14 T.C. 1241">*1241 The respondent determined deficiencies in the petitioners' income tax liabilities, as follows:

1950 U.S. Tax Ct. LEXIS 161">*163 The year 1942 is involved in these proceedings because of the provisions of the Current Tax Payment Act of 1943.

14 T.C. 1241">*1242 Certain minor adjustments made by the respondent in the petitioners' tax returns were not contested, leaving in issue the following:

(1) Whether or not the income of six trusts is taxable to the beneficiaries Franklin, Robert H., and Frederick W. Flato.

(2) Whether or not the gain realized by Franklin Flato in 1943 and 1944 on the sale of cattle used for breeding purposes is taxable as ordinary income or as capital gain under the provisions of section 117 (j) of the Internal Revenue Code.

The cases were consolidated for hearing and presented on a stipulation of facts, exhibits, and oral testimony.

FINDINGS OF FACT.

The stipulated facts are so found. The other facts are found from the evidence.

Edwin and Winnifred Flato are respectively the father and mother of petitioners Franklin, Frederick, and Robert Flato. The petitioners Grace and Shelley Flato are the wives of Franklin and Frederick Flato, respectively, who filed community property tax returns.

Prior to 1941, Edwin Flato, the father, and Winnifred, the mother, owned as community property a three-fourths1950 U.S. Tax Ct. LEXIS 161">*164 interest in each of three companies. The other one-fourth interest was owned by Franklin Flato. The three companies were operated as separate partnerships by Edwin and Franklin. The three companies were Nueces Hardware Co., dealing in hardware and appliances at retail; Edwin Flato Co., dealing in appliances at wholesale; and the United Securities Co., engaged in the financing of retail paper and dealers' appliance inventories.

Edwin Flato wanted his three sons to carry on the business. Franklin and Frederick Flato were married and their father was concerned about the possibility that their wives "could cause them more trouble" by interfering in the business. The youngest son, Robert, was a minor and it was believed that he could not enter into a partnership.

It was decided that Edwin and his wife, Winnifred, would sell their interest in two of the companies to trusts to be created for the benefit of each of the three sons. In furtherance of this plan, Edwin and Winnifred each created a trust for the benefit of each of their three sons, Franklin, Frederick, and Robert -- a total of six trusts. These trusts were dated "as of the 1st day of January, 1941." As of that same date1950 U.S. Tax Ct. LEXIS 161">*165 Edwin transferred $ 1,000 to each of the trusts created by him, and Winnifred, his wife, transferred $ 1,000 to each of the three trusts of which she was the trustor. Also as of January 1, 1941, Edwin transferred $ 4,000 to each of his sons (and not to the trusts) and Winnifred also transferred $ 4,000 to each of the sons. As matters then stood after these transfers, the principal of each of the six trusts consisted 14 T.C. 1241">*1243 of $ 1,000 and each of the three beneficiaries had been given in his own right a total of $ 8,000. Federal gift tax returns were properly filed covering each of these gifts.

The trustees of each of the trusts were as follows: Franklin was trustee of the two trusts for the benefit of Frederick; Frederick was trustee for the two trusts created for the benefit of Franklin; and Franklin and Frederick were cotrustees of the two trusts for the benefit of Robert.

All of the trusts were similar and gave the trustee power to retain the corpus or to reinvest it, to receive other property from the trustor or others, and to purchase an interest in the partnership, firm, business, or corporation belonging to the trustor or others. Article III gave the trustee the power1950 U.S. Tax Ct. LEXIS 161">*166 to employ a manager of the properties and protected the trustee from liability if he acted in good faith upon the advice of the manager. Article IV relieved the trustee of personal liability to any beneficiary on account of his management of the trust property. Article V directed him to keep books of account. Article VI provided that the trustee could make a distribution in kind of the principal in his discretion. Article VII provided:

From and after the creation of this Trust Estate, as nearly as may be, the Trustee shall, in his discretion, pay to [the named beneficiary], all, or such portion as he deems reasonable and proper, of the net income of this Trust Estate, accumulating all surplus income and adding it to the principal of the Trust Estate.

Article VIII allowed the trustee to apply for the use of the beneficiary any part of the principal that he might deem wise and expedient. Articles IX and X provided for the operation of the trust upon the death of the beneficiary. Article XI provided:

This Trust Estate being one of several created by the Trustor, the Trustee shall not be required to effect an actual physical division of any properties or securities held hereunder, 1950 U.S. Tax Ct. LEXIS 161">*167 but shall be at liberty, for convenience of administration, to retain the same in solido and to regard the shares or property in his hands as constituting pro rata investments in common of the several separate Trust Estates above provided for until and as the given separate parts shall respectively and from time to time be released from the separate Trust Estates.

Article XII provided that:

This Trust Estate shall be and remain irrevocable and not subject to modification, alteration, or revocation, and in no event shall the Trustor have the right to repossess the income or principal of the Trust Estate, or any part thereof, during his lifetime.

Article XIII provided as follows:

Neither the income nor principal of this Trust Estate shall be liable for the debts of any beneficiary hereunder, nor shall the same be subject to seizure by any creditor of any beneficiary under any writ or proceeding at law or in equity, and no beneficiary hereunder shall have any power to sell, assign, transfer, 14 T.C. 1241">*1244 encumber, or in any manner to anticipate or dispose of his or her interest in the Trust Estate, or the income therefrom.

Article XIV provided as follows:

After the death or resignation1950 U.S. Tax Ct. LEXIS 161">*168 of [named trustee] or in the event of the death or resignation of any successor Trustee during the term of this trust [the named beneficiary], may appoint a successor Trustee. If, prior to the occurence [sic] of either of the above contingencies, [the named beneficiary] be dead, the beneficiary, or a majority of the persons who are beneficiaries hereunder, of full age, or if no beneficiary is of age, his or her legal representative, may appoint a successor Trustee.

On or after the expiration of ten (10) years from and after the date of this trust instrument, [the first named beneficiary] or in the event of his death, the [next] beneficiary, or a majority of the persons who are beneficiaries hereunder, of full age, or if no beneficiary is of age, his or her legal representatives, may at his or their option, in writing, declare this trust terminated and shall be entitled to a full accounting and settlement of this trust and may withdraw the same from this trust, in which event the same shall be his or their individual property in full and complete ownership of the same for his or their own use and behalf, and have and hold the same to him or them, their heirs and assigns forever; 1950 U.S. Tax Ct. LEXIS 161">*169 or at his or their option may remove the then acting trustee or trustees hereunder and appoint a successor trustee.

A successor Trustee shall have all the powers, rights and duties imposed and conferred upon the original Trustee herein named.

A successor Trustee, as that term is hereinabove used, may be a corporation or an individual or individuals.

* * * *

Also, "as of the 1st day of January, 1941" Edwin Flato, the father, transferred to each of the three trusts an undivided one-third of the three-fourths interest held by Edwin and his wife as community property in the two partnerships, Edwin Flato Co. and United Securities Co. The father's interest in the Nueces Hardware Co. was retained and the company was operated as before; that is, as a partnership, three-fourths of which was owned by the father and mother, and one-fourth by the son Franklin.

Pursuant to the plan that the trusts would buy the partnership interest from the parents, the trustees of each of the six trusts gave a consideration of $ 14,716.52 represented by $ 5,000 ² in cash and a note given to Edwin Flato for $ 9,716.52, bearing interest at one-half of one per cent per annum. On June 30, 1941, Franklin, individually, 1950 U.S. Tax Ct. LEXIS 161">*170 and Franklin and Frederick as trustees of the three trusts, entered into an agreement as of January 1, 1941, to operate as a partnership the two businesses, United Securities Co. and Edwin Flato Co. The respective interests in the new partnership as shown by that agreement were as follows: 14 T.C. 1241">*1245

1950 U.S. Tax Ct. LEXIS 161">*171 The partnership kept regular books, and year-end inventories and statements were prepared. ³ Profits were divided on the books in accordance with the partnership agreement. Franklin and Frederick worked for the partnership. They received fixed salaries as employees. Robert was in school or in the Army during the taxable years. The partnership regularly filed annual income tax returns. The partnership was later dissolved in 1946 or 1947.

The difference between the $ 19,570.89 shown on the partnership agreement as the pro rata share of each trust interest in the partnership's net worth and the $ 14,716.52 shown as consideration given by the trusts to Edwin Flato on the sale of the old partnership interest to each trust, or $ 4,854.37, represented the 1950 U.S. Tax Ct. LEXIS 161">*172 trust's pro rata share of partnership profits from January 1 to June 30, 1941. The notes given by the several trusts were paid in cash on August 18, 1942.

The net income of the new partnership after deductions for amounts paid as salaries to Franklin and Frederick, as shown on the returns filed for the years 1941 to 1944, was as follows:

1950 U.S. Tax Ct. LEXIS 161">*173 For each of the years 1941 to 1944, inclusive, each trust filed a fiduciary income tax return, Form 1041, and reported a pro rata share of partnership income.

Three bank accounts were maintained, one for each group of trusts. From the deposits in the bank accounts of the trusts, distributions were made to the petitioners as beneficiaries of the respective trusts 14 T.C. 1241">*1246 as follows: In 1941, to Robert, $ 2,500 from each trust, or a total of $ 5,000; in 1942, to Frederick, $ 2,000 from each trust, or a total of $ 4,000; to Robert, $ 2,000 from each trust, or a total of $ 4,000; to Franklin, $ 1,100 from each trust, or $ 2,200, as a contribution to his church; in 1943, to Frederick, $ 3,500 from each trust, or a total of $ 7,000. The distributions made to Robert in 1941 and 1942 were made because of a request made by him in which he stated that he needed the money. The distributions to Frederick were made because of a request and his statement that he needed money to live on and in 1943 he wanted money to buy a farm. The contributions to the church made from Franklin's trusts were at his request. The amounts distributed by the trusts to the beneficiaries were reported in their1950 U.S. Tax Ct. LEXIS 161">*174 income tax returns.

Upon audit of the petitioners' returns, the Commissioner determined that income reported by the several trusts as adjusted by increases in partnership income was distributable to the petitioners, with the following explanation in the notices of deficiencies:

(b) It is held that the income of the so-called trusts, [naming the trusts, the trustees and the grantors] is taxable to the named beneficiary of each trust, no part being taxable to the so-called trusts for the taxable years ended December 31, 1942, 1943, and 1944 * * *.

Prior to 1940 Franklin Flato acquired a ranch of about 1,900 acres, which he stocked with cattle of mixed breed with the purpose of raising and selling cattle as beef. After three years of operation, Franklin decided in 1943 to sell the ranch. The breeding animals were sold separately during 1943 and 1944, during which time the cattle raised primarily for beef were sold as they matured. The sales of the beef cattle in the years 1943 and 1944 were made to customers in the ordinary course of his business.

In 1944 Franklin, together with his father-in-law, bought a portion of another ranch and moved a few of the cattle from his 1,900-acre 1950 U.S. Tax Ct. LEXIS 161">*175 ranch to the newly acquired ranch. The sale of the first ranch was completed in 1944.

In 1943 and 1944 Franklin asked his manager to report the sale of cows and bulls previously held for breeding separately from the sale of calves and steers. On his income tax returns for those years Franklin reported the sales of breeding cattle as a capital asset and the sales of beef cattle as ordinary income. Franklin filed his returns and reported his income on the cash basis.

On his 1943 and 1944 income tax returns Franklin claimed depreciation of $ 425.23 and $ 459.60 on breeding stock. Depreciation was claimed on the cattle bought, but not on the cattle which had been raised and retained for breeding.

14 T.C. 1241">*1247 If a cow was over 1 year old when sold, Franklin reported it in the sale of breeding cattle. If under 1 year old, it was reported in the sale of beef cattle. Franklin did not sell any bulls as breeding cattle, but as beef. The cattle classified as breeding cattle when sold had been held for longer than 6 months.

In his income tax returns, Franklin reported sales of breeding cattle in the amounts of $ 2,200 and $ 5,459.84 in the years 1943 and 1944, respectively. These sales 1950 U.S. Tax Ct. LEXIS 161">*176 were reported as long term capital gains, of which 50 per cent was reported as income. Franklin reported sales of "other livestock" in the amounts of $ 714.75 and $ 4,084.27 in the years 1943 and 1944, respectively.

The respondent determined that Franklin had failed to establish that section 117 of the Internal Revenue Code applied to any of the proceeds from the sales of cattle in 1943 and 1944.

OPINION.

The first question is whether or not the income of the six trusts is taxable to the beneficiaries of those trusts.

Three of the petitioners are sons of the grantors of six trusts. The other two petitioners are wives of two of the sons. The mother and father owned a three-fourths interest in three partnerships. The other one-fourth interest was owned by the son Franklin. It was the parents' desire to divest themselves of the interest in two of these partnerships and place it in trust for the benefit of their three sons. The mother and father each created three trusts, one for the benefit of each son, and transferred $ 1,000 to each trust. Also, the mother and father each gave $ 4,000 to each of the three sons. The first son was trustee of the two trusts for the second son; 1950 U.S. Tax Ct. LEXIS 161">*177 the second son was trustee of the two trusts for the first son; and the first and second sons were trustees of the two trusts for the third son. All of the six trusts were "discretionary" trusts.

The trusts bought the parents' interest in two of the partnerships, each trust paying $ 5,000 in cash and giving a note for $ 9,716.52. A formal partnership agreement was executed between the two sons as trustees of the trusts which now owned a three-fourths interest in the two businesses, one of those same sons owning the remaining one-fourth interest. The partnership profits were divided equally; that is, three-fourths was equally divided among the six trusts and one-fourth went to Franklin, who himself owned this interest. The trustees made various distributions of trust income to the beneficiaries on the request of the latter.

The respondent contends "that the creation of the [trusts] was a mere sham and artifice and an attempt to divide the partnership income 14 T.C. 1241">*1248 six ways instead of three ways; that the three brothers are the real partners; and the income of the partnership is taxable to them under section 22 (a) of the Internal Revenue Code."

The broad question presented in1950 U.S. Tax Ct. LEXIS 161">*178 this case is a familiar one. We are told in Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, that:

* * * Technical considerations, niceties of the law of trusts or conveyances, or the legal paraphernalia which inventive genius may construct as a refuge from surtaxes should not obscure the basic issue. * * *

A similar thought was expressed differently in Higgins v. Smith, 308 U.S. 473">308 U.S. 473, where it is said that "It is command of income and its benefits which marks the real owner of property."

Article VII of each trust provided that "the Trustee shall, in his discretion, pay to [the named beneficiary], all, or such portion as he deems reasonable and proper, of the net income of this Trust Estate." It is because of the characterization of the trusts as "discretionary" that the petitioners defend, principally, their position that the partnership income is trust income rather than income to the beneficiaries.

The petitioners have gone to considerable length in offering testimony from witnesses and argument on brief to show that there was no collusion as a result of the trustee-beneficiary interrelations here and that in each instance1950 U.S. Tax Ct. LEXIS 161">*179 the payments to the beneficiaries at their request of the trust income were in fact made at the "discretion" of the trustees. In our judgment, the petitioners have overproven their case. The very proof to which they point with confidence, to us establishes the position contended for by respondent. In short, the proof arouses our incredulity. The appellation "discretionary" scarcely seems to fit a trust where, as here, its trustee-beneficiaries are so similar as to age, experience, and ability to influence each other.

We believe that it is fair to infer from the facts of this case that although the distributions of trust income were to be made at the "discretion" of the trustees, the intention of the grantors was that the beneficiaries could have what they wanted of the trust income and that the discretionary provision was more in the nature of a safeguard to be withheld unless family considerations dictated its enforcement. Albeit there is no evidence of any collusion by the trustee-beneficiaries, on the other hand, there is no evidence of any substantial discretion exercised. The evidence indicates that the beneficiaries requested and got such amounts of trust income as they1950 U.S. Tax Ct. LEXIS 161">*180 desired. The fair inference is that they got what they wanted. In our opinion the evidence is sufficient to cause this trust income to be taxed to the beneficiaries. Edward Mallinckrodt, Jr., 2 T.C. 1128; affd., 146 Fed. (2d) 1. Edgar R. Stix, 4 T.C. 1140; affd., 152 Fed. (2d) 562.

14 T.C. 1241">*1249 There remains for discussion the respondent's contention that the beneficiaries were substantially the settlors of the trust. The respondent points out that the mother and father transferred $ 1,000 to each of the trusts when they created them. At the same time, they each transferred $ 4,000 to each beneficiary. The trusts then each paid $ 5,000 for the partnership interest. The record does not explain how the trusts got the $ 4,000 from the beneficiaries. Possibly, there was a transfer of $ 4,000 from each beneficiary to each of his two trusts. Gift returns were filed and notes for the balance of payments signed, but these may well have been the "legal paraphernalia" which tend to "obscure the basic issue." The $ 8,000 cash given to each of the beneficiaries1950 U.S. Tax Ct. LEXIS 161">*181 and the $ 1,000 given the trusts were returned almost immediately to the father and mother. The notes, representing the balance due, were paid out of the trusts' share of partnership profit in 2 years.

The petitioners contend that "both the $ 1,000 and the $ 4,000 came from the father and mother and that it was all part of a single transaction. * * * It was a single-package transaction. No part of the money or property originated with the petitioners." This does not adequately explain this devious aspect of the transaction, and, although in itself not decisive, it is, however, one of the factors which weigh in our conclusion.

It is our opinion that the income of the six trusts is taxable to the respective beneficiaries under the provisions of section 22 (a) of the Internal Revenue Code, and we so hold.

The second issue is whether or not the gain realized by Franklin Flato in 1943 and 1944 on the sale of cattle used for breeding purposes is taxable as ordinary income, or as capital gain under the provisions of section 117 (j) of the Internal Revenue Code.

This issue affects only Franklin Flato and his wife, Grace, who filed community property tax returns.

Prior to the taxable years, 1950 U.S. Tax Ct. LEXIS 161">*182 Franklin Flato acquired a ranch on which he raised beef cattle for sale. In 1943 Franklin decided to sell the ranch and all the cattle except a few which he transferred to a newly acquired ranch. The sale of the first ranch was completed in 1944. The ranch and cattle were sold separately. Some of the cattle sold in those years were the young animals sold as the product of the business of raising beef. The other cattle sold were the breeding stock, the sale of which was not a part of the ordinary business of raising beef cattle and more analogous to the liquidation of a business. The amounts received from the sale of the breeding cattle were reported as long term capital gains and not as ordinary income as the respondent contends they should be.

14 T.C. 1241">*1250 We can see no substantial difference between the situation in this issue and the cases of Isaac Emerson, 12 T.C. 875, and Fawn Lake Ranch Co., 12 T.C. 1139. Both of these cases followed Albright v. United States, 173 Fed. (2d) 339, in which the court said:

In order for the taxpayer to come within the provisions of section 1171950 U.S. Tax Ct. LEXIS 161">*183 (j) permitting him to treat the sales from his dairy and breeding herds as sales of capital assets, the burden is upon him to show: (1) that the animals sold were used in his trade or business; (2) were subject to allowance for depreciation; (3) were held for more than six months; (4) were not property of the kind includible in the inventory of the taxpayer if on hand at the close of the taxable year; and (5) that the animals were not held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. * * *

The respondent contends that the petitioners have failed to show that the breeding cattle were not held primarily for sale in the ordinary course of the business. We can not agree. The respondent's position in this respect is the same as taken in the above cited cases, from which position he has not receded here. On the authority of those cases we therefore hold that the sale of breeding cattle should be considered a capital gain under the provisions of section 117 (j).

Decision will be entered under Rule 50.

Black, J., dissenting: I dissent from the majority opinion wherein it refuses to recognize the validity of the six trusts1950 U.S. Tax Ct. LEXIS 161">*184 here involved and taxes all the income to the beneficiaries.

My dissent is based on the following: (1) The trusts were irrevocable; (2) the income was distributable within the discretion of the trustees; and (3) the income which was distributed to the beneficiaries in each of the taxable years was returned for taxation by them and the remainder of the income was returned for taxation by the trusts. This was, in my opinion, proper.

That the trusts were irrevocable is shown by the following provision in each trust:

This Trust Estate shall be and remain irrevocable and not subject to modification, alteration, or revocation, and in no event shall the Trustor have the right to repossess the income or principal of the Trust Estate, or any part thereof, during his lifetime.

That the trusts were discretionary trusts is shown by the following provision in each trust:

From and after the creation of this Trust Estate, as nearly as may be, the Trustee shall, in his discretion, pay to [the named beneficiary], all, or such portion as he deems reasonable and proper, of the net income of this Trust Estate, accumulating all surplus income and adding it to the principal of the Trust Estate.

14 T.C. 1241">*1251 1950 U.S. Tax Ct. LEXIS 161">*185 The law itself provides how the income of a discretionary trust shall be taxed. Section 162 (c), I. R. C. provides as follows:

SEC. 162. NET INCOME.

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that --

* * * *

(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estates, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

Apparently in the instant case the foregoing provisions of the law have been complied with and, so far as I can see, the law does not require more. I do not agree that the entire income of the trusts, whether distributed or not, is taxable to the1950 U.S. Tax Ct. LEXIS 161">*186 beneficiaries under the doctrine of Helvering v. Clifford, 309 U.S. 331">309 U.S. 331; Edward Mallinckrodt, Jr., 2 T.C. 1128; affd., 146 Fed. (2d) 1; Edgar R. Stix, 4 T.C. 1140; affd., 152 Fed. (2d) 562. These cases, relied upon by the majority in support of its conclusions, are, in my opinion, not applicable to the facts which are present here. If, by the majority opinion, it is meant that the six trusts could not become partners in the partnership which was organized by proper partnership agreement, then it seems to me that such holding is contrary to the weight of authority and is wrong. Cf. Thompson v. Riggs (CA-8), 175 Fed. (2d) 811.

Because of the foregoing reasons, I respectfully dissent.