action in
making annual payments to Doran from 1968 to October 31, 1973 5
to be ignored. Obviously Doran was considered one of the group regarded
as entitled to some distribution.
law clearly establishes, moreover, that an aggrieved trust beneficiary
can enforce his right to trust property or income against a trustee who
refuses to exercise his discretion as directed in the trust instrument. Matter
, 269 N. Y. 247 (1935); Collister v. Fassitt, 163 N. Y. 281
, 84 N. Y. 321 (1881).
We also note,
though the trustee has not contended otherwise, that the New York Court
of Appeals has included taxes within the definition of the term
"support" in a case involving enforcement of a federal tax
lien against a beneficiary's rights in a spendthrift trust. Matter of
court, after proper consideration of relevant
cases, found that Thomas W. Doran had a right to property in his
mother's trust under
law, a right which can be attached pursuant to the federal tax lien. We
agree with that decision.
The breakdown of this amount was as follows:
Period Type of Tax Assessed Balance
1969 Income 6 6,809.56
(1Q & 2Q) W/H & FICA
(2Q-4Q) W/H & FICA
1965-1971 W/H & FICA
Payments were made to Doran as follows:
1968 ................ $1,500.00
1969 ................ 2,000.00
1970 ................ 1,039.61
1971 ................ 3,000.00
1/1/72-10/31/72 ..... 2,000.00
11/1/72-10/31/73 .... 3,500.00
The Trustee had not paid Doran any trust proceeds from the date of the
levy until Doran's death on
February 19, 1975
. The amount here in issue, stipulated by the parties to be $2,305.50,
is thus the amount allegedly due Doran for the period of
December 5, 1973
(the date of the levy) to the date of his death.
Section 6321, 26
C. §6321, reads as follows:
person liable to pay any tax neglects or refuses to pay the same after
demand, the amount (including any interest, additional amount, addition
to tax, or assessable penalty, together with any costs that may accrue
in addition thereto) shall be a lien in favor of the United States upon
all property and rights to property, whether real or personal, belonging
to such person."
Section 6332, 26
C. §6332, reads as follows:
as otherwise provided in subsection (b), any person in possession of (or
obligated with respect to) property or rights to property subject to
levy upon which a levy has been made shall, upon demand of the Secretary
or his delegate, surrender such property or rights (or discharge such
obligation) to the Secretary or his delegate, except such part of the
property or rights as is, at the time of such demand, subject to an
attachment or execution under any judicial process."
It is significant that annual payments ceased only after the levying of
the Government's tax lien on
December 5, 1973
I agree with
the majority that the decision of the Surrogate's Court in this case is
not binding on the federal courts, but I disagree with its conclusion
that the district court, "sitting as a state court," Commissioner
v. Estate of Bosch [67-2 USTC ¶12,472], 387 U. S. 456, 465 (1967),
correctly construed the trust instrument in light of applicable New York
law. I would therefore reverse.
concludes, as did the court below, that "[t]he trustee is bound to
distribute some trust income to each of the beneficiaries. . .
." Ante at 1951 (emphasis added); see 415 F. Supp. at
220. This question is critical because, if the trustee were held not to
be so bound, that is, if he could withhold payment from any beneficiary
at his discretion, then Mr. Doran, the taxpayer beneficiary here, would
concededly have no state property right in the trust income. Without
such a right, there is nothing to which the Government tax lien may
attach. See 26
C. §§ 6321, 6331; Aquilino v. United States [60-2 USTC ¶9538],
509, 512-14 (1960). Significantly, in reaching their respective
conclusions, neither the majority nor the court below indicates how
much trust income the trustee must distribute to any particular
beneficiary, and indeed no one could do so, since the decision rests
entirely with the trustee under the terms of the trust instrument. The
key sentence directs the trustee to "pay . . . whatever part
or all of the net income or principal . . . he shall deem proper or
necessary . . . to the individual members of the said family
group" (emphasis added).
If this court
and the court below were faced with the problem of determining the
amount of money to which Mr. Doran, the taxpayer, had a claim--and thus
the amount the Government could take via its tax lien--I believe a
different result would be reached from that the parties by stipulation
in effect reached here, agreeing as they have upon the amount the
trustee will pay to the Government if the Government succeeds on the
legal issues. The stipulation, it can be seen, permits the majority
opinion to avoid facing the fact that the amount due from the trustee to
any particular beneficiary is utterly undefinable and thus to avoid
wrestling with the really vital question whether, for example, the
payment of one dollar to Mr. Doran, if that sum were deemed "proper
or necessary" by the trustee, would satisfy the trustee's
obligation to convey, as the majority says, "some" funds from
the trust to each beneficiary.
If it is
conceded--and nothing I can find in the majority opinion is to the
contrary--that a good faith payment of one dollar would satisfy the
trustee's obligation to Mr. Doran, I am puzzled how a good faith
"payment" of zero can be held not to satisfy that obligation.
The difference between zero and one dollar is surely of no consequence
either to Mr. Doran or the Government, and many of the beneficiaries of
the trust here involved, including Mr. Doran himself for years prior to
1968, have accepted the trustee's failure to give them any payments for
several years without, so far as the record indicates, asking a court to
compel him to give them 'some" of the trust income. The trust
instrument on its face certainly seems to give the trustee the option of
deeming zero to be the "proper or necessary" level of funding
for any particular beneficiary.
construction suggested by the words of the instrument and by the
inability of anyone to specify what is owed Mr. Doran is that this trust
is what has been called a "blended trust." G. G. Bogert &
G. T. Bogert, The Law of Trusts and Trustees §230 (2d ed. 1965).
According to the Restatement (Second) of Trusts §161 (1959)
[hereinafter cited as Restatement]:
a trust is created for a group of persons and the interest of one member
of the group is inseparable from the interests of the others, he cannot
transfer his interest and his creditors cannot reach it.
in the twentieth century have apparently always followed the Restatement
view that a creditor cannot reach interests of this sort, even in cases
where, as the majority construes the trust here, the trustee has
"no right . . . totally to exclude any one beneficiary from
benefits . . .." G. G. Bogert & G. T. Bogert, supra, §230,
at 731; see A. W. Scott, The Law of Trusts §155, at 1184
(3d ed. 1967) ("Where a trust is created for the benefit of a
person and the members of his family, . . . [e]ven if he is entitled to
receive part of the income from the trust or to have it applied to his
use, his interest may be so inseparable from that of the members of his
family that it cannot be assigned and his creditors cannot reach
it.") See also id. §161.
here, moreover, is one for "support, maintenance and/or
education," with regard to which a beneficiary has no right to
compel payment by the trustee, see In re Martin's Will, 269 N. Y.
305, 312-13, 199 N. E. 491, 494 (1936); In re Cuff's Will, 118 N.
Y. S. 2d 619, 624 (Sur. Ct. 1953); Restatement §128, Comment e,
and creditors cannot reach the beneficiary's interest, see Ellis v.
Chapman, 165 App. Div. 79, 150 N. Y. S. 673 (1914); Restatement
§154. See also Restatement §182, Comment c. While the claim of
the Government for taxes might be enforceable against the interest of a
sole beneficiary of a trust for support, see Restatement §157(d);
cf. In re Rosenberg, 269 N. Y. 247, 199 N. E. 206 (1935) (federal
tax lien enforceable against beneficiary's interest in spendthrift
trust), cert. denied, 298 U. S. 669 (1936), this rule does not
apply when, as here, there are several beneficiaries with inseparable
interests, see Herzog v. Commissioner [41-1 USTC ¶10,010], 116
F. 2d 591, 594 (2d Cir. 1941) (A. Hand, J.).
The problem of
determining what amount is due Mr. Doran illustrates the soundness of
rule that the courts will not interfere on behalf of a creditor of a
beneficiary with the exercise of the discretion vested in the trustee. Sand
v. Beach, 270 N. Y. 281, 284, 200 N. E. 821, 822 (1936);
v. Drogo, 241 N. Y. 401, 404, 150 N. E. 496, 497 (1926); 26
Colum. L. Rev. 776, 776 (1926); see Restatement §155(1). In the
one case relied on in the majority and district court opinions for the
conclusion that "some" income must be paid out here, Sand
v. Beach, supra, there was no interference with the trustee's
discretion because the judgment debtor had a right "to require
payment to him of the entire net income of the trust fund,"
either directly or through "its application for his use and
benefit." 270 N. Y. at 286, 200 N. E. at 823 (emphasis added). A
case in which the entire trust income must be paid to one beneficiary is
manifestly different from the instant case, in which the most the
majority can say is that "some" unspecified amount of trust
income is due each of several beneficiaries. In the former or Sand v.
Beach situation, it makes sense to require that the defined sum owed
to a single, specific beneficiary be paid to his creditor. Here, where
the trustee has virtually complete discretion to allocate funds among
several beneficiaries, it makes no sense to impose a similar
requirement, since the other beneficiaries, in favor of whom the trustee
might otherwise exercise his discretion, will be the losers--the last
result a settlor would wish.
reached by the majority thus violates the
rule against interfering with a trustee's discretion and is not
supported by the principal case the majority relies upon. The practical
result it seems to countenance, moreover, by which a one dollar payment
would be sufficient but a zero "payment" would not, cannot be
seriously intended by my brothers in the majority, who concededly are
spared having to face the question by a stipulation that may have made
this case appear simpler than it is, but that should not control the
legal result reached. I would reverse the judgment.
Laurence B. Howard, Jr., Petitioner
(and Respondent) v.
United States of America
, Respondent (and Petitioner) and William F. Howard, Trustee, Respondent
Court of Tenn., at
, 566 SW2d 521,
[Code Secs. 6321, 6331 and 6334--result unchanged by '76 Tax Reform Act]
Spendthrift trust: Income interest: Subject to tax lien: State v.
Federal law.--Income from a spendthrift trust was subject to a lien
for the payment of federal taxes. Under federal law, the income right
was a property right reachable by a tax levy. Federal law, and not
state law, determined whether the income was exempt from federal
Sec. 6323--result unchanged by '76 Tax Reform Act]
Tax lien: Notice of: Filing: Legal registration: State v. federal
law.--Two certified notices of tax lien were legaly registered and
admissible as evidence in a state trial. They did not meet the state law
requirements for admissibility, but they were validly filed under
federal law, and federal law was held to be controlling.
Davis, Jr., Elliott Warner Jones, Waller, Lansden, Dortch & Davis,
One Commerce Place, Nashville, Tenn. 37239, for petitioner (and
respondent). Harold D. Hardin, United States Attorney,
, for respondent (and petitioner). M. Carr Ferguson, Assistant Attorney
General, Gilbert E. Andrews, Crombie J. D. Garrett, Carleton D. Powell,
Department of Justice, Washington, D. C. 20530, for respondent (and
petitioner). William F. Howard, pro se.
In this action
of interpleader, the principal inquiry is whether the income from a
spendthrift trust is subject to a lien for the payment of federal taxes.
The last will
and testament of Laurence B. Howard established a residuary trust with
his two sons, Laurence B. Howard, Jr. and William Felder Howard,
designated as income beneficiaries, with income payable quarterly during
their respective lives, and with the trust being terminated upon the
death of the survivor. Item VI(m) reads, in pertinent part, as follows:
the principal nor the income of the trust estates shall be liable for
the debts of any beneficiary nor shall the same be subject to seizure by
attachment, garnishment or execution, nor by any writ of proceeding at
law, in equity, in bankruptcy or receivership; nor shall the
beneficiaries thereof have the right or power to sell, assign, transfer,
pledge, mortgage or in any other manner encumber or anticipate or
dispose of their interest in the trust estates or in the income
agree, and we hold, that this language operates to create a spendthrift
It should be
emphasized that the income beneficiaries do not have the legal title to
the corpus of the trust estate, nor do they have any right to the use or
possession of any part of the corpus. They are purely income
September 24, 1974
, the Nashville District of the Internal Revenue Service served upon
William F. Howard, as trustee, a Notice of Levy reciting an indebtedness
in the sum of $27,068.95 owed by Laurence B. Howard, Jr., for federal
Laurence B. Howard, Jr., disputes the entitlement of the Internal
Revenue Service to levy upon the trust proceeds and makes other defenses
to the claim. 1
Chancellor, after a full evidentiary hearing, concluded that the federal
tax lien attached to the trust income while in the hands of the trustee.
The Court of Appeals "affirm[ed] the abstract legal conclusion of
the Chancellor that the Federal Government is entitled to attach income
from a spendthrift trust in spite of Tennessee Decisions and
Statute" but declined to affirm the Chancellor's award in favor of
the government on the basis of its view that the evidence necessary to
document the government's claim was not competent.
Is the income from a spendthrift trust subject to seizure in
satisfaction of a federal tax lien?
We respond to
the captioned question in the affirmative and thus affirm both the
Chancellor and the Court of Appeals as to this phase of the controversy.
We specify our reasoning in some detail in view of the fact that there
are no guiding precedents under
At first blush
the answer would appear to be determined by Section 26-601, T. C. A.,
which reads as follows:
Grounds for discovery and subjection--The creditor whose
execution has been returned unsatisfied, in whole or in part, may file a
bill in the chancery court against the defendant in the execution, and
any other person or corporation, to compel the discovery of any
property, including stocks, choses in action, or money due to such
defendant, or held in trust for him, except when the trust has been
created by, or the property so held has proceeded from some person other
than the defendant himself, and the trust is declared by will duly
recorded or deed duly registered. Provided, however, that where the
state of Tennessee shall be such judgment creditor, the chancery court
shall have jurisdiction to subject such property to the satisfaction of
the claims of the state, despite the fact that the trust has been
created or the property so held has proceeded from some person other
than the defendant himself and the trust declared by will duly recorded
or deed duly registered.
The history of
this statute is simultaneously significant and interesting. In 1831
abolished imprisonment for debt. 2
As stated in 35
Law Review 319, at 320, "[a]lthough this was entirely in
keeping with the moral sense of Tennesseans at the time, it did have the
effect of eliminating a part of the plaintiff's remedy at law."
decisions are conflicting, the case of Erwin v. Oldham, 14 Tenn.
185 (1834) (decided under the law as it existed prior to the adoption of
Chapter 11, Public Acts of 1832), is clear authority for the proposition
that in the absence of fraud, the court has no power to subject
"stocks, credits, and rights of action" held by a debtor to
the satisfaction of his indebtedness. The Court specifically relied upon
case of Donovan v. Finn, 1 Hopk. Ch. 59, 14 Am. Dec. 531 (N. Y.
1823), as "conclusively settling the point."
By Chapter 11,
Public Acts of 1832, the Tennessee Legislature enacted a statute
patterned after a
act designed to meet Donovan. This statute forms the basis for
Sec. 26-601, T. C. A.
Thus within a
two-year period, a
creditor lost the remedy of imprisonment for debt, but gained the right
to discover assets in equity and subject them to his demands.
equitable remedy was withheld for trust funds when the trust was created
by a third person by recorded will or registered deed. This provision
breathed the breath of life into spendthrift trusts in
. The landmark case is Jourolmon v. Massengill, 86 Tenn. 81, 5 S.
W. 719 (1887).
Court, in an opinion by Justice Lurton, held that the 1832 act was
"a rule of property, and . . . very many such trusts have been
created in reliance upon it."
at 126, 5 S. W. at 734.
proviso of Sec. 26-601, T. C. A., excepts from the application of the
statute cases where the state of
is the judgment creditor. This proviso, with additional language making
it retroactive, was adopted by Chapter 108, Public Acts of 1943, in an
abortive effort to reach the assets of three spendthrift trusts created
for Rogers Caldwell by his parents, in satisfaction of an indebtedness
to the state in an amount in excess of four million dollars. This Court,
in State v. Caldwell, 181
74, 178 S. W. 2d 624 (1944), declared the 1943 amendment "invalid
insofar as it is retrospective in character." The court declared
that the 1832 act was a rule of property and "not an exemption
statute for the benefit of poor debtors."
spendthrift trusts are solidly entrenched in our law and it is clear
that Sec. 26-601 is a rule of property and not an exemption statute.
If we were
dealing solely with
statutory and decisional law, we would be inclined to hold that the
income from spendthrift funds is insulated against the claims of all
creditors, including the Internal Revenue Service; however, such is not
clause 2 of the Constitution of the
contains the Supremacy Clause:
Constitution, and the laws of the United States which shall be made in
pursuance thereof; [and all treaties] shall be the supreme law of the
land; and the judges in every state shall be bound thereby, anything in
the Constitution of laws of any state to the contrary notwithstanding.
paragraph requires that all judges, state and federal, "shall be
bound by oath or affirmation, to support this Constitution."
and collection of federal income taxes are governed by federal laws
deriving their validity from the sixteenth amendment to the federal
constitution. As a general rule, where there is a conflict between state
laws and federal laws, the latter must prevail. United States v.
Dallas National Bank [46-1 USTC ¶9117], 152 F. 2d 582 (5th Cir.
Under 26 U. S.
C. Sec. 6321, it is provided that unpaid federal taxes, after demand
shall be a
lien in favor of the
upon all property and rights to property, whether real or
personal, belonging to such person. (Emphasis supplied).
There is no
exception in favor of income beneficiaries under spendthrift trusts and
most assuredly such income is embraced within the phrase "property
and rights to property."
creates no property rights but merely attaches federally defined
consequences to state created rights. See United States v. Bess
[58-2 USTC ¶9595], 357
1054, 2 L. Ed. 2d 1135 (1958) (construing a similar provision of the
Internal Revenue Code of 1939). State law governs the question of the
existence of "property" or "rights to property" and
the "nature of the legal interest" that the taxpayer has in
the property. Aquilino v. United States [60-2 USTC ¶9538], 363
1277, 4 L. Ed. 2d 1365 (1960).
law, it is essential to the creation of a spendthrift trust that (1)
legal title be vested in the trustee, (2) the gift to the donee be of an
equitable interest in the income, and (3) the trust be active. Robertson
v. Brown, 13
App. 211 (1931). In the instant case these criteria are met; petitioner
as income beneficiary has a vested property right in the income
generated by the trust.
Once we have
made the determination that under
law petitioner owns property or rights to property, federal law takes
over for the purpose of determining whether a lien will attach. United
States v. Bess, supra; Broday v. United States [72-1 USTC ¶9269],
455 F. 2d 1097 (5th Cir. 1972); United States v. Taylor [66-2
USTC ¶9522], 254 F. Supp. 752 (N. D. Cal. 1966).
As we have
heretofore indicated, we are in full accord with petitioner Howard's
position that Sec. 26-601, T. C. A., is not an exemption statute.
, supra. If it were, the results we reach would be no different.
This follows from the established legal proposition that federal law
exclusively governs what is exempt from federal taxation. United
States v. Mitchell [71-1 USTC ¶9451], 403
1763, 29 L. Ed. 2d 406 (1971).
The lien for
federal taxation arises under 26 U. S. C. Sec. 6321 and covers "all
property and rights to property." Levy is governed by Section
6331(a), and exemptions are enumerated in Section 6334(a). 3
Section 6334(c) specifically provides that "no property or rights
to property shall be exempt from levy other than the property
specifically made exempt by subsection (a)."
The fact that
we do not deal with an exemption statute is of no significance. What is
significant is the fact that we deal with "property and rights to
property." The argument of petitioner Howard is precisely the same
as was made by the taxpayer in Leuschner v. First Western Bank and
Trust Company [58-2 USTC ¶9723], 261 F. 2d 705 (9th Cir. 1958). The
Court responded thusly:
the bastion of the claim built up by Leuschner is that he had a property
right to receive this income. . . . It is for the very reason that
Leuschner acquires a property right that the government has the power to
levy thereon. (Emphasis supplied).
F. 2d at 708.
Howard relies upon Meyer v. United States [64-1 USTC ¶9111], 375
233, 84 S. Ct. 318, 11 L. Ed. 2d 293 (1963). But Meyer stands for
the proposition that state law determines what is "property or
rights to property," and generally it is the policy of Congress to
recognize and give effect to state exemption laws. This holding was made
in the context of the applicability of the doctrine of marshaling
assets. The holding is not at variance with the general rule that
federal law determines exemptions from federal taxation.
of the Court of Appeals is fully validated by the cases it cited,
notably United States v. Dallas National Bank, supra; Leuschner v.
First Western Bank and Trust Company, supra; and In re
Rosenberg's Will [35-2 USTC ¶9650], 269 N. Y. 247, 199 N. E. 206
(1935). We fully agree with petitioner that we are not bound by the
decisions of the courts of our sister states nor of the federal system;
however, we respect their decisions and are entitled to follow the
conclusions reached in any well-reasoned opinion irrespective of source.
We affirm the
action of the Chancellor and Court of Appeals and hold that respondent's
share of the income generated by the spendthrift trust may be subjected
to the payment of federal taxes, assuming a proper levy and the
observance of all requisite procedural steps. 4
The Certificates of Assessments
The Court of
Appeals held that the Certificates of Assessments and Payments were not
properly validated or certified under Rule 44.01, Tenn. R. Civ. P.,
because (1) the signature of the Director of the Internal Revenue
Service was affixed thereto by a deputy and (2) there is no provision in
Rule 44.01 for certifying a "true extract."
We dispose of
the latter contention first. Rule 44.01 provides for the proof of an
official record "by a copy attested by the officer having the legal
custody of the record, or by his deputy." We do not think it even
arguable that the right to evidence an official record by the
presentation of a certified copy does not carry with it the right to
certify pertinent parts of the record. If other parts are germane, our
rules contain ample procedures to require their production and
44.01, Tenn. R. Civ. P., official records, if in the custody of any
public official within this state, "may be evidenced by an official
publication thereof or by a copy attested by the officer having the
legal custody of the record, or by his deputy." Clearly, under this
rule the Certificates of Assessments and Payments could have been
certified by Claude A. Kyle, the Director of the
for the Southeast Region, at
, or by his deputy, Dale Crimpley, Branch Chief of the Certification
Branch, who had been designated to sign Kyle's name.
in this case stems from the fact that the Certificates bear the
purported signature of Kyle, affixed by Crimpley, without any indication
that it was so signed. The failure of Crimpley to sign his own name as
Branch Chief, and therefore, as Kyle's "deputy," is
unexplained in the record. While we view this as incredibly sloppy
procedure, under the facts of this case, we hold that these records were
Not only were
the documents certified over an official signature and under an official
seal, but also the government presented these records by a senior
technician employed at the
, who testified that they were made under her supervision and personally
verified by her. Further, the accuracy of these figures is not
challenged. In the last analysis we deal with a formality that should
not be permitted to frustrate the orderly reception in evidence of an
Notice of Tax Liens
notices of tax lien were received in evidence by the Chancellor. Each
was certified by the Deputy Register of
, but neither was acknowledged by an official of the Internal Revenue
Service, and neither was witnessed. Instead, they contained a
certificate over the signature of a Revenue officer. Below the signature
of the Revenue officer appears this notation:
Certificate of officer authorized by law to take acknowledgments is not
essential to the validity of Notice of Federal Tax Lien G. C. M. 26419,
C. B. 1950-51, 125.)
The Court of
Appeals, relying upon Sec. 64-2201, T. C. A., 5
held that these notices were not legally registered and were
inadmissible in evidence. We disagree.
It is true, as
noted by the Court of Appeals, that Haynes v. State, 213 Tenn.
447, 374 S. W. 2d 394 (1964), stands for the general proposition that an
instrument will not be considered legally registered unless acknowledged
by the maker or properly witnessed.
The filing of
tax liens in
is governed by Sec. 64-2110, T. C. A., which reads, in pertinent part,
liens for taxes payable to the
United States of America
and certificates discharging such liens shall be filed in the office of
the register of deeds of the county within which the property subject to
such liens is situated.
It will be
noted that there is no requirement that they be acknowledged or
witnessed--merely that they be filed.
authorization for the filing of tax liens derives its efficacy from
federal statutes, since remedies for the collection of federal taxes
have "always been conceded to be independent of the legislative
action of the States," and the federal statute (now 26 U. S. C.
Sec. 6323[f]) "does not purport to permit the States to prescribe
the form or the contents of that notice." United States v. Union
Central Life Insurance Co., [62-1 USTC ¶9103], 368
291, 293-94, 82 S.Ct. 349, 351, 7 L. Ed. 2d 294, 296-97 (1961). In the
cited case the Court points out that allowing the respective states to
prescribe the form and contents of tax notices would run "counter
to the principle of uniformity which has long been accepted practice in
the field of federal taxation."
at 294, 82
at 351, 7 L. Ed. 2d at 297. See also Atlas Finance Co. v. Wilkerson,
619, 382 S. W. 2d 529 (1964).
held in United States v. Estate of Donelly, 397 U. S. 286, 294,
90 S. Ct. 1083, 1038, 25 L. Ed. 2d 312, 319 (1970):
of Congress are generally to be applied uniformly throughout the country
from the date of their effectiveness onward.
federal law relating to form and contents is contained in 26 U. S. C.
form and content of the notice referred to in subsection (a) shall be
prescribed by the Secretary. Such notice shall be valid notwithstanding
any other provision of law regarding the form or content of a notice
of lien. (Emphasis supplied).
The place of
filing personal property liens is governed by 26 U. S. C. Sec.
6323(f)(1)(A)(ii), which provides that the notice shall be filed
"in one office within the State (or the county, or other
governmental subdivision), as designated by the laws of such State, in
which the property subject to the lien is situated." Sec. 64-2110,
T. C. A. is
's designation. Notices so filed must meet the requirement of federal
law. We hold that such notices need not be acknowledged or witnessed.
Finally, it is
the declared purpose of Sections 64-2110-64-2115, T. C. A., to
"authoriz[e] the filing of notices of liens in accordance with the
provisions of Sections 6321-6326 of the United States Internal Revenue
Code of 1954, and any acts or parts of acts of Congress amendatory
thereof." Sec. 64-2114, T. C. A. This section points unerringly to
federal law and by that law we are bound.
There is for
further consideration the fact that the lien imposed by Sec. 6321 arises
at the time the assessment is made; and, therefore, unlike other liens
its perfection does not depend upon its recordation. In re
Reconstruction, Borough of
, City of
, 11 App. Div. 2d 240, 205 N. Y. S. 2d 125 (1960), aff'd mem.,
12 N. Y. 2d 1051, 190 N. E. 2d 240, 239 N. Y. S. 2d 880 (1963).
The Specific Claims
involves two claims, asserted by the government. One of them was based
on petitioner's ownership of Harding at Harding Car Wash; the other on
his status as a responsible officer of Roman International, Inc.
Involved were unpaid Withholding and Federal Insurance Contribution Act
(FICA) taxes. Separate notices of tax liens were filed in the Register's
May 30, 1974
. A notice of levy was served on the Trustee on
September 24, 1974
, and prior demand had been made upon the Petitioner.
There is a
presumption that tax assessments are valid and the burden is on the
taxpayer to prove that they are erroneous. United States v. Rexach
[73-2 USTC ¶9527], 482 F. 2d 10 (1st Cir. 1973). We agree with the
Chancellor that there is no such proof in the record. Actually the
taxpayer agreed to the assessment against Roman International. We concur
in all factual findings made by the Chancellor and in the conclusion he
The taxes in
question were due and unpaid; assessments were legally made; the
taxpayer had actual notice of the claim and demand for payment had been
made; notices of liens were seasonably filed. We find nothing in this
record that would justify giving relief to this taxpayer. Absent a bona
fide dispute as to tax liability, we do not look with favor upon
technical objections which, if sustained, would frustrate the government
in the collection of tax revenues. This record does not reflect a bona
fide defense to the claims asserted by the government.
This action is
remanded to the Chancery Court at
for the entry of a final order containing the current amount of the tax
liability and such other matters as may be appropriate. The judgment
heretofore entered in chancery will bear interest at the legal rate. All
costs--both those in the trial court and those incident to this
appeal--will be taxed one-half to the
United States of America
and one-half to the Petitioner. The entire judgment and Petitioner's
share of the court costs are payable out of the income of the trust
Simultaneously with the filing of the Complaint, the trustee tendered
into the registry of the court all funds in his hands belonging to
Laurence B. Howard, Jr., and has since paid into court all sums due him
when and as income has accrued. The total so deposited as of the date of
the hearing in Chancery Court was approximately $28,000.00.
Ch. 40, Public Acts of 1831, "An Act to abolish imprisonment for
debt except in cases of fraud." This act would be suspect today--it
prohibited the imprisonment of female debtors under any circumstances.
This section exempts wearing apparel and school books, fuel, provisions,
furniture and personal effects, books and tools of a trade, business or
profession, unemployment benefits, undelivered mail and workmen's
Also in accord with the decision of this Court and the Court of Appeals
is Sec. 157(d) of the Restatement (Second) of Trusts (1959):
"Although a trust is a spendthrift trust or a trust for support,
the interest of the beneficiary can be reached in satisfaction of an
enforceable claim against the beneficiary . . . by the United States or
a State to satisfy a claim against the beneficiary." See also the
Comment on Clause (d).
Sec. 64-2201, T. C. A., provides:
authenticate an instrument for registration, its execution shall be
acknowledged by the maker, or proved by two (2) subscribing witnesses,
Concurring in Part; Dissenting in Part
I concur in
the opinion of the Court in all respects, except its determination that
income from a
spendthrift trust is subject to a federal tax lien.
States Supreme Court has made in clear, I think, that federal law does
not create any property rights or determine the nature, attributes, or
quality of property rights of a taxpayer; instead, it has left that
determination to the several states. Aquilino v. United States
[60-2 USTC ¶9538], 363
1277 (1960); United States v. Bess [58-2 USTC ¶9595], 357
1054 (1958); Morgan v. Commissioner [40-1 USTC ¶9210], 309
78, 60 S. Ct. 424 (1940).
I also think
it clear, as stated in the majority opinion, that under
law the interest of a beneficiary of a spendthrift trust is of such a nature
and quality that it may not be alienated either voluntarily by
the beneficiary-debtor or involuntarily by his creditors; inalienability
is an attribute of such an interest. State v. Caldwell, 181
74, 178 S. W. 2d 624 (1944). Therefore, such a beneficiary, as a debtor
for taxes owed to the United States, does not, insofar as his trust
interest is concerned, own any property or rights to property within the
terms of 26 U. S. C. §63.21. It is not a matter of such a beneficiary
having property which is exempt from the claims of creditors; rather, he
simply has never received from the settlor of the trust any right which
he may alienate or which may be taken from him.
here presented is not answered merely by finding, as does the majority,
that the debtor-taxpayer owns property or rights to property; it is
necessary to go further and ascertain the nature of such property
or rights, i. e., whether it is alienable by the taxpayer. In my view,
the Aquilino decision clearly shows that this determination is
one to be made by state courts based upon state law; it is not
determined by federal statutes and the supremacy clause of the
Constitution has no application.
supra, the taxpayer was a general contractor. The government
asserted its tax lien against an indebtedness allegedly owed by a
property owner to the general contractor. A dispute concerning the
nature and extent of the interest of the taxpayer-contractor ensued.
Certain subcontractors, who had performed work on the job, asserted that
the money actually received by the contractor-taxpayer and his right to
collect amounts still due under the construction contract constituted a
direct trust for the benefit of sub-contractors, and that the only
property rights which the contractor-taxpayer had in the trust were to
bare legal title to any money actually received and a beneficial
interest in so much of the trust proceeds as remain after the claims of
sub-contractors should be settled. The Federal Government, on the other
hand, claimed that the New York State Lien Law merely gave
sub-contractors an ordinary lien, and that the contractor-taxpayer's
property rights encompassed the entire indebtedness of the owner under
the construction contract. In dealing with this problem, the Supreme
threshold question in this case, as in all cases where the Federal
Government asserts its tax lien, is whether and to what extent
the taxpayer had 'property' or 'rights to property' to which the tax
lien could attach. In answering that question, both federal and state
courts must look to state law, for it has long been the rule that 'in
the application of a federal revenue act, state law controls in
determining the nature of the legal interest which the taxpayer
had in the property . . . sought to be reached by (citation omitted).
Thus, as we held two (citation omitted). Thus, aswe held two Terms ago,
Section 3670 'creates no property rights but merely attaches
consequences, federally defined, to rights created under state law . .
.' United States v. Bess, (citation omitted). However, once the
tax lien has attached to the taxpayer's state-created interest, we enter
the province of federal law, which we have consistently held determines
the priority of competing liens asserted against the taxpayer's
'property' or 'rights to property.' (Citations omitted.) The application
of state law in ascertaining the taxpayer's property rights and of
federal law in reconciling the claims of competing lienors is based both
upon logic and sound legal principles. This approach strikes a proper
balance between the legitimate and traditional interest which the State
has in creating and defining the property interests of its citizens, and
the necessity for a uniform administration of the federal revenue
statutes." (Emphasis added.)
conflict [regarding the nature of the contractor-taxpayer's interest]
should not be resolved by this Court, but by the highest court of the
. We cannot say from the opinion of the Court of Appeals that it has
been satisfactorily resolved. We find no discussion in the court's
opinion to indicate the nature of the property rights
possessed by the taxpayer under state law. Nor is the application to be
made of federal law clearly defined. We believe that it is in the
interests of all concerned to have these questions decided by the state
. We therefore vacate the judgment of the Court of Appeals, and remand
the case to that court so that it may ascertain the property interests
of the taxpayer under state law and then dispose of the case according
to established principles of law." (Emphasis added.)
at 1280, 1281.
conclude that Tennessee is free to determine the nature and quality of
the interest of a beneficiary under a Tennessee spendthrift trust; that
for more than 150 years it has been the law of Tennessee as shown by State
v. Caldwell, supra, and other decisions of this Court and by T. C.
A., §26-601, that such a beneficiary has no interest which may be
alienated either voluntarily or involuntarily and thus is of a nature
and quality which cannot be reached by creditors, even the United States
government. Accordingly, I respectfully dissent from that portion of the
majority opinion which is to the contrary.
Mercantile Trust Company v. George
Hofferbert, Collector of Internal Revenue of the
for the District of Maryland
Court of the United States for the District of Maryland, Civil Action
No. 2302, 58 FSupp 701, Filed December 21, 1944
Property subject to lien: Spendthrift trust: Paramount claim for U.
S. taxes.--In a suit to quash notices of lien and warrants of
distraint laid by the Collector against a trustee upon income belonging
to a beneficiary to enforce collection of taxes against him where the
trustee claimed the protection of a decree of the state court by the
terms of which the income was to be held as a spendthrift fund free from
the claims of creditors, it was held that the income from such trust in
the hands of the trustee and payable to such beneficiary may validly be
subjected to the claim of the government under the provisions of Code
Sec. 3670, there being no distinction for tax purposes between
spendthrift trusts established by a donor and those established or
upheld by statutes or judicial decisions. The Court further held that
the Collector's proceedings to collect were not made ineffective because
the trust property was in custodia legis by the State court.
Machen, Alexander Gordon 3rd, 1209 Calvert Bldg., Baltimore 2,
, for plaintiff. Bernard J. Flynn, U. S. Attorney, P. O. Bldg.,
Baltimore 2, Md., for defendant.
substantial question in this case is whether income payable to a
beneficiary under a
spendthrift trust may be subjected to a claim of the federal government
for income taxes due from the beneficiary, while the income is still in
the hands of the trustee before payment to the beneficiary. The question
is presented by a motion to dismiss the trustee's complaint in this
court against the Collector of Internal Revenue to quash or vacate
notices of lien and levy and warrants of distraint laid by the Collector
in the hands of the trustee, and to enjoin the Collector from further
proceedings to enforce collection of the taxes. The motion to dismiss is
based on three separate points: (1) that the complaint fails to state
facts sufficient to constitute a cause of action; (2) that the plaintiff
has an adequate remedy at law and (3) that the court is without
jurisdiction of the subject matter under the express provisions of
section 3653 of the Internal Revenue Code which prohibits the
maintenance of any suit to restrain the collection of an internal
revenue tax. The substance of the complaint may be briefly stated.
Findlay, the mother of the income taxpayer, John V. L. Findlay, died
January 8, 1939
, leaving a will which was probated in the
. In it the testatrix gave to the Mercantile Trust Company of
as Trustee, a certain fund in trust to pay the net income arising
therefrom to her son, John V. L. Findlay, during the term of his natural
life, in monthly instalments, "his receipt alone to be a sufficient
of the will, a copy of which was filed with the complaint, were
ambiguous and uncertain in application with respect to the composition
and amount of the trust fund, and therefore required judicial
construction to determine the respective rights of the life beneficiary
and the residuary legatee under the will. Thereupon the plaintiff, as
executor and trustee under the will, instituted a proceeding in the
Circuit Court No. 2 of
, a Maryland State Court, to which all persons having any interest under
the will were made parties. Pending the proceeding the parties reached a
compromise agreement which was carried out and made effective by decree
of the court by which (1) the court assumed jurisdiction of the
completion of the administration of the trust created by the will, all
further actions of the trustee to be subject to the approval and
supervision of the court; (2) the amount and composition of the trust
fund was stated; and (3) the executor was directed to forthwith transfer
and pay over to itself as trustee the securities and cash constituting
the trust fund, and "that said trustee shall pay the net income
therefrom in monthly instalments to the defendant, John V. L. Findlay,
during his life, and not into the hands of any other person, whether
claiming by his authority or otherwise". (italics supplied) and
(4) that the court retain jurisdiction for the purpose of supervising
the administration of the trust and for the purpose of deciding any
question which may arise in the course thereof.
On July 1,
1944, the Collector laid in the hands of the trustee a notice of lien
and levy advising that there was due and owing from the said John V. L.
Findlay the sum of $1,158.61 federal income taxes for the years 1941,
1942 and 1943, and notifying the trustee that "the property rights
to property, moneys, credits and/or bank deposits then in the
plaintiff's possession and belonging to the said Findlay, and all sums
of money owing from the plaintiff to the said Findlay were thereby
seized and levied upon for payment of the said tax, and demand was made
upon the plaintiff for payment of the said sum of $1,158.61 or for such
lesser sum as the plaintiff might be indebted to the said Findlay".
On the same day the Collector served upon the plaintiff copy of the tax
levy for about the same amount; and again on the same day the Collector
served upon the plaintiff three warrants of distraint to satisfy the
income taxes due. On the 2nd day of August 1944, the Collector again
caused the aforementioned notice of levy, lien and distraint to be
served on the plaintiff.
On these facts
the bill sets up the legal contention that the will of Mary K. Findlay
as construed by the decree of the State Court constituted a
"spendthrift trust for the benefit of the taxpayer, John V. L.
Findlay, and therefore the income arising therefrom is not subject to
attachment or distress levied against Findlay and laid in the hands of
the trustee". In this connection attention is called to decisions
of the Court of Appeals of
that the income from a spendthrift trust cannot validly be subjected to
the claims of creditors. And the complaint further alleges that under
the decree of the State court the trustee is prohibited from paying the
income from the trust estate except to the beneficiary and if the
trustee otherwise pays it over to the Collector, the trustee would be in
contempt of the decree of the State Court. It is then alleged that the
Collector's proper remedy is to file his claim in the State Court and
not levy on the fund in the hands of the trustee. In effect the
complaint takes the position that the accrued income payable in due
course to the beneficiary is not property of the beneficiary until it is
in fact paid to him by the trustee. The complaint further states that
the trustee had in its possession accrued income payable to the
beneficiary in the amount of $449.50 on
July 1, 1944
, and has further received similarly payable income in the amount of
$555.38 up to the time of filing the complaint on
August 9, 1944
by Court Decree]
It may be
observed that, before the decree of the State Court, it is doubtful
whether the language in Mrs. Findlay's will was sufficient to create a
spendthrift trust. Quite similar wording was held insufficient for that
purpose by Judge Soper as District Judge in Dudley's Estate, 3
Fed. (2d) 831, affirmed 7 Fed. (2d) 118. The decree of the State Court
was the result of a family compromise approved by the court. As the
jurisdiction of this court is not based on diverse citizenship (Erie
RR. v. Tompkins, 304 U. S. 64) but on a federal question, and as the
government was not a party to the State Court case, there might have
been some question whether the language of the decree construing the
will as a spendthrift trust, is conclusive here as res adjudicata
of the question. But there is no contention by counsel for the defendant
that the decree of the State Court was collusive, and I take it that it
must be considered binding here. Blair v. Commissioner, 300
5 [37-1 USTC ¶9083].
authority for the Collector's action is to be found in the Internal
Revenue Code, title 26 USCA, ss. 3670, 3678 and 3690 and 3692. Section
3670 reads as follows:
PROPERTY SUBJECT TO LIEN. If any person liable to pay any tax neglects
or refuses to pay the same after demand, the amount (including any
interest, penalty, additional amount, or addition to such tax, together
with any costs that may accrue in addition thereto) shall be a lien in
favor of the United States upon all property and rights to property,
whether real or personal, belonging to such person.
authorizes suit to enforce the lien of the
for taxes, all persons having interest in the property to be made
parties. Section 3690 provides that if any person liable to pay taxes
neglects or refuses to pay the same within ten days after notice and
demand, the Collector may collect the taxes with interest by distraint
and sale of the goods, chattels or effects including stock, securities,
bank accounts and evidences of debt of the delinquent taxpayer. And
section 3710 further provides that any person in possession of property
or rights to property subject to distraint upon which levy has been made
shall upon demand by the Collector surrender the property or rights to
the Collector, and on failure to do so such person shall be personally
liable to the United States in a sum equal to the value of the property
or rights not so surrendered but not exceeding the amount of the tax
(including penalty and interest).
the arguments of counsel, and consideration of their excellent briefs, I
have reached the conclusion that the income under the spendthrift
trust in the hands of the trustee and payable to the beneficiary, when
the notices of lien and levy were given, may validly be subjected to the
claim of the government for the unpaid taxes.
of Spendthrift Trusts]
There is a
large volume of judicial decisions with respect to the validity of
spendthrift trusts in general, and the extent to which, if at all, they
can be subjected to the valid claims of creditors or other persons
having lawful demands upon the beneficiary. A spendthrift trust is in
the nature of a restraint upon alienation. In the English courts it was
decided more than a hundred years ago that the restraint upon alienation
similar to that in a spendthrift trust was invalid. In this country wide
attention to the particular subject was first attracted in 1875 by the
case of Nichols v. Eaton, 91 U. S. 716, in which the opinion by
Mr. Justice Miller stated the view that the restraint, in view of our
general recording statutes giving notice to creditors, should not be
held invalid as a matter of public policy. Subsequently a considerable
number of State Court decisions have followed to the same effect; and in
still other States, the subject matter is controlled by statutes. In
the first case dealing directly with the validity of a spendthrift trust
is Smith v. Towers, 69 Md. 77 (1888). It upheld the validity of
the trust as against creditors of the beneficiary although with a strong
dissent by Chief Judge Alvey and Judge Bryan. In numerous subsequent
cases the court has adhered to the same position, the most recent
decisions being Bauernschmidt v. Safe Deposit and Trust Company of
Baltimore, 176 Md. 351, and Medwedeff v. Fisher, 179 Md. 192.
Against General Creditors]
In some of the
States where the spendthrift trust is held valid as against creditors,
the income of the beneficiary may nevertheless be subjected to the valid
claims of particular classes of persons especially the wife or children
of the beneficiary; but there is yet no such Maryland decision. See Bauernschmidt
v. Safe Deposit and Trust Co., supra; Vol. 4, Md. Law Rev. pp.
417-423. In A. L. I. Restatement of Trusts, s. 157, p. 389, it is
157. Particular Classes of Claimants.
trust is a spendthrift trust or a trust for support, the interest of the
beneficiary can be reached in satisfaction of an enforceable claim
against the beneficiary.
by the wife or child of the beneficiary for support, or by the wife for
for necessary services rendered to the beneficiary or necessary supplies
furnished to him;
for services rendered and materials furnished which preserve or benefit
the interest of the beneficiary.
also Griswold, Spendthrift Trusts, c. 5, p. 289; Scott on Trusts,
Vol. I, s. 157.
It has been
held that the beneficiary's interest in a spendthrift trust, as to both
principal and income, does not pass to his trustee in bankruptcy where
the spendthrift trust is valid by the applicable State decisions. But
this results from the particular provisions of the Bankruptcy Act which
give the trustee in bankruptcy no greater rights than the bankrupt
himself possessed. Eaton v. Boston Trust Co., 240 U. S. 427; Medwedeff
v. Fisher, 179 Md. 192, 196; Suskind & Berry v. Rumley,
4th Cir. 37 Fed. (2d) 304.
been only a very few judicial decisions dealing with the enforceability
of federal tax claims against the income from a spendthrift trust. The
first and still the leading case upon the subject is Re Rosenberg,
269 N. Y. 247, cert. den. 298
669. There, a New York statute exempted 90 per cent of the spendthrift
trust income from the claims of creditors, but the court held that the
whole income was subject to the claims of the United States under the
same federal statute here relied on (s 3670). (See also U. S. v.
Guaranty Trust Co. of New York, 2d Cir. 76 Fed. (2d) 747 [35-1 USTC
¶9274]). In United States v. City of
, S. C., 4th Cir. 118 Fed. (2d) 963, 965 [41-1 USTC ¶9381], in
speaking of a claim of the government for income taxes, Judge Parker
said: "Nor can it be affected by homestead, spendthrift trust or
stock transfer acts of the states", citing among other cases the
case, supra. In
v. Canfield, D. C. Cal. 29 Fed. Supp. 734 [39-2 USTC ¶9641],
the taxpayer, one Canfield, was the beneficiary of a spendthrift trust
which was held reachable by the
case was again cited favorably for the proposition. A state statute was
again involved. See Canfield v. Security-First National Bank, 13
2d. 1, 12; 87 P. 2d. 831. United States v.
Nat. Bank, (D. C. Texas) 56 Fed. Supp. 181 [44-2 USTC ¶9426], is
apparently to the contrary, but it will be noted from the brief opinion
that the question was also complicated by the apparent invalidity of the
tax assessment. Counsel inform me that the case is now pending on
appeal. With the exception of this last mentioned case, there seems to
be no prior reported judicial decision with respect to the impact of
federal taxes on a spendthrift trust valid under the State law
unaffected by a State statute. The reasons which have actuated some
courts, as in Maryland, to uphold spendthrift trusts against the claims
of creditors do not necessarily apply to tax claims of the government
either federal or State. Griswold, supra, s. 342, p. 302. The
public policy involved is quite different. In the one case the donor of
the property has the right to protect the beneficiary against his own
voluntary improvident or financial misfortune; but in the other the
public interest is directly affected with respect to collection of taxes
for the support of the government. The imposition of the tax burden is
not voluntary by the beneficiary. In a sense the property itself incurs
the tax; or rather the property is held cum onere.
Distinction of Types]
the plaintiff concedes the correctness of the decision in the
case and others that have followed it where state exemption statutes
were involved, but contends they do not apply to the instant case where
the spendthrift trust was created by the voluntary will of the donor. It
is said that in the latter case a rule of property is involved, entirely
separate and apart from any statute; and that in making the gift the
donor had the absolute right to impose limitations on the application of
the income. See State of
, 178 S. W. 2d. 624; 151 A. L. R. 1410, 1422. But I am unable to
concur in the soundness of the distinction sought to be made. Public
policy is the determining factor whether the restraint on alienation
involved in a spendthrift trust is upheld by statute or judicial
decision. In the one case the public policy is expressed by the
Legislature of the State and the other by its courts. If, as is
conceded, the public policy of the State expressed in a statute must
yield to federal taxes, so also must trust instruments created by a
donor. In many States spendthrift trusts are not validated either by
judicial decision or by statute; but federal income taxes are intended
to be uniform in their application throughout the Nation. (See Lyeth
v. Hoey, 305
188 [38-2 USTC ¶9602].) The invalidity of the attempted distinction
between the effect of statutes and judicial decisions is aptly expressed
by Professor Griswold in his text book on Spendthrift Trusts, p.
306, as follows:
case involves an interest made inalienable by a statute rather than as a
result of an express provision in the terms of the trust. But the same
result should follow in either case. In either event, spendthrift trusts
exist because of policy and not because of logic. If the policy declared
by the legislature yields to a claim for taxes, the declarations of the
settlor should be no more effective. In the quotation from the
opinion set out above, the court refers to the
statutory restraint as an exemption law. This was in accordance with
previous decisions in
. The consequence is no different if the exemption is obtained from the
terms of the trust rather than from statute. The state is not an
ordinary creditor, and its claims should not be made dependent on the
will of a former owner of the property.
to such general exemptions as the state sees fit to grant to all
taxpayers, all property should be equally subject to tax claims. There
is no reason for granting to the beneficiaries of trusts an immunity not
shared by the other owners of property.
also for somewhat analogous situations in which the government is
entitled to reach the income from a spendthrift's trust, Griswold,
ss. 343-344, and Scott on Trusts, Vol. I, s. 157.4.
[Although in Court's Custody]
the plaintiff also argues that the notice of levy, lien and distraint
should be vacated because the spendthrift trust constitutes property now
in custodia legis by the State court. This proposition is at
least doubtful. Commonwealth Co. v. Bradford, 297
v. Art Students League, 4th Cir. 37 Fed. (2d) 225: Compare
v. Swink (D. C. Va.) 41 Fed. Supp. 98 [41-2 USTC ¶9794]. It is
also contended that if the plaintiff trustee yields to the Collector's
demand and pays the accrued income to the Collector it will subject
itself to contempt proceedings in the State Court. On this premise it is
argued that the proper procedure for the Collector is to petition the
State Court for an order on the trustee to honor the government's claim
for the taxes. No doubt the latter procedure is now permissible after
the Collector has made the levy and distraint, and I am inclined to
think that would be the preferable course in this case. Similar action
seems to have been taken by the Collector in the
case, supra. But however that may be, I think there is no warrant
here for vacating the Collector's notice of levy, lien and distraint.
Indeed that procedure seems to be a condition precedent to the enforced
collection of the tax hereafter, whether by petition to the State Court
or by proceedings in this court under the federal statutes above
referred to. Nor is there any necessity to vacate the Collector's
notices to enable the trustee to avoid a possible conflict of State and
federal authority. The Collector's notices in this case to the trustee
are not of themselves self-executing with respect to the payment of the
accrued interest. If the trustee considers it necessary or prudent so to
do, it can itself petition the State Court for authority to make the
payment of income to the Collector, and presumably on such a petition a
rule would be served upon the beneficiary, from whom the income taxes
are alleged to be due, to show cause against the requested order; and
from an adverse decision either the trustee or the beneficiary would
doubtless have the right to appeal, ultimately if necessary, to the
Supreme Court of the United States on the federal question involved.
conclusion on the substantial question requires the dismissal of the
complaint. But as the case may be appealed, it is appropriate to briefly
consider the procedural points included in the defendant's motion to
dismiss. If the plaintiff's contention on the substantial point that the
spendthrift trust income is not property of the income taxpayer
reachable by the government were sound, I would not think this court is
without jurisdiction of the complaint under s. 3653 of title 26 USCA,
which provides that no suit for the purpose of restraining the
assessment or collection of any tax shall be maintained in any court. Hubbard
Inv. Co. v. Brast, 4th Cir. 59 Fed. (2d) 709 [1932 CCH ¶9366]; Rothensies,
Collector, v. Ullman, 3d. Cir. 110 Fed. (2d) 590 [40-1 USTC ¶9308];
Allen v. Regents of the University System of Ga., 304
439 [38-2 USTC ¶9321]; Cannon v. Nicholas, 10th Cir. 80 Fed.
(2d) 934 [35-2 USTC ¶9672].
But the other
procedural ground relied upon by the defendant, that the plaintiff has
an adequate remedy at law, is, I think, good in this case. As heretofore
pointed out, the Collector's notices to the trustee are not
self-executing with respect to the collection of the taxes; and the
Collector has not undertaken to actually sell under the notice of
distraint. If the demand for payment is refused by the trustee, the
right of the United States to enforce collection will necessitate a sale
under the distraint by the Collector, or an independent judicial
proceeding by the United States under section 3678 to enforce the lien
by sale or a suit against the trustee for individual liability under
section 3710; or a petition by the trustee filed in the State Court. To
any such proceeding the trustee will have the opportunity to present any
legal defenses that it may have. If the Collector should undertake to
sell under the distraint, or to sue the trustee under section 3710,
which applies by its terms only with respect to property subject to
distraint (ss. 3690 and 3692), the question may arise whether the
accrued income in the possession of the trustee was liable to distraint
under the federal statute. This particular question has not been argued
by counsel and it is not necessary here to decide it. It is sufficient
now to note apparently conflicting decisions on the point. In some cases
it has been held, or at least assumed, that a chose in action of the
character here involved is subject to distraint. Cannon v. Nicholas,
10th Cir. 80 Fed. (2d) 934 [35-2 USTC ¶9672]; United States v. Long
Island Drug Co., 2d. Cir. 115 Fed. (2d) 983 [41-1 USTC ¶9140]; Commonwealth
Bank v. United States, 6th Cir. 115 Fed. (2d) 327 [40-2 USTC ¶9769];
United States v. Penn Mutual Life Ins. Co., 3d. Cir. 130 Fed.
(2d) 495, 497 [42-2 USTC ¶9623]. But other cases, some quite recent,
are seemingly to the contrary.
v. Metropolitan Life Ins. Co., 2d. Cir. 130 Fed. (2d) 149 [42-2
USTC ¶9609]; United States v. Morris & Essex R. Co., 2d.
Cir. 135 Fed. (2d) 711 [43-1 USTC ¶9432]; United States v. Aetna
Life Ins. Co. of Hartford, Conn., (D. C. Conn.) 46 Fed. Supp. 30
[42-1 USTC ¶9266]; Re
, 269 N. Y. 253.
For all these
reasons I have concluded that the complaint must be dismissed with
taxable court costs against the plaintiff. Counsel may submit the
United States of America, Complainant,
v. Charles O. Canfield, Security-First National Bank of Los Angeles, a
corporation, Laura Elaine Votion, Daisy C. Moreno, Caroline E. Spalding,
Dorothy C. Cheseldine, Florence E. Whitney, Eilleen C. Himes, Defendants
Court of the
in and for the Souther District of
, Central Division, No. Q-53-M, 29 FSupp 734, Decided July 24, 1939
Enforcement of lien: Spendthrift trust.--A lien on taxpayer's
portion of the income from a testamentary spendthrift trust is
enforcible in collecting his tax liability for 1922, 1923, 1925, and
1926, where the defendant bank received adequate notice, the
Government's right and lien is paramount to the claims of all other
defendants herein, and an alleged compromise was vitiated.
U. S. Attorney, Eugene Harpole and C. L. Christie, Special Attorneys,
Treasury Department, and Armond Monroe Jewell, U. S. Attorney, Los
Angeles, Calif., for plaintiff. Newlin & Ashburn, by Allen W.
Ashburn and Hudson B. Cox, 1020 Edison Bldg., Los Angeles, Calif., for
Security-First National Bank; Wm. W. Lovett, Jr., and H. S. Hazeltine,
824 Richfield Bldg., Los Angeles, Calif., for Caroline C. Spalding;
Lawler, Felix & Hall and C. L. Tupper, by Oscar Lawler and L. C.
Tupper, 800 Standard Oil Bldg., Los Angeles, Calif., for Florence E.
Whitney and Dorothy C. Cheseldine; Neblett, Warner & McDonald, by
Allen H. McCurdy, 1009 Transamerica Bldg., Los Angeles, Calif., for
Laura E. Votion; Walter H. Robinson, Bank of America Bldg., Beverly
Hills, Calif., for Eilleen C. Himes.
reviewed the entire record of this action, as well as causes No. 0-3-H
time that the suit has been pending, various motions have been made and
rulings entered which reflect this court's views of issues which at such
times have been presented for decision. Throughout the trial many
important and crucial questions of evidence have been determined, and
the transcript fully discloses the opinion of the court in such matters.
concluded that a further detailed memorandum is unnecessary, not only
because the findings of fact and conclusions of law which have been made
and entered this day fully and formally decide all issues, but also
because the progressively increasing penalties and interest assessable
under the law against the defendant until final judgment should be
avoided without unnecessary delay.
conclusions from the entire case may be thus summarized:
indisputable that income taxes, interest and penalties for the calendar
years 1922, 1923, 1925 and 1926 in an aggregate amount exceeding $32,750
are due, owing and unpaid from Charles O. Canfield, and that every
possible effort has been made by the government to collect from the
taxpayer, wholly without success, and that if the United States is
unable to reach the property right of Canfield in a trust created in his
father's will and of which defendant bank is trustee and enforce payment
of such taxes in this suit, complete avoidance and evasion of the large
tax obligation will have been achieved. We think such result should be
obviated, as we believe it has been, by the application of the legal
principles invoked by the
in this action.
Reached by Process]
has seasonably and regularly pursued all of the requirements of
applicable federal statutes for the assessment, collection, attachment
of liens and enforcement of payment of the income taxes of Canfield for
the years in question as to the taxpayer, and the processes invoked by
the government should, and we believe do, reach all property and rights
to property of Canfield in the trust of which defendant bank is trustee.
, 269 N. Y. 247. There is also respectable authority to the effect
that issues of the legality of the assessments or the collection of the
taxes of Canfield cannot be raised by the defendant bank, as it is not
v. First Capital National Bank (C. C. A. 8, 1937) 89 F. (2d) 116
[37-1 USTC ¶9201]; United States v. American Exchange Irving Trust
Co., 43 F. (2d) 829 [2 USTC ¶577].
Canfield having failed and refused to pay and discharge the tax
obligations, under Title 26, Sections 1545, 1560, et seq., U. S. C. A.,
a lien arose and attached to all property or rights to property of
Canfield in the trust established for him and for his benefit by his
father's will. Such lien arose by virtue of the receipt of the
assessments by the Collector of Internal Revenue at the respective times
which the evidence proves the assessments were in the hands of the
Collector, and these liens have continued and are still effective and
enforceable. The respective assessments are also, under Bull,
Executor, v. United States, 295 U. S. 247, at pp. 259 and 260 [35-1
USTC ¶9346], given the force of a judgment, and seizure of all property
rights of the defaulting taxpayer is lawful to satisfy the debt. The
enforcement of the lien for unpaid taxes upon all property and rights to
property of Canfield and the subjecting of such property to the payment
of his unsatisfied taxes exists not only because of applicable statutes
of the United States, but also arises by virtue of the service of
summons issued pursuant to the bill in equity in this action under
Section 1568 of Title 26, U. S. C. A.
has all the rights that any other creditor may enjoy under the processes
of equity. The amended bill of complaint may be considered in the light
of the Federal Rules of Civil Procedure as a creditor's bill
establishing in addition to the statutory liens an equitable one also.
See Canfield v. Security-First National Bank (
Supreme Court) 87
of Defendant Bank]
Upon as early
as July 16, 1927, when notice of levy was served upon the defendant
bank, and later, and also upon the filing of the complaint in this suit,
at times when said defendant had in its possession or under its control
property and rights to property, adequate notice of Canfield's defaulted
tax obligations and liabilities was given to said defendant, and it was
required to withhold from Canfield and surrender to the government
amounts in satisfaction of the unpaid tax obligations of the taxpayer
Canfield. Instead of complying with the demands of the government and
the requirement of the federal statutes relative to the surrender and
payment of income taxes that Canfield owes to the United States, the
defendant trustee has yearly since 1927 allocated and paid from the
income of the trust estate of Canfield sums of money ranging from
approximately $51,785 in 1927 to more than $35,000 in 1932. The entire
amount of unpaid taxes due from Canfield to the
at this time is less than $35,000.
It has been
unquestionably settled that Canfield at all times involved in this
action had an interest in the income of the trust created and vested by
his father's will. And it can no longer be disputed that Canfield's
right to receive income from the trust was and is property or a right to
property belonging to Canfield, which was reachable by the United States
in satisfaction of the government's unpaid tax claim under Section 1610
of Title 26, U. S. C. A. Canfield, et al., v. Security-First National
Bank, supra; Matter of Rosenberg, supra.
We also find
from the record before us that the government's right and lien upon
Charles O. Canfield's portion of the income from the testamentary
spendthrift trust is and has been at all times paramount and
preferential to the rights or claims of all other defendants herein.
ascertaining the legal attendants to the investiture of the property and
rights to property of Canfield by the allocation of trust income to him,
it should be noted that before giving money to Canfield the trustee must
necessarily decide to give it to him, and that during appreciable time,
however brief, the allocation and award must precede the delivery of the
income Canfield is to receive, and during that time the lien of the
sovereign taxing power attaches. The lien for taxes is thus definitely
affixed to the allocations before manual delivery to Canfield takes
place, and the trustee in failing to observe and discharge the lien, and
indeed by frustrating the purpose of the lien, has rendered itself
liable under federal tax laws for the amount of income taxes, interest
and penalties due from Charles O. Canfield for the years 1922, 1923,
1925 and 1926.
before us fails to establish any enforceable compromise or settlement of
the tax obligations of Canfield which operates to relieve the defendant
trustee of liability to the government in this case. The true factual
situation as we have found it from the evidence shows willful
falsification of existing material facts which misled the
and which vitiates the alleged compromise averred in the pleadings in
ordered for plaintiff, with costs, in accordance with the findings of
fact and conclusions of law filed this day which constitute the decision
in this action.
United States of America
, et al., Plaintiffs v. Riggs National Bank, et al., Defendants
District Court, D.C., 84-2889,
, 636 FSupp 172, (636 FSupp 172.)
[Code Sec. 6321 ]
Lien for taxes: Property subject to: Trusts: Spendthrift clause.--Income
generated by a trust created under
law was subject to a lien for taxes owed by the taxpayer-beneficiary and
the trustee was ordered to turn over the income to the government until
the tax liabilities are satisfied. Although the trust's spendthrift and
forfeiture provisions could shield the beneficiary from ordinary
creditors, and even if the tax collection process triggered forfeiture
by the beneficiary under state law, such provisions could not defeat the
tax lien as a matter of federal law.
comes before the court on the parties' cross-motions for summary
judgment. Oral argument was heard on
April 4, 1986
. For the reasons set forth below, the government's motion is granted
and defendant Riggs National Bank's motion is denied.
In her last
will and testament, Isabel G. Zantzinger established a trust fund. By
the terms of the fund, her three children were entitled to distributions
of income generated by the trust fund during their lifetimes and her
grandchildren were entitled to distributions of both income and
principal during their lifetimes. There were certain spendthrift and
forfeiture provisions attached to the entitlements. Defendant Riggs
National Bank ("Riggs") is the trustee of the trust fund.
In 1983, the
Internal Revenue Service ("IRS") determined that William D.
Zantzinger, one of Isabel Zantzinger's three children, owed $78,182.05
in unpaid federal income taxes, interest and penalties. By "Notice
of Levy," served
October 18, 1983
, and "Final Demand," served
May 23, 1984
, the IRS seized all property in possession of Riggs belonging to
William Zantzinger, not to exceed $78,182.05.
of the levy, Riggs made regular distributions of the trust's income to
William Zantzinger. Once the levy was served, Riggs took the position
that certain forfeiture provisions of the trust wiped out William
Zantzinger's entitlement under the trust. Therefore, Riggs paid over to
the IRS $1,948.23 in income accumulated prior to
October 18, 1983
but not distributed to Zantzinger. Riggs maintains, however, that any
further income has been forfeited. Income that has accrued since
October 18, 1983
therefore has been accumulated and held by Riggs pending the outcome of
trust, there is a paragraph which limits William Zantzinger's life
estate in the trust income ("Trust C"). The paragraph begins
with what is called a "spendthrift" clause, which prevents
William Zantzinger from transferring his right to the income or from
subjecting it to the claims of his creditors. It reads:
part of the income or principal of the Trust C estate hereunder shall be
pledged, assigned, transferred, sold, or in any manner whatsoever
accelerated, anticipated, or encumbered by my said son, William Devereux
Zantzinger, nor shall any part of the income or principal of said trust
estate hereunder be in any manner subject to or liable, in the hands of
the Trustee, for the debts, contracts, or engagements of my said son,
whether existing at the time of my death or arising subsequently.
same paragraph ends with what is called a "forfeiture" clause,
which strips William Zantzinger of the right to the income should he try
to alienate it and gives the trustee considerable discretion in then
distributing the trust funds. It reads:
Should my said
son attempt in any manner to anticipate, encumber, or charge his
interest in this trust or any part thereof, and in the event of
bankruptcy or the rendition of any judgment or decree against the
interest of my said son, or the levy of any execution, or writ of
attachment, or garnishment thereon, or if, in the judgment of the
Trustee, it shall be to my said son's interest, then any amounts which
would otherwise be paid over directly to my said son, shall, in the
discretion of the Trustee, be applied directly for his support and
maintenance, or be allowed to accumulate in the hands of the Trustee and
be treated as and form a part of the principal of the trust estate from
which it was derived and be disposed of as a part thereof.
believes that these clauses are not properly invoked in this case and
that the income accumulated since 1983 (rather than paid over to William
Zantzinger) is now owed the IRS. Riggs believes that William
Zantzinger's right to the income was forfeited and that the
discretionary aspect of the trust prevents treating the income as a
property right against which the government may levy to satisfy a tax
assessment. The IRS responds that the property right was not forfeited,
and even if the forfeiture clause was triggered, it cannot defeat an
internal revenue assessment as a matter of federal law.
To ensure that
William Zantzinger's three children do not choose to participate in this
action, this court has received statements from each to that effect,
April 25, 1986
there appears to be no genuine issues of fact in dispute, this matter is
appropriately dealt with on cross-motions for summary judgment. The
question presented is whether the United States can reach the income
stream of the Zantzinger trust (despite its "spendthrift" and
"forfeiture" provisions) pursuant to the government's
statutory tax liens against all "property and rights to
property" of a delinquent taxpayer. This involves two analytically
separate issues: (1) was there a property right forfeited by William
Zantzinger; and (2) can, as a matter of federal law, such a forfeiture
provision defeat an internal revenue assessment.
A. Was a
Property Right Forfeited by William Zantzinger? 26 U.S.C. §§6331
-32 establish the IRS' ability to levy against property belonging to
a taxpayer and 26 U.S.C. §7403
provides for foreclosure of a tax lien. Determining whether certain
proceeds are the "property" of an individual, however,
requires this court to review state property law. Magavern v. United
USTC ¶9249 ], 550 F.2d 797, 800 (2d Cir.), cert. denied, 434
U.S. 826 (1977). The parties appear to agree and this court concludes
that determination of the property passed by Isabel Zantzinger's trust
must be done in accordance with the law of the State of
, where the trust was created.
accepts the use in a trust of a "spendthrift" clause subject
to certain exceptions. Watterson v. Edgerly, 388 A.2d 934, 935-36
(Md. Ct. Spec. App. 1978). If income is withheld under such a clause,
the beneficiary may sue to get it; therefore there is a property right
upon which someone such as the IRS may levy a claim.
states allow the use of forfeiture and trustee-discretion provisions to
create a "protective trust", whereby if either the beneficiary
or his creditors try to alienate the beneficiary's right to trust
income, then that right ceases and the trustee is given discretion to
distribute the income among some group that may or may not include the
prior beneficiary. See Restatement (Second) of Trusts, §150
, Comment c (1959). Since the beneficiary has no right to the income
until the trustee decides when and how to distribute it, the beneficiary
in such a situation has no property right upon which the IRS may levy. See
Nichols v. Eaton, 91 U.S. 716, 722-25 (1875) (protective trust,
after forfeiture, confers no "substantial rights," or right
which a court would enforce, so a right to income did not pass to
assignee in bankruptcy); McGavern v. United States, 550 F.2d 797
(2d Cir.), cert. denied, 434 U.S. 826 (1977) (government lien was
effective under trust in which income payments were not completely
discretionary with the trustee); United States v. Taylor [66-2
USTC ¶9522 ], 254 F. Supp. 752 (N.D. Cal. 1966) (where forfeiture
provision is illusory and beneficiary may continue to receive entire
income, a property right exists and a levy may occur). Though Riggs
law supporting such treatment of a "protective trust," this
court agrees that a
court would treat the use of forfeiture and trustee discretion
provisions as creating a "protective trust."
then becomes whether the government's levy or other collection efforts
triggered a permanent forfeiture of William Zantzinger's interest. Riggs
contends that it is now within Riggs' discretion to use the income that
would have gone to William Zantzinger either (1) for the support and
maintenance of William Zantzinger or (2) as part of the principal of the
trust estate, to be disposed of as part thereof. Since this
determination is a discretionary one, William Zantzinger has had no
right to income from the trust since
October 18, 1983
and has had no enforceable interest upon which the IRS can levy.
contends that the language of the forfeiture clause shows that mere
service of an administrative internal revenue levy was not intended to
trigger a forfeiture of William Zantzinger's right to trust income. The
government interprets the clause to require both an attempt by
Zantzinger to alienate his interest and an external event such as
bankruptcy, judgment, or levy of execution. The trustee could only
invoke the clause on its own if Zantzinger attempted to alienate his
interest. Since Zantzinger never tried to alienate his interest, the
forfeiture clause is inapplicable.
that the language shows that either an attempt to alienate or
some external event triggers forfeiture. This court agrees with Riggs
that either situation can lead to forfeiture; the clear intent of the
trust was to prevent William Zantzinger from recklessly mortgaging away
all his future rights in the trust income.
that forfeiture was triggered by an encumbrance caused by William
Zantzinger. When someone fails to pay tax liabilities after demand, a
statutory lien on all his property arises in favor of the government. 26
U.S.C. §6321 . By
neglecting to pay his taxes, William Zantzinger caused all his
property--including his interest in the trust income--to be encumbered
by a statutory lien. Riggs also believes that the government's levy
triggered forfeiture. Both lien and levy come within the natural meaning
of the testamentary language and are broad enough to include such
actions taken administratively rather than just judicially.
argues that Zantzinger did not "attempt" to encumber his trust
income in the sense meant by the trust language. Further, the service of
an internal revenue levy is not a "rendition of any judgment or
decree against the interest" of Zantzinger, nor a "levy of any
execution, or writ of attachment, or garnishment . . .". As the
government sees it, a prejudgment internal revenue levy is an
administrative levy that falls outside the language of the trust. A
"levy of execution" is a term of art under
law referring to the act of execution by a judgment creditor on a
judgment already obtained.
agrees with the government.
law requires that a will which purports to limit a beneficiary's
enjoyment of his interest under a spendthrift clause must state that
limitation in clear and unequivocal terms. Manders v. Mercantile
Trust & Deposit Co., 128 A. 145, 149 (
1925). While it is clear that Mrs. Zantzinger sought to restrict her son
from squandering his future income stream, this court sees a distinction
between language designed to prevent general creditor foreclosure and
language that would stop government assessments. Other states have
accepted distinctions in trust language based on whether the creditor is
a private or public entity. See, e.g., Industrial National Bank v.
Budlong, 264 A.2d 18 (R.I. 1970) (inherent distinction exists
between private creditors and the government in respect of the
underlying purpose of a forfeiture clause in a spendthrift trust). As
that court noted:
nothing in the language employed from which it may be reasonably
inferred that the intent of the testator was to relieve the beneficiary
from the payment of obligations which arise out of his status as a
member of society, particularly such as the payment of taxes properly
and legally assessed. We have carefully scrutinized the language used by
the testator and find nothing therein that is persuasive of an intention
that the limitation on the liability of the income to payment of debts
was to extend beyond those debts arising out of normal and conventional
A.2d at 24. This court finds that while Mrs. Zantzinger may have
intended to protect her grandchildren from having their interests in her
estate dissipated by reckless spending by her son, she could not have
intended that her son be able to avoid liability for income taxes on
some of the very income he earned from the trust. Therefore, it was
improper for Riggs to treat the tax collection process itself as
triggering foreclosure under
B. Can Such
a Forfeiture Provision Defeat a Federal Assessment? Even if
forfeiture did occur under
law, it would not be effective against an IRS assessment. Whether state
law can prevent a federal tax lien from attaching to a state-created
interest by creating a forfeiture whenever the government tries to levy
is a question of federal law. Aquilino v. United States [60-2
USTC ¶9538 ], 363 U.S. 509, 512-13, 80 Sup.
1277, 1280 (1960). Many courts have held that a simple spendthrift trust
cannot defeat a federal tax lien. See, e.g., First Northwestern Trust
Co. v. Internal Revenue Service, 622 F.2d 387 (8th Cir. 1980). One
federal court has held that a spendthrift trust combined with a
forfeiture clause is not effective to defeat a federal tax lien. United
States v. Taylor [66-2
USTC ¶9522 ], 254 F.Supp. 752 (N.D.
, the forfeiture was found illusory; in this case William
Zantzinger may continue to receive benefits from the trust for his
"support and maintenance."
reached this result after balancing the policies of state property law
and policies of federal tax collection, as called for in Aquilino:
(O)nce the tax
lien has attached to the taxpayer's state-created interests, we enter
the province of federal law, which we have consistently held determines
the priority of competing liens asserted against the taxpayer's
"property" or "rights to property." . . . This
approach strikes a proper balance between the legitimate and traditional
interest which the State has in creating and defining the property
interest of its citizens, and the necessity for a uniform administration
of the federal revenue statutes.
at 513-14, 80 Sup.
at 1280-81 (citations omitted).
behind all the cases that say a federal tax lien cannot be defeated by a
pure spendthrift trust supports the idea that it also cannot be defeated
by a forfeiture provision. The point is that while such trust clauses
create a legitimate property right under state law which can shield the
beneficiary from ordinary creditors, such trusts cannot be effective
against a federal tax lien, as a matter of federal law. Cf. United
States v. Mitchell [71-1
USTC ¶9451 ], 403 U.S. 190, 91
1763 (1971) (wife liable for federal income tax on marital property even
though state law right to such property was renounced). It would be
offensive and disruptive to federal tax law for a beneficiary to receive
an income stream for years without paying taxes on it, only to have the
income stream disappear once the IRS discovers the misfeasance and moves
Order accompanies this Memorandum.
the motion for summary judgment of defendant Riggs National Bank be, and
the same hereby is, DENIED; and it is further
the motion for summary judgment of plaintiff
United States of America
be, and the same hereby is GRANTED; and it is further.
the statutory liens of the United States pursuant to 26 U.S.C. §6321
in respect of the unpaid income tax liabilities of defendant William
D. Zantzinger for the years 1976, 1977 and 1978, be and hereby are
FORECLOSED as against all income earned by Trust C of the Trust known as
the Isabel G. Zantzinger Trust u/w C b/o William No. 011047-01, from
October 18, 1983 until said liabilities are satisfied, or until the
death of William D. Zantzinger, whichever first occurs; and it is
defendant Riggs National Bank shall immediately turn over to the United
States all such income earned by said Trust from October 18, 1983 until
the date of this Order, excepting the $1,948.23 of such income which
defendant Riggs National Bank has previously turned over to the United
States; and it is further
defendant Riggs National Bank shall continue to turn over to the United
States at regular intervals, and no less than semi-annually, all income
earned by said Trust from the date of this Order until the tax
liabilities described above have been fully satisfied, or until the
death of William D. Zantzinger, whichever first occurs
LaSalle National Bank, as Trustee
under Trust of Virginia Schnadig Bensinger, Plaintiff v. United States
of America, Defendant
District Court, No. Dist.
, East. Div., 85 C 7760,
, 636 FSupp 874
[Code Sec. 6321 ]
Liens: Attachable property: Spendthrift trust.--A federal tax
lien could be imposed against an interest in a spendthrift trust created
for the taxpayer's benefit. The interest in a trust qualified as
attachable "property" under
law. A state law barring the attachment of liens against trust property
was superseded by federal law sanctioning tax liens against any
Roche, James F. Flanagan, Halfpenny, Hahn & Roche,
20 North Wacker Drive
, for plaintiff. Joseph Cammarata, Department of Justice,
, for defendant.
was brought by LaSalle National Bank (plaintiff), under 26 U.S.C. §7426
, as Trustee under the trust of Virginia Schnadig Bensinger seeking
an order that a levy served upon LaSalle, as trustee, by the Internal
Revenue Service (IRS) was unlawful, and also seeking an injunction
prohibiting enforcement of said levy by the United States. Before the
Court are the parties' cross-motions for summary judgment. For the
reasons stated below, this Court denies the plaintiff's motion and
grants defendant's motion for summary judgment.
February 18, 1960
, Virginia Schnadig Bensinger established a trust, naming the plaintiff
as trustee. The settlor died on
October 11, 1961
. Upon her death, Hope Allen became the sole beneficiary of the trust.
Upon the death of Hope Allen on
October 28, 1963
, Edward S. Mayer became and continues to be the sole beneficiary under
the trust has made and continues to make monthly payments on behalf of
Mayer for rent, food, insurance, water, utilities, and clothing. Other
expenses provided for by the trust include reasonable medical, legal,
and accounting fees. The trust also paid for a new automobile in 1980,
in 1983, income tax liability in 1984, and will provide for income tax
liability in 1985. Since Mayer is currently unemployed, all but an
insignificant portion of his support, maintenance and medical needs are
paid by the trust. The value of the corpus of the trust was
approximately $148,000 as of
December 31, 1985
June 11, 1984
, an assessment was made against Mayer for income tax, interest, and
penalty for the year 1983. The assessment was attributable, in part, to
the liquidation and distribution of the assets of another trust which
was established by Mayer's grandmother. He failed to pay the amount
June 22, 1985
, the Internal Revenue Service served a Notice of Levy upon LaSalle
National Bank, as trustee, seeking collection of the unpaid tax
assessment. The amount of the unpaid assessment for the 1983 income tax
liability, interest and penalty is $9,348.02, plus statutory additions
from the date of assessment equaling a total of $11,232. LaSalle
National Bank, as trustee, has refused to honor the levy, despite being
requested in 1984 by Mayer to pay the tax. A Notice of Federal Tax Lien
was filed on
February 28, 1986
with the Cook County Recorder of Deeds.
asserts that Mayer's interest in the Bensinger Trust does not constitute
"property or right to property" under
law and therefore may not be attached by the Internal Revenue Service
pursuant to 26 U.S.C. §6321
plaintiff asserts that Mayer's beneficiary interest in the trust is
protected from creditors by Chapter 110, §2
-1403 of the Illinois Revised Statutes. Briefly, this statute
provides that a trust established in good faith by a third party for the
debtor may not be attached by a creditor.
, asserts that Mayer's beneficiary interest does constitute
"property or right to property" under
law and therefore LaSalle National Bank is in possession of an
attachable interest under tax lien statutes. Defendant further states
that once a legal interest is defined by state law, the legal
consequences of such an interest are determined solely by federal law
and that Chapter 110, §2 -1403
is inapplicable to tax liens imposed by the IRS.
The first key
issue to be determined by the Court is whether Mayer's interest in the
trust constitutes "property or right to property" under
law. The Court must then determine what consequences, if any, derive
from this legal interest.
Existence of Property Right
Pursuant to 26
6321 , a federal tax lien arises in favor of the
in the amount of any unpaid tax upon all property and right to property
of any person who, after demand thereof, refuses to pay said tax. Both
parties agree that the Court must use
law because "state law controls in determining the nature of the
legal interest which the taxpayer had in the property." Aquilino
v. United States [60-2
USTC ¶9538 ], 363 U.S. 509, 513 (1960), quoting Morgan v.
USTC ¶9210 ], 309 U.S. 78, 82 (1940).
argues that the Bensinger Trust, which is a spendthrift trust, does not
constitute a property interest under
law. Defendant states that Mayer's interest in the Bensinger Trust does
constitute a property interest. Two important factors which must guide
the Court on this issue are the settlor's intent and prior case law.
intent is important when determining trust construction. Bond v.
576 (1908). In the instant case, there is strong evidence to indicate
the intention of the settlor to create a property interest in the
beneficiary. The trust agreement provides in Article One, Paragraph (c):
"I declare that my primary intent is to provide adequate care,
support, maintenance needed for him during his lifetime and I desire
that the use of income and principal be dependent on his needs."
The Court finds that this wording indicates a clear intent to establish
an equitable interest in the beneficiary.
The fact that
the settlor intended to limit the trustee's discretion is evidenced by
the fact that the agreement states in Article One, Paragraph (c),
"the trustee shall use . . . ." The word "shall"
indicates that an obligation to pay is imposed on the trustee. This
obligation is also supported by deposition testimony on the part of
LaSalle National Bank's Administrator, Nancy O'Leary. Finally, the fact
that the trust does in fact pay a significant portion of Mayer's
expenses, support, and maintenance lends support to the contention that
the settlor intended to create a property interest in the beneficiary.
common law supports defendant's claim that a beneficiary's interest in a
spendthrift trust constitutes "property or right to property."
There are several cases in which the courts have found that a
spendthrift trust created an equitable fee interest. Wagner v.
Wagner, 244 Ill. 101 (1910); Steib v. Whitehead, 111 Ill. 247
(1884); Moore v. Braun, 263
App. 243 (2nd Dist. 1931); Lake Shore National Bank v. Coyle [68-2
USTC ¶12,548 ], 286 F.Supp. 412 (N.D.Ill. 1968); rev'd on other
grounds, 419 F.2d 958 (7th Cir. 1969); and DeKorwin v. First Nat.
, 170 F.Supp. 112 (N.D.Ill. 1958), aff'd, 275 F.2d 755 (7th
Cir. 1960). Moreover, plaintiff has failed to point out, and there seems
to be no cases directly stating that a beneficiary's interest in a
spendthrift trust does not constitute "property or right to
examining evidence of the settlor's intent and prior
case law, the Court is persuaded that Mayer's beneficiary interest in
the trust constitutes "property or right to property."
The Court is
not persuaded by plaintiff's assertion that Chapter 110, §2
-1403 is a "rule of property" and therefore serves to
protect Mayer's interest. Plaintiff's argument proves too much. Section
2 -1403 protects a beneficiary's interest in spendthrift trusts from
attachment by certain creditors. A property interest must exist in order
for it to be protected by the statute. Therefore, the existence of this
statute implies that a property right exists in a beneficiary's interest
in a spendthrift trust.
Attachment of IRS Levy
position is that, once a property interest has been defined under state
law, consequences are to be defined solely by federal law. Defendant
further asserts that, when there is a conflict between federal tax liens
and state protection statutes, the tax lien will prevail over the state
statute. Plaintiff counters that Edward Mayer's beneficiary interest
falls squarely within the protection of Chapter 110, §2
-1403 of the Illinois Revised Statutes which states:
No court shall
order the satisfaction of a judgment out of any property held in trust
for the judgment debtor if such trust has, in good faith, been created
by, or the fund so held in trust has proceeded from a person other than
the judgment debtor.
rule is that, once the court finds that the taxpayer has property or a
right to property in a trust under state law, any state law is
inoperative to prevent attachment of a lien created by federal statutes.
U.S. v. Bess [58-2
USTC ¶9595 ], 357 U.S. 51 (1958). The rule which is often
enunciated was stated by the Court of Appeals of
in In re Rosenberg's Will, 199 N.E. 206 (N.Y. 1935), cert.
, 298 U.S. 669 (1936). This rule states: "No policy of state
may interfere with power of Congress to levy and collect income
taxes." This rule has been followed in several federal courts. Mercantile
Trust Co. v. Hofferbert [45-1
USTC ¶9124 ], 58 F.Supp. 701 (D.Md. 1944); U.S. v. Canfield
¶9641 ], 29 F.Supp. 734 (S.D.Cal. 1939). See generally, First
Northwestern Trust Company v. Internal Revenue Service, 622 F.2d 387
(8th Cir. 1980); U.S. v. Rye [77-1
USTC ¶9264 ], 550 F.2d 682 (1st Cir. 1977). The Illinois Supreme
Court has recently ruled that, under certain circumstances, a competing
state statute can prevail over Chapter 110, §2
-1403. In Re Matt, 473 N.E.2d 1310 (
In the instant
case, it has been established that there is "property or right to
law. Therefore, a federal tax lien will attach under 26 U.S.C. 6321 and
Chapter 110 §2 -1403 of
the Illinois Revised Statutes will be ineffective to protect the
property from the IRS levy attaching. Since LaSalle National Bank, as
trustee, was in possession of the trust at time of attachment, it is
obligated to pay the tax liability arising from the assessment, under 26
U.S.C. §6332(a) .
reasons stated above, plaintiff's motion for summary judgment is denied
and defendant's motion for summary judgment is granted.
IT IS SO
Dallas National Bank, Successor
Trustee Under the Will of Belle Shumard, Deceased, et al., Appellants,
United States of America
In the United States Circuit Court of Appeals for the Fifth Circuit, No.
12237, 167 F2d 468, April 16, 1948
Appeal from the District Court of the United States for the Northern
District of Texas.
Property subject to lien: Spendthrift trust: Future income.--A
District Court decree was herein affirmed, such decree being in
accordance with the remand opinion of the Circuit Court of Appeals to
the effect that the United States tax lien attached to taxpayer's
monthly income under a spendthrift trust, as well to that income
accumulated since the judgment date as to that due when suit was filed.
Affirming District Court decree rendered pursuant to remand of the
Circuit Court of Appeals, 164 Fed. (2d) 489, 47-2 USTC ¶9405, which
reversed the decision of the District Court, 67 Fed. Supp. 573, 46-2
USTC ¶9311, rendered pursuant to remand of the Circuit Court of
Appeals, 152 Fed. (2d) 582, 46-1 USTC ¶9117, which reversed the
decision of the District Court, 56 Fed. Supp. 181, 44-2 USTC ¶9426.
Hamilton and Hoyet A. Armstrong, both of
, for the appellants. Melva M. Graney and Sewall Key, Special Assistants
to the Attorney General; Theron L. Caudle, Assistant Attorney General,
all of Washington, D. C., and William P. Fonville, Assistant U. S.
Attorney, Dallas, Texas, for the appellee.
HUTCHESON, HOLMES, and WALLER, Circuit Judges.
When this case
was last here, 1 we said:
"In the former opinion 2
we held the taxpayer had an interest in the trust property, but not an
interest that could be sold; but that her share in the income after it
accrued and was ready to be paid over to her was fully her property and
could be subjected to the tax lien of the United States, and that the
lien could be fastened on the future monthly income as it became payable
to the taxpayer."
decree appealed from follows the mandate to make a new judgment "in
accordance with this opinion." It is
v. Dallas National Bank, 164 Fed. (2) 489 [47-2 USTC ¶9405].
v. Dallas National Bank, 152 Fed. (2d) 583 [46-1 USTC ¶9117].
Circuit Judge, specially concurring:
many states, including
, the validity of spendthrift trusts is upheld. 1
In other American jurisdictions, the rule is that a trust, which
restrains the alienability of property, is invalid as against public
In our second opinion in this case, we are said to have held that the
taxpayer had an interest in the trust property but not an interest that
could be sold. 3
Since the appellee has not prayed for a sale of said interest, I think
the statement or holding that the same could not be sold was unnecessary
and should be withdrawn.
taxpayer is the equitable owner for life of an undivided interest in
Texas realty, which under local law is not subject to seizure or sale
for ordinary debts incurred by the taxpayer; but this does not mean that
testamentary restraints against alienation should prevail against the
fastening of a lien for federal income taxes on the taxpayer's equitable
interest in the trust estate. We are, in fact, holding the contrary in
statutes of a state must give way to the fixation and enforcement of a
federal lien for income taxes. 4
Testamentary restraints on alienation by the creation of what are known
as spendthrift trusts, although respected by state laws, are likewise
ineffective as to the lien for federal income taxes. 5
lien sought to be enforced in this case has attached to the taxpayer's
equitable interest in the corpus of the trust estate, notwithstanding
the testamentary provisions against its alienation, seizure, and sale.
That is the effect of our decision.
1 42 Tex. Jur., Sec. 92, p. 705; 54 Am. Jur., p. 126, et
seq.; 65 C. J., p. 238, et seq.
54 Am. Jur., p. 129, note 14; 65 C. J., p. 238, note 97.
164 Fed. (2) 489 [47-2 USTC ¶9405].
Shambaugh v. Scofield, 132 F. (2) 345 [42-2 USTC ¶9826].
, 269 N. Y. 247 [35-2 USTC ¶9650]; An article in Harvard Law
Review, entitled "Reaching the Interest of the Beneficiary of a
Spendthrift Trust," Vol. 43, p. 63, 68. Cf. Glass City Bank v.
U. S., 326
265 [45-2 USTC ¶9449].
United States of America
, Appellant, v. Dallas National Bank, Successor Trustee Under the
Will of Belle Shumard, Deceased, et al., Appellees
United States Circuit Court of Appeals for the Fifth Circuit, No. 11832,
164 F2d 489, December 4, 1947
Appeal from the District Court of the United States for the Northern
District of Texas.
Lien for taxes: Spendthrift trust: What subject to lien.--In a
former appeal an opinion was rendered and the case remanded to the
District Court and the government moved in that court to enter a
judgment subjecting to a tax lien all monthly payments due to the
taxpayer from a spendthrift trust. Counsel for the taxpayer considered
that the opinion applied only to $54.45 due when suit was filed. Held,
that the lien can be enforced by requiring the trustee to pay over all
the money now in his hands belonging to the taxpayer, both the $54.45
which he had when suit was filed and what has been added to it since the
judgment date. Reversing the decision of the District Court, 46-2 USTC
Shepard and Sewall Key, Special Assistants to Attorney General, both of
Washington, D. C., and William P. Forville, Assistant U. S. Attorney,
Dallas, Texas, for appellant. Dexter Hamilton and Hoyet A. Armstrong,
, for appellee.
HOLMES, and MCCORD, Circuit Judges.
In a former
appeal, United States v. Dallas National Bank, 152 Fed. (2d) 582,
[46-1 USTC ¶9117] an opinion was rendered and the cause remanded to the
district court for further proceedings conformable to the views so
announced. Counsel for the
moved in the district court to enter a judgment subjecting to the tax
lien all monthly payments then due the taxpayer from the trust involved
and withheld since the institution of this suit, and also all payments
that may subsequently become due and payable, till the demand of the
shall be fully extinguished. Counsel for the taxpayer considered that
our opinion applied only to the one payment of $54.45 due when the suit
was filed. The last stated view was adopted by the district judge, 67
Fed. Supp. 573 [46-2 USTC ¶9311], and judgment was entered accordingly.
This appeal followed.
suit prayed for a judgment establishing the tax liability; and for an
injunction against paying over any income pending the suit; for the
establishment of a tax lien against the taxpayer's share in the trust
property, and that a foreclosure of it be adjudged and the taxpayer's
interest in the trust be sold, "together with all accumulations of
her distributive share of the income therefrom in the possession of the
defendant successor trustee at the termination of this suit". In
the former opinion we held the taxpayer had an interest in the trust
property, but not an interest that could be sold; but that her share in
the income after it accrued and was ready to be paid over to her was
fully her property and could be subjected to the tax lien of the United
States, and that the lien could be fastened on the future monthly income
as it became payable to the taxpayer. Although no sale of anything is to
be had, the lien can be enforced by requiring the trustee to pay over
all the money now in his hands belonging to the taxpayer, both the
$54.45 which he had when the suit was filed, and what has been added to
it since the date of judgment, conformably to the prayer of the
petition. The judgment should be thus modified. The judgment rendered is
set aside the the cause remanded with direction to make one in
accordance with this opinion.
Jud Plumbing & Heating, Inc.,
Petitioner, v. Commissioner of Internal Revenue, Respondent Alice
Gorrell Jud (Wife of Ed. J. Jud), Transferee, Petitioner, v.
Commissioner of Internal Revenue, Respondent Ed. J. Jud, Transferee,
Petitioner, v. Commissioner of Internal Revenue, Respondent
United States Circuit Court of Appeals for the Fifth Circuit, No. 11481,
153 F2d 681, February 18, 1946
Petitions for review of decisions of the Tax Court of the United States
(District of Texas).
Accounting methods: Dissolved corporation: Income from uncompleted
long-term construction contracts.--Where taxpayer carried on a
business for two-thirds of the taxable year and then dissolved after
assigning and transferring all its assets and liabilities, including
several long-term construction contracts still uncompleted, to its chief
stockholder and made no return of income from such contracts for that
year, it is held that such corporation is liable for the taxes on income
earned from such contracts during the year of its dissolution even
though it had for previous years reported its income thereon under the
completed-contract method of accounting. Accordingly, the Commissioner's
determination was approved in allocating income for the year of
dissolution between the corporation and its stockholder, who completed
the contracts, based upon the relative percentages that the cost paid by
the corporation during that part of the tax year prior to the
dissolution and the cost paid by such stockholder after dissolution each
bore to the profit from the completed contracts. Affirming the decision
of the Tax Court.
, for petitioners. Richard H. Forster,
, Amicus Curiae. Harold C. Wilkenfeld, J. Louis Monarch, Special
Assistants to the Attorney General, Sewall Key, Acting Assistant
Attorney General, J. P. Wenchel, Chief Counsel, Bureau of Internal
Revenue, Bernard D. Daniels, Special Attorney, Bureau of Internal
Revenue, all of Washington, D. C., for respondent.
WALLER, and LEE, Circuit Judges.
Ed. J. Jud was
the President and owned substantially all of the capital stock of Jud
Plumbing & Heating, Inc., a corporation under the laws of
, which corporation was dissolved on
September 5, 1941
. In the dissolution all assets of the Corporation were transferred, as
August 31, 1941
, to the chief stockholder, Jud, who assumed all of its obligations,
with the result that the contracts which the Corporation had begun
before its dissolution were continued and completed without
From the year
1933 to the date of its dissolution the Corporation had made its income
tax returns from the "completed contract" or "job
cost" method of accounting as to all income from contracts where
the amount involved exceeded $100. This method of accounting enabled the
corporation accurately to ascertain and report the profit derived from
each contract, and apparently had been satisfactory to the Commissioner
of Internal Revenue throughout former years.
dissolution of the Corporation, Jud not only completed the existing
contracts of the Corporation, but undertook to continue the same method
of accounting, holding the view that since the Corporation would not
have reported or accounted for income on any of the contracts until same
had been completed, and since it had not completed the contracts
involved, and had transferred all of its assets, including its profits,
it, therefore, was not required to account, in whole or pro tanto,
for any unrealized and undetermined profits under any of the contracts
which the Corporation had begun but which Jud, as an individual, had
completed; and since he had succeeded to all assets and liabilities of
the Corporation, he should likewise account for the profits on each of
the contracts when ascertained upon completion; that completion of
contract determined not only income but liability for the tax on such
Jud and his
wife reported, on the community basis, the net income from all of the
contracts of the Corporation which Jud had completed within the tax
year, and they insist that since the Corporation made no completions of
these contracts it realized no profits and had no income to report
therefrom, and to taxes to pay thereon.
repair work, or from jobs which did not exceed $100, was reported and
accounted for on the cash basis and is not involved in this controversy.
Commissioner computed the gross income of the Corporation so as to
include the sum of $32,854.06 as its income for the year 1941 which had
accrued to it out of the contracts which it had begun but which it had
not completed at the time of its dissolution. The Commissioner did not
reject the completed-contract method of accounting that had been
previously followed by the Corporation, but thought that such a method
of accounting, under the facts in this case, did not reflect the income
that should be allocated to the Corporation.
Commissioner recognized the right of the taxpayer to adopt and follow
the method of waiting until the completion of the contract in order to
ascertain the profits therefrom, but rejected the contention that none
of the income from the contracts so completed was allocable to the
Corporation. The Commissioner used the completed-contract method to
ascertain the profits, but then computed, by what he considered an
equitable and proper method, the portion of the income from such
contracts that should be charged to the Corporation. This method was to
determine the total cost incurred for each job prior to the transfer, by
ascertaining from the books of the Corporation and from the books of Jud
and items in each job that the Corporation and its successor each had
paid. He thus determined the total cost of each completed job, as well
as the profits therefrom. The percentage of job cost paid by the
Corporation to the total cost was ascertained as determinative of the
percentage of completion of the contract by the Corporation. This
percentage of completion so obtained was then applied to the ultimate
profit so as to ascertain, or to approximate, the income that had
accrued to the Corporation at the time of the transfer of its assets and
liabilities to its chief stockholder. 1
Corporation had twenty-two uncompleted contracts at the time of its
liquidation. There was an ultimate profit in all except two, but the
profit or loss from eighteen of these contracts was so inconsequential
that the Commissioner disregarded them and made his determination only
on four which involved substantial sums and which were all completed
within the same tax year as the corporate dissolution.
It is not
disputed that the transfer of the assets rendered the Corporation
insolvent, and that if the Corporation is liable for taxes, its
transferees are likewise liable. Nor is the question as to whether or
not the Corporation realized a capital gain or a capital loss by the
transfer involved here.
conceded, also, that the Corporation, prior to its dissolution, received
progress payments from its contracts as the work went forward. These
payments would be a part of the gross income of the Corporation unless
the dissolution or transfer would otherwise alter their character.
The Tax Court
[CCH Dec. 14,573] upheld the Commissioner.
involved is whether, under the completed-contract method of accounting
which had been used by a corporation in previous years, such corporation
was liable for taxes on income, earned during the year of its
dissolution, from long-term contracts entered into by it but completed
by its successor after the dissolution of the corporation; and whether
the Commissioner used, and the Tax Court approved, an erroneous method
of accounting, under Secs. 41, 42, and 45, Internal Revenue Code, in
allocating income for the year of dissolution between the Corporation
and its successor, based upon the relative percentages that the cost
paid by the Corporation during that part of the tax year prior to its
dissolution and the cost paid by its successor after dissolution each
bore to the profit from the completed contracts.
Sec. 41 of the
Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 41] provides that the
net income should be computed in accordance with the method of
accounting regularly employed in keeping the books of the taxpayer, but
that if the method employed does not clearly reflect the income, the
computation should be made in accordance with such method as in the
opinion of the Commissioner does clearly reflect the income.
Sec. 42 of the
Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 42] provides that all
items of gross income shall be included in the gross income for the
taxable year in which received by the taxpayer unless under some other
lawful method of accounting such amounts are to be properly accounted
for at a different period, and in case of the death of the taxpayer, the
net income accruing up to the date of his death shall be computed as his
net income unless it is properly includable in some other tax period.
Sec. 45 of the
Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 45] authorizes the
Commissioner to distribute, apportion, or allocate gross income or
deductions between two or more organizations, trades, or businesses
owned or controlled directly or indirectly by the same interests, if he
determines that some distribution, apportionment, or allocation is
necessary in order to prevent an evasion of taxes or clearly to reflect
the income of such organizations, trades, or businesses.
Treasury regulations relating to the use of the completed-contract
method of accounting have been promulgated. 2
Amendment gave Congress the power to lay and collect taxes on incomes
from whatever source derived, and we agree with the Tax Court that it is
a fundamental concept of taxation that income is chargeable to him who
earns it, in the absence of statutory exemption or provision to the
It should be
apparent that a corporation, by a transfer of all of its assets and
liabilities, cannot absolve itself from liability for income taxes due
to the United States, and that any right to an exemption from reporting
income received by the taxpayer must be found in the federal law, rather
than in the acts of the taxpayer.
being a separate legal entity, its net earnings, whether ascertained or
not, belong to it, and the tax upon unexempt income in each taxable year
is chargeable to it [Sec. 13(b) Int. Rev. Code], and this liability
cannot be discharged by the simple expedient of dissolution and the
turning over of all its assets, including current and unreported income,
to its sole stockholder, even though such corporation receives no money
consideration for the transfer of such income. It is the actuality of
income rather than its disposition that is important in determining the
A taxpayer has
the option of reporting his income on either a cash, accrual, or
completion-of-contract, basis if the method selected clearly reflects
his income. But where a corporation: (a) carries on a business for
two-thirds of the taxable year; (b) thereupon dissolves; (c) assigns and
transfers all of its assets and liabilities to its chief stockholder;
and (d) makes no return of its income; an annual return made by the
corporation's chief stockholder and his wife, on the community basis,
wherein they charge themselves with the net profits that they and the
Corporation had earned during the tax year, could not be said to be such
a method of accounting as would clearly reflect the income of the
In the absence
of a statute that compels such a result the courts should not undertake
to bestow upon a corporation the privilege of having its income reported
by the community as if it were a participant in the marital relation. To
sustain the Petitioner's contention here would be in disobedience of
this principle. This statement may be dictum but it serves to
demonstrate the unsoundness of any effort to avoid the charging of
corporate income taxes to other than the corporation.
Corporation's income was not returned in a manner that would clearly
reflect its income, such a return need not be accepted by the
Commissioner, regardless of the method of accounting used. The
Commissioner has definite statutory authority [Secs. 41, 42, and 45,
Int. Rev. Code] not only to reject the method but to require the use of
a method that does clearly reflect such income.
a taxpayer, ordinarily, has the right to adopt the completed-contract
method of accounting where such method clearly reflects his income, but
it cannot avoid taxes by the simple expedient of not completing its
contracts; and where a corporation puts itself in such position that it
could never complete its contracts, it is in no position to insist that
even if it had income it has no tax liability, or that its tax liability
can be measured only by completed contracts.
Commissioner followed the completed-contract method in that he has
computed profits only from contracts that were completed, during the
taxable year, by the Corporation's successor. Instead of striking down
that method of accounting he has recognized and followed it, but because
of the dissolution and death of the Corporation he has found it
necessary to allocate the income so as to reflect that which belonged to
the Corporation--a detail which the completed-contract method of
accounting by the transferees did not supply.
completed-contract method of accounting determines profits, but it does
not always, necessarily and conclusively, determine legal rights to
those profits, nor the tax liabilities thereon. "Ascertainment of
income" is chiefly a matter of accounting. "Allocation of
income" is chiefly a matter of the application of income tax law to
basic legal rights. The terms are not synonymous.
Petitioners have defended a method of accounting that in actuality has
not been assaulted. They have decried a method of allocation, or
apportionment, of income as improper, meanwhile failing either; (a) to
show that the method produced an illegal, or a substantially inaccurate,
result; or (b) to suggest a better method.
of the Tax Court are affirmed.
The computation of the Commissioner on the four contracts was:
Costs Per Cent
Incurred Total or Completed Profit to
to August Final August Total August
Name of Job Cost Account 31, 1941 Cost 31, 1941 Profit 31, 1941
Courts ................... $68,334.97 $ 69,785.15 97.70 $13,861.55 $13,573.23
Courts .................. 97,968.03 154,765.95 63.30 22,304.61 14,118.82
..................... 10,736.02 18,219.63 58.93 8,344.37 4,917.34
Fred Poage ... 1,041.02 2,362.78 44.06 555.32 244.67
"Income from long-term contracts is taxable for the period in which
the income is determined, such determination depending upon the nature
and terms of the particular contract. * * * Persons whose income is
derived in whole or in part from such contracts may, as to such income,
prepare their returns upon either of the following bases:
Gross income derived from such contracts may be reported upon the basis
of percentage of completion. * * *
Gross income may be reported for the taxable year in which the contract
is finally completed and accepted if the taxpayer elects as a consistent
practice so to treat such income, provided such method clearly
reflects the net income. * * *." [Italics supplied.] [Sec.
19.42-4, Treasury Regulation 103.]