The opinion of the court was delivered by: CARTER
Plaintiff initiated this action to recover $143,050.31, plus appropriate interest, which it claims to have erroneously paid as income tax. Jurisdiction of the court is founded upon 28 U.S.C. § 1346(a) (1). The parties cross moved for summary judgment pursuant to Rule 56, Federal Rules of Civil Procedure, and in accordance with the provisions of Rule 9(g) of the General Rules of this court the parties filed a joint statement stipulating to all the relevant facts.
On June 26, 1957, Ernest Weir, a resident of Pennsylvania, died and by his will, duly admitted to probate in that state, established in Article "TENTH" a "Trust A", for the benefit of his wife, Mary Weir. The trust income was payable for life and Mrs. Weir was given a general testamentary power of appointment to dispose of the trust principal upon her death.
The power of appointment was unrestricted and decedent expressed in his will no wish as to how it should be exercised.
Mrs. Weir organized the plaintiff corporation, during her lifetime, as a charitable organization dedicated to the advancement of medical research and education. Plaintiff was given, and still enjoys, an exemption as a charitable corporation under §§ 170(c) and 2055 of the Internal Revenue Code of 1954, as amended ("I.R.C."), 26 U.S.C. §§ 170(c), 2055. The creation of the plaintiff corporation was totally unrelated to Ernest's will (except insofar as it may have provided Mrs. Weir the means to establish this organization) and Mrs. Weir's power of appointment thereunder.
Mary Weir died in August 1968, and her will was duly admitted to probate in New York, her state of residence at the time of death. By Articles "FOURTH" and "SIXTH"
of her will she exercised her power of appointment over Trust A created in her deceased husband's will by directing that the principal of Trust A be distributed to charity and preferably to the plaintiff corporation.
Trust A (by its Trustee, First National City Bank) filed its tax returns for the fiscal year ending September 30 in January 1969 and paid $135,415.95 taxes on $541,783.82 capital gains realized during that fiscal year. In February, 1969, the Bank, as Trustee, filed a claim for refund in the amount of $135,415.95 -- the entire capital gains tax paid for fiscal 1968. In short, the trustee was claiming that the entire capital gains, which would, of course, now inure to the benefit of the charity, was permanently set aside during 1968 for charitable purposes and, therefore, pursuant to § 642(c) I.R.C., 26 U.S.C. § 642(c), was deductible from income in its entirety. By letter dated January 22, 1970, the Manhattan District Director of the Internal Revenue Service ("I.R.S.") notified the Bank that the refund claim "has been rejected as no mention of charitable contribution was made in the original governing instrument section 642(c) I.R.C."
In March, 1969, the trustees under Mary Weir's will, duly executed a document directing that all property subject to her power of appointment be distributed to the plaintiff and the principal of Trust A was so transferred. Furthermore, in a state court proceeding
to settle the accounts rendered by the bank, as trustee of Trust A, the court held that any monies received as a refund in this action shall be distributed to the plaintiff.
Thus, the Foundation has succeeded to the interests of First National City Bank (as trustee of Trust A) and is properly before this court pressing the claim for refund.
Congress has provided that under certain conditions amounts paid or permanently set aside for charitable purposes by an estate or trust shall not be subject to the provisions of § 170 I.R.C., 26 U.S.C. § 170, which limits the total percentage of deductions permitted. Rather, any amount of gross income (including all of gross income) so paid or permanently set aside may be deducted in computing taxable income, § 642(c) I.R.C., 26 U.S.C. § 642(c).
The Issue for Determination
The sole question to be decided is whether the distribution of the principal of Trust A to the plaintiff was made "pursuant to the terms of the governing instrument." The difficulty, of course, is that Trust A itself did not provide for the distribution of the principal to charity but rather, left the disposition of that property to the beneficiary's discretion by way of an unrestricted testamentary power of appointment over the principal. Mrs. Weir was the one who directed the property to charity.
It would be well to begin by noting briefly what is not in issue. First, there is no question but that plaintiff is a proper charitable recipient within the terms of § 642(c). Secondly, it is undisputed that the amount in question was "paid or permanently" set aside "during the taxable year for which the deduction is claimed." Finally, and most importantly, it is conceded by all parties that it is Ernest's will which is the governing instrument; it is that document which established the trust (Trust A) now seeking a deduction from gross income for charitable contributions. Thus, in order to allow such deductions it must be shown that property was paid or permanently set aside for charity pursuant to the will creating the trust in question.
The Applicability of State Law
A. Basic Principles To Be Followed:
The plaintiff first contends that state law must govern the definition of the words "pursuant to". In this case plaintiff maintains that applicable state law
treats property distribution by way of power of appointment as passing directly from the original source to the ultimate recipient without vesting in the intervening or intermediate estate of the person exercising the power. Thus, in this case, the property would be deemed as passing directly from the husband's estate to the Weir Foundation without ever having vested in the wife.
The defendant does not question plaintiff's reading of state law, but rather, argues that it is not applicable in this case because federal law, not state law developed under circumstances other than the interpretation of federal tax statutes, must govern.
Our federal system of taxation is essentially one of financial surcharge on existing fundamental legal relationships. Congress obviously did not intend to define a whole code of primary relationships upon which to levy its tax, but rather, sought to impose a generally uniform system of taxation upon an existing legal structure. See, e.g., Note, The Role of State Law in Federal Tax Determinations, 72 Harv. L.R. 1350 (1959); 10 Mertens, Law of Federal Income Taxation § 61.01 et seq. (1970). Given the inherent diversity in our federal system it was inevitable that the appropriateness of applying state law to federal tax questions should become a major problem of statutory interpretation.
The Supreme Court has enunciated some basic principles to be applied in a case such as this. In Burnet v. Harmel [3 USTC P 990], 287 U.S. 103, 77 L. Ed. 199, 53 S. Ct. 74 (1932) the Court was called upon to interpret § 208(a) (1), Revenue Act of 1924, providing for lower tax rates on the gain from the "sale or exchange of capital assets." Harmel had leased oil and gas rights on his property for a set sum, plus royalties. The state (Texas) where the transaction occurred treated oil and gas leases as a sale of the oil and gas in place and, therefore, defendant argued that the gain resulting from the cash payment he received as consideration for the lease was really a gain from the sale of a capital asset. The issue, of course, was the interpretation of the term "sale" in the statute.
In deciding that state law was not applicable, the Court took into account two threshold considerations: first, that it was interpreting a federal statute duly enacted pursuant to Congress' "plenary power under the Constitution" and, therefore, "not subject to state control", id. at 110; second, that federal tax legislation, "in the absence of language evidencing a different purpose, is to be interpreted so as to give a uniform application to a nationwide scheme of taxation." Ibid. The Court then enunciated the following rule to be applied in cognate cases:
"State law may control only when the federal taxing act, by express language or necessary implication, makes its own operation ...