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Ellsworth M. Statler Trust of January 1 v. Commissioner of Internal Revenue

decided: May 13, 1966.

ELLSWORTH M. STATLER TRUST OF JANUARY 1, 1920, FOR ELLSWORTH MORGAN STATLER, FRANK C. MOORE, EDWIN F. JAECKLE AND THE MARINE TRUST COMPANY OF WESTERN NEW YORK, TRUSTEES, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ELLSWORTH M. STATLER TRUST OF JANUARY 1, 1920, FOR MARIAN F. STATLER, ELLSWORTH M. STATLER PORTION, FRANK C. MOORE, EDWIN F. JAECKLE, AND THE MARINE TRUST COMPANY OF WESTERN NEW YORK, TRUSTEES, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ELLSWORTH M. STATLER TRUST OF JANUARY 1, 1920, FOR MARIAN F. STATLER, MILTON HOWLAND STATLER PORTION, FRANK C. MOORE, EDWIN F. JAECKLE, AND THE MARINE TRUST COMPANY OF WESTERN NEW YORK, TRUSTEES, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT



Friendly and Hays, Circuit Judges, and Dooling, District Judge.*fn* Dooling, District Judge (dissenting).

Author: Friendly

FRIENDLY, Circuit Judge:

This petition to review a decision of the Tax Court, 43 T.C. 208 (1964), on capital gains and deductions as applied to the income taxation of trusts, raises a novel question of the construction to be given the Internal Revenue Code of 1954.

In 1920 Ellsworth M. Statler executed an indenture conveying large amounts of stock of Hotels Statler Company, Inc., in trust for the benefit of his descendants. The indenture provided that separate trusts be established for each of Mr. Statler's children, though in all significant aspects the trust estate was to be administered as a single fund. The trustees were directed to make charitable gifts of not less than 15% nor more than 30% of the net income in each year; the charities were to be chosen by majority vote of the trustees and Mr. Statler's children, but only the trustees were to determine the precise percentage, within the stated limits, to be expended from the income of each trust. By 1954, the year to which this controversy relates, the trustees were obligated to pay all the income remaining after the charitable set-aside to persons who were of full age; upon their death the corpus passes to other individuals, with no charity having an interest therein.

In 1954, the trusts owned 217,088 shares of Statler stock, which they had held for many years. Under a series of agreements they and other large Statler shareholders sold their stock to Hilton Hotels Corporation pursuant to a plan whereby the assets of Statler would be sold and the company liquidated. The trustees received some $50 per share, of which approximately $47 was long-term capital gain. Initially they allocated the entire proceeds to principal, but income beneficiaries contested the propriety of this under New York trust law. A compromise agreement between the trustees, the income beneficiaries, the Attorney General of New York representing the undesignated charitable beneficiaries, and a special guardian representing an infant and unknown contingent beneficiaries, was executed in November 1955 and approved by the Supreme Court, Erie County, in December. This provided that $15.50 per share should be allocated to income, that 15% of this sum less commissions of 2% should be paid to charities in accordance with the indenture, that the balance of the $15.50 should be distributed to the other beneficiaries, and that the rest of the proceeds should be added to corpus. On December 30, 1955, the trustees made payments of some $367,000 to charities qualifying for exemption under the Internal Revenue Code.*fn1

The trustees filed their 1954 federal income tax returns prior to the execution of the compromise but evidently in anticipation of its terms. Deductions other than the charitable contributions under the compromise agreement sufficed to offset income other than long-term capital gains. The returns reported the capital gain, subtracted the payments to the charities, and computed the tax on the balance under the alternative tax provided in § 1201(b) of the 1954 Code.*fn2 The issue, decided against the trusts by the Tax Court, is whether the payments to the charities were properly subtracted.

It will be useful to begin by dissipating any obscurities caused by the delayed execution of the compromise agreement and the resulting form of the tax returns. The Commissioner does not dispute that the issue is to be determined as if the correct allocation had been determined and payments made in 1954. See Rev. Ruling 62-147 and cases under earlier Revenue Acts there cited, 1962-2 Cum. Bull. 151. It is agreed also that if the settlement had been concluded before the tax returns were filed, the entire amount of the gain distributed to the non-charitable income beneficiaries, approximately $13 per share, would have been deductible by the trustees under § 661(a), and each non-charitable beneficiary, in computing his tax on such gain, would have been entitled under § 662(b) to avail himself of the alternative tax. Hence nothing turns on the fact that the trustees here paid the capital gains tax attributed to the amounts dsitributable to these beneficiaries and deducted this from the amount the beneficiaries would otherwise receive. The case concerns only two items, the capital gain added to corpus, some $31.56 per share, and the portion distributed to charity, some $2.28; the issue is whether the alternative tax is to be computed on the former figure alone, as the trustees insist, or on the sum of the two, $33.84, as the Commissioner and the Tax Court have ruled.

It will be easier to understand the issue if we take a hypothetical case and assume that, after payments to non-charitable income beneficiaries of their share of the gain, the remaining gain is $500,000, the required income payment to charities is $40,000 and the trust has no other income or expense, so that, apart from taxes, $460,000 would be added to corpus. The parties agree that, the trust having already deducted the payments to the non-charitable income beneficiaries, we next turn to § 1202, which allows it to deduct 50% of the gain other than amounts includible by the income beneficiaries, to wit, $250,000. They agree also that § 642(c) allows a deduction for half of the $40,000 paid to charities, or $20,000 -- the remaining half having been already deducted under § 1202 -- thereby leaving taxable income of $230,000, all representing long-term capital gain. We thus arrive at the computation of the alternative tax under § 1201(b), see fn. 2. The Commissioner computes this as follows:

(1) Partial tax on tax-

able income, $230,000,

reduced by 50% of

long-term capital

gains of $500,000, or

$250,000, to ...


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