79 T.C. 846">*847 The Commissioner determined the following deficiencies in, and additions to, the petitioner's Federal income taxes: ²

The issues for decision are: (1) Whether the income1982 U.S. Tax Ct. LEXIS 16">*20 reported by a family trust created by Robert Luman is taxable to the petitioner, individually; (2) whether the petitioner is entitled to deduct under section 212 the expenses of establishing the family trust; and (3) whether the petitioner is liable for the addition to tax under section 6653(a) for negligence.

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found.

The petitioner, Doris B. Luman, was a legal resident of Wyoming at the time she filed the petition in this case. She and her husband, Robert B. Luman, filed joint Federal income tax returns for the years 1974, 1975, and 1976 with the Internal Revenue Service, Ogden, Utah.

The petitioner and her husband, who died on March 31, 1978, were, 1982 U.S. Tax Ct. LEXIS 16">*21 for many years prior to 1974, engaged in ranching in Sublette County, Wyo. They conducted their ranching activities on property (the ranch) which Robert Luman's 79 T.C. 846">*848 father acquired in 1904. This ranch was originally a part of the elder Luman's property, which included eight other ranches in Utah and Wyoming. At the time of the elder Luman's death, these other properties went to the elder Luman's other sons and daughters. These other properties have since been transferred out of the family so that by 1974 the only remaining family ranch was the ranch owned and operated by Robert and Doris Luman.

Mr. Luman wanted to retire from the ranching business. The Lumans consulted with their attorney, sometime prior to 1974, for his assistance in ensuring that this last Luman ranch remain within the family as long as possible. The attorney presented the Lumans with a proposal wherein the ranch would be placed in a trust with himself as the manager. For his services, the attorney would charge a fee of 20 to 25 percent of the income from the trust. The Lumans considered this fee to be exorbitant and rejected the proposal.

Subsequently, the Lumans' next-door neighbors approached them1982 U.S. Tax Ct. LEXIS 16">*22 with an offer to purchase their ranch. The offer was made through a certified public accountant who did work for both the Lumans and their neighbors. The Lumans rejected this offer because they wanted to keep the ranch within the family as long as possible.

On April 19, 1974, the Lumans were visited by two men, Logan Barclay and Frank Carnefix, who were representatives of Educational Scientific Publishers (ESP). Mr. Barclay and Mr. Carnefix sought to persuade the Lumans to establish a family trust, using forms provided by ESP. The Lumans saw this proposal as an opportunity to ensure the "orderly transfer of [their] assets to * * * [their] children when * * * [they] should be gone," and for such reason, the Lumans accepted the ESP proposal. The ESP family trust documents are drawn with a purpose of shifting the incidence of taxation from the grantor to the trust, but the discussions between the Lumans and the representatives of ESP included no discussions about taxes. The Lumans did not consult with an attorney before deciding to accept the ESP proposal because they lacked respect for attorneys as a result of their prior experience with attorneys.

The ESP family trust plan used1982 U.S. Tax Ct. LEXIS 16">*23 by the Lumans involved the creation of two trusts: the Robert B. Luman Educational Trust 79 T.C. 846">*849 (the educational trust) and the Robert B. Luman Family Estate (A Trust) (the family trust). On April 20, 1974, Robert Luman executed a declaration of trust by which he, as grantor, created the educational trust. The purpose of this trust was to provide the Lumans with information regarding the establishment and operation of the family trust. The trustees of the educational trust were the two representatives of ESP, Mr. Barclay and Mr. Carnefix. The Lumans paid this trust $ 20,000. The payment was, in effect, the fee charged by ESP for its assistance in establishing the family trust. Such assistance included the furnishing of forms for establishing the trust and advice from a lawyer, Paul Wright, and a CPA concerning the conduct of the trust as it related to the Lumans' business affairs. However, the Lumans received no legal advice in establishing the trust; in fact, they received no legal advice concerning the trust until 1976. The educational trust is no longer in existence.

On May 13, 1974, Robert Luman executed a declaration of trust creating the family trust. The original1982 U.S. Tax Ct. LEXIS 16">*24 trustees of the family trust were Doris B. Luman and Hazel Werner, a person unrelated to the Lumans. The declaration of trust gave the trustees the power to distribute "proceeds and income" in the trustees' unlimited discretion. The trust instrument also provided that a majority of all trustees was needed to constitute a quorum and to take any affirmative action. The trust instrument gave the trustees extremely broad powers respecting the trust property and the carrying on of any business. The trustees could amend the trust instrument by resolution "covering contingencies as they arise," and the minutes of the trustees' resolution authorizing any action were to be considered evidence that such an action was within their power. Finally, the trust instrument expressly declared "neither The Trustees, officers, or certificate holders, present or future, have or possess any beneficial interest in the property or assets of Said Trust." The certificates representing units of beneficial interest in the trust also expressly stated that "This certificate conveys no interest of any kind in The Trust assets, management, or control thereof."

At the first meeting of the board of trustees of1982 U.S. Tax Ct. LEXIS 16">*25 the family trust, held on June 25, 1974, Robert Luman was appointed a trustee of the family trust for life. He received a certificate 79 T.C. 846">*850 representing all 100 beneficial units of the family trust. By quitclaim deeds and other documents, the Lumans transferred virtually all of their property to the family trust. This property consisted of the ranch, such non-income-producing property as the family residence and its furniture and fixtures, and a number of stocks, bonds, and Treasury notes. However, the Lumans retained as their own property two automobiles, which they subsequently leased to the trust, but which they continued thereafter to use for both business and personal purposes. Both Robert Luman and the petitioner also transferred to the family trust the exclusive use of their lifetime services and any income therefrom. The Lumans had not received any such income in the recent past, and they did not anticipate receiving any in the future. Neither Robert Luman nor the petitioner received any income from personal services performed for anyone other than the trust in 1974, 1975, or 1976.

On June 26, 1974, the certificate evidencing Robert Luman's ownership of all 100 1982 U.S. Tax Ct. LEXIS 16">*26 units of beneficial interest in the family trust was canceled. On the same day, Robert Luman and the petitioner each received a certificate representing 50 units of beneficial interest in the family trust. On the next day, Hazel Werner, an original trustee, resigned, and she was replaced by a daughter of the Lumans, Roberta Luman Bacheller (the daughter), in July 1974. In November 1974, Robert Luman and the petitioner had their certificates of beneficial interest canceled. Robert Luman then received a new certificate representing 20 units of beneficial interest; the petitioner received a certificate representing 35 units; and each of the Lumans' three children received a certificate representing 15 units of interest. These children were all adults and were not dependent on Mr. Luman and the petitioner.

After the creation of the family trust, the Lumans operated the ranch in generally the same manner as they had prior to the creation of the trust. The trustees passed resolutions authorizing Robert Luman to manage the ranch and to invest trust income in stocks using his best discretion. The Lumans, as the trustees, prepared and executed minutes of their meetings in which they 1982 U.S. Tax Ct. LEXIS 16">*27 meticulously recorded their consideration and approval of investments and capital expenditures for the ranch and recorded their other decisions relating to the 79 T.C. 846">*851 investments of the trust and the management of the ranch. The minutes also reflect a decision by the trustees to purchase a new refrigerator for the residence, but it is not clear who paid for such refrigerator. Nevertheless, the Lumans continued to make decisions together as they had done prior to the creation of the trust. The daughter rarely attended the trustees' meetings, although she communicated with the petitioner weekly by letter and telephone regarding important ranch matters. The petitioner and the daughter occasionally overruled Mr. Luman regarding decisions to be made in managing the ranch.

The family trust filed fiduciary income tax returns for 1974, 1975, and 1976, and on such returns, it reported all income earned from assets transferred to the trust by the Lumans. It also deducted all expenses connected with the operation of the ranch, including the costs of leasing and maintaining the automobiles leased from the Lumans and the consulting fees paid to them.

The family trust reported the following1982 U.S. Tax Ct. LEXIS 16">*28 amounts for its first 6 months of operations (July 1 through December 31 in 1974) and for 1975 and 1976:

The trust utilized the accrual method of reporting its farm income, employing inventories in its computation. It sold no livestock in 1974. During 1975, the trust lost or consumed 9 cows, raised 117 calves and 2 horses, and sold 31 cows, 60 calves, and 2 horses. These livestock operations produced gross receipts of $ 10,566.39. During 1976, the trust lost 4 cows and 3 calves, raised 98 calves, and sold 67 yearlings, all of which produced gross receipts of $ 22,662.25.

The income of the family trust was distributed to the holders of the beneficial units in accordance with their interests in the trust. The petitioner and her husband reported their share of this distributed income on their Federal income tax returns for 1974, 1975, and 1976. In addition, for 1975 and 1976, they reported as income consulting fees of $ 3,000 received from the trust each year. These fees were paid for Mr. Luman's 79 T.C. 846">*852 managing the ranch. 1982 U.S. Tax Ct. LEXIS 16">*29 Finally, on their 1974 return, the Lumans deducted the $ 20,000 paid to ESP through the educational trust.

In his notice of deficiency, the Commissioner determined that all the income reported by the trust in 1974, 1975, and 1976 was includable in the income of Robert Luman and the petitioner for those years. The Commissioner removed the consulting fees of $ 3,000 from their taxable income for 1975 and 1976 because he included in their taxable income all trust income for those years. For 1974, the Commissioner disallowed the deduction taken by the Lumans for the payment to ESP on the grounds that the Lumans did not establish that this item was an expense of carrying on a trade or business or an expense incurred for the production of income. Finally, the Commissioner determined additions to tax for each year pursuant to section 6653(a) for negligence or intentional disregard of rules and regulations.

OPINION

This case represents another in a long series of cases arising out of the sale of "canned" trusts by ESP and similar organizations. ⁴ Although the Lumans created the family trust for legitimate estate planning reasons, the arrangement has raised several tax questions. Once1982 U.S. Tax Ct. LEXIS 16">*30 again, we direct our attention to them.

The first issue for decision is whether the income generated by the trust property is taxable1982 U.S. Tax Ct. LEXIS 16">*31 to the Lumans individually or to the trust they created. The petitioner maintains that the income from the trust property is taxable to the trust and to its beneficiaries as distributed, that the facts of this case are unique, and that because of such facts, this trust is distinguishable from the many family trusts which have been held ineffective to shift the burden of Federal income taxation. See, 79 T.C. 846">*853 e.g., Schulz v. Commissioner, 686 F.2d 490">686 F.2d 490 (7th Cir. 1982), affg. a Memorandum Opinion of this Court. On the other hand, the Commissioner maintains that the income from the trust property is taxable to the petitioner individually for three alternative reasons: (1) Because the trust has no economic substance; (2) because the trust effects an anticipatory assignment of income; and (3) because of the applicability of the grantor trust provisions of section 671 through 677. We will first consider the Commissioner's argument under the grantor trust provisions.

When the grantor of a trust retains any of the powers described in sections 673 through 677, he is treated, for income tax purposes, as the "owner" of that portion of the trust over which the1982 U.S. Tax Ct. LEXIS 16">*32 power extends. Where the grantor is so treated, section 671 includes in his income "those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account * * * in computing taxable income or credits against the tax of an individual." Secs. 1.671-2, 1.671-3, Income Tax Regs. These provisions apply if their conditions are met, regardless of the existence of a bona fide non-tax reason for creating the trust. One of the retained powers which will trigger the operation of the grantor trust provisions is contained in section 677.

Section 677 provides, in part:

SEC. 677. INCOME FOR BENEFIT OF GRANTOR.

(a) General Rule. -- The grantor shall be treated as the owner of any portion of a trust, * * * whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party or both, may be --

(1) distributed to the grantor or the grantor's spouse; [or]

(2) held or accumulated for future distribution to the grantor or the grantor's spouse; * * *

Nims, J., concurring: While I fully agree with the result reached in this case, I do not fully agree with the route by which it was reached. I regard this case merely as one more routine family trust case, and as such do not view 1982 U.S. Tax Ct. LEXIS 16">*50 it as an appropriate vehicle for an extended reexamination of the deductibility of estate planning expenses. In particular, I do not agree with the mixed signals we are sending out regarding the continued efficacy of Bagley v. Commissioner, 8 T.C. 130">8 T.C. 130 (1947).

Goffe, J., concurring in part and dissenting in part: I respectfully dissent as to the second issue. In my view, the majority has failed to heed the admonition of Justice Frankfurter, "The baby is not to be thrown out with the bath." International Salt Co. v. United States, 332 U.S. 392">332 U.S. 392, 332 U.S. 392">405 (1947). I fully recognize the problems that have been created by what the majority describes as "canned" trusts sold by ESP and others. Horvat v. Commissioner, 671 F.2d 990">671 F.2d 990 (7th Cir. 1982), affg. a Memorandum Opinion of this Court. Nevertheless, the instant case does not involve an attempt to tax income from personal services to a trust instead of taxing it to the true earner of the income. In its enthusiasm to deny the deduction for the $ 20,000 which petitioner and her husband paid for the 79 T.C. 846">*862 creation of the trust, 1982 U.S. Tax Ct. LEXIS 16">*51 the majority has seriously undercut the case law which permits deductions under section 212(2).

I was the trier of fact in this case. I agree with the findings of fact as stated by the majority but I do not agree with some of the inferences which it draws, and I strongly disagree with the manner in which the majority has applied the law.

The majority points out that petitioner received no legal advice regarding the trust until 1976. If this is interpreted to mean that petitioner received no advice from a lawyer until 1976, then it is correct. If, instead, it implies that petitioner and her husband received no advice as to the legal effect of having their property held in trust, then the inference is incorrect. As the majority points out, petitioner and her husband prepared and executed meticulous minutes of the meeting of the trustees. This fact demonstrates that they received considerable instructions on the law, the cost of which should be deductible as part of the cost of management, conservation, or maintenance of property held for the production of income. Petitioner, her husband, and their daughter carefully observed the legal distinctions brought about by the creation1982 U.S. Tax Ct. LEXIS 16">*52 of the trust.

I strongly disagree with the legal reasoning of the majority. Its opinion is in conflict with our previous holding in Bagley v. Commissioner, 8 T.C. 130">8 T.C. 130 (1947), as to what constitutes a deduction for estate planning under section 212(2). Indeed, the majority overrules that decision. Bagley was not appealed by the Commissioner, nor has it previously been criticized nor limited in its application, although it has been relied upon for a long period of time. In Schultz v. Commissioner, 50 T.C. 688">50 T.C. 688, 50 T.C. 688">700 (1968), we stated the following:

The record herein furnishes no basis for an allocation. Such being the case, we cannot determine to what extent the services included estate planning of the type which might give rise to a deductible expense under section 212. Nancy Reynolds Bagley, 8 T.C. 130">8 T.C. 130 (1947). * * *

The present case, involving a trust tainted with the pejorative connotations of an ESP trust which was expressly designed to shift income, is an exceedingly poor vehicle for reconsidering the parameters of section 212(2). The vast majority of estate planning expenses1982 U.S. Tax Ct. LEXIS 16">*53 are legitimate in all respects. I would not characterize the expenses which we allowed in Bagley as "investment advice" as does the majority, but would, instead, 79 T.C. 846">*863 describe them as estate planning expenses. The expenses incurred by the Lumans were for advice in the establishment and operations of an inter vivos trust, the income from which is deemed retained by them for life. Under the rationale of Bagley, the $ 20,000 fee paid by the Lumans is deductible.

Let us suppose, for example, that an elderly couple owns a large ranch with a large herd of cattle. They want their children to inherit the ranch and, in the meantime, want the ranch to be managed carefully. They consult their attorney, who is a member of a prominent, "silk stocking" law firm, who prepares an inter vivos trust to own the ranch in which the couple retains the income of the trust for life. They approve the trust agreement and appoint the trust department of a large bank as trustee because it has a very competent farm and ranch management department. Under the rationale of the majority in the instant case, the fee which the couple pays to their attorney is not deductible. But doesn't this fee1982 U.S. Tax Ct. LEXIS 16">*54 represent services rendered for the management, conservation, or maintenance of property held for the production of income? I think that it does and that such a fee should be deductible. I view the payment in my example, in Bagley, and in the instant case as coming within the plain language of section 212(2).

The majority attempts to bolster its holding by relying upon Epp v. Commissioner, 78 T.C. 801">78 T.C. 801 (1982). I likewise think Epp is a poor vehicle for overruling Bagley. I viewed Epp when it was filed as merely a case where the taxpayer failed to prove that the property she conveyed to the trust was income-producing property. In the instant case, the majority makes a point of the fact that the residence on the ranch was not income-producing property. The residence on an active, income-producing ranch has been held by us to be a part of the business premises of a ranch, and it follows, therefore, that it is an integral part of the income-producing asset, the ranch. McDowell v. Commissioner, T.C. Memo. 1974-72.

Lastly, the suggestion of the majority as to an allocation of such fees is unworkable. If 1982 U.S. Tax Ct. LEXIS 16">*55 I were an attorney preparing an estate plan, I could not conceive of a way to allocate my fee among the various results of my work in order for some of the fee to be deductible. Any allocation would be nothing more than a fiction.

79 T.C. 846">*864 I conclude, therefore, that the Court should have continued to apply the correct interpretation of section 212(2) as it did in Bagley.