Petitioner was the grantor of four trusts. Because the trustee of the trusts had the power to add beneficiaries, the trusts were grantor trusts pursuant to
84 T.C. 667">*668 OPINION
Respondent determined a deficiency of $ 27,618 in petitioners' Federal income tax for the taxable year 1978. The issues for decision are: (1) Whether
This case was submitted fully stipulated pursuant to Rule 122. 2 The stipulation of facts and the attached exhibits are incorporated herein by this reference. The pertinent facts are summarized below.
Petitioners Bernard and Joyce Madorin were residents of Chicago, Illinois, at the time they filed their petition in this case. On December 19, 1975, Bernard Madorin (petitioner), as grantor, established four separate 1985 U.S. Tax Ct. LEXIS 94">*96 irrevocable trusts: the Miles Trust; the Mark Trust; the Melanie Trust; and the Bernard Descendant's Trust. The trust agreement designated Richard Coen (Coen) as the trustee of each of the four trusts. Coen was at all times a "nonadverse party" as defined by section 672(b). Further, he was not a "related or subordinate" party as defined by section 672(c). A provision in the trust agreement gave the trustee the power to add one or more section 501(c)(3) charitable organizations as beneficiaries to any of the trusts. As a result of this provision, petitioner, the grantor, was 84 T.C. 667">*669 treated as the owner of the four trusts pursuant to the provisions of
On or about December 19, 1975, petitioner funded each of the trusts with $ 5,075 in cash. Petitioners filed United States Quarterly Gift Tax Returns (Forms 709) with respect to the gifts. The $ 5,075 gift to each trust was its only funding.
On December 19, 1975, each of the four trusts contributed $ 5,010 to Metro Investment Co. (Metro), an Illinois partnership. The trusts each acquired a one-ninth interest in Metro. On or about December 22, 1975, Metro contributed $ 45,000 to Saintly Associates (Saintly), a partnership 1985 U.S. Tax Ct. LEXIS 94">*97 involved in servicing the production of motion pictures. Of the $ 45,000 invested, approximately $ 20,000 was attributable to the contributions made by the four trusts. On October 17, 1975, Saintly had entered into an agreement with Warner Bros., Inc., to perform all services necessary to produce a motion picture. To finance the performance of these services, Saintly obtained a nonrecourse loan of $ 3,270,000 from Security Pacific National Bank.
On petitioners' 1975 through 1977 Federal income tax returns they reported the following losses and income from the four trusts:
1975 | Loss | ($ 50,709.60) |
1976 | Loss | (20,753.92) |
1977 | Income | 1,544.28 |
On January 1, 1978, Coen, the trustee of the four trusts, irrevocably renounced his power to add beneficiaries to each trust. As a result, the trusts ceased to be grantor trusts and petitioner, the grantor, was no longer considered the owner of the trusts under
In August 1981, respondent sent petitioners a notice of deficiency. Relying on
Petitioners contend that example (
It is well established that regulations "must be sustained unless unreasonable and plainly inconsistent with the revenue statutes."
We note, however, that "Regulations must, by their terms and in their application, be in harmony with the statute. A regulation which is in conflict with or restrictive of the statute is, to the extent of the conflict or restriction, invalid."
The 1985 U.S. Tax Ct. LEXIS 94">*102 Supreme Court has ruled that statutory terms should be given their "usual, ordinary and everyday meaning."
Petitioners set forth several arguments toward establishing that "owner" as defined in example (
Where it is specified in this subpart that the grantor or another person shall be treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of the 84 T.C. 667">*672 trust which are attributable to that portion 1985 U.S. Tax Ct. LEXIS 94">*103 of the trust to the extent that such items would be taken into account under this chapter in computing taxable income or credits against the tax of an individual. * * *
Petitioners assert that the plain language of
Second, petitioners point to the legislative history of
We find petitioners' argument to be unpersuasive. The authorities cited in support of petitioners' argument do not specifically state that "owner" was used solely as a device to include items of deductions, losses, and other allowances. 81985 U.S. Tax Ct. LEXIS 94">*105 1985 U.S. Tax Ct. LEXIS 94">*106 84 T.C. 667">*673 Absent a clear and unambiguous legislative directive in this matter, limiting the usage of the word "owner," we will apply the usual, ordinary, and everyday meaning of the word.
Third, petitioners argue that a grantor trust maintains its existence as a transactional entity separate and distinct from its grantor for Federal income tax purposes. In support of their contention, petitioners direct us to several cases. Petitioners' reliance upon these cases is misplaced.
Petitioners rely heavily upon
In
The "grantor trust rules" treat the grantor as if he were the owner in cases where he has reserved to himself some of the powers normally attendant to 84 T.C. 667">*674 outright ownership. Thus, their design is to expand the coverage of the taxing statute. On the other hand, Subchapter S was enacted as a remedial measure to relieve qualifying small business corporations of a tax otherwise payable.
We, therefore, think that
Petitioners also cite
In
84 T.C. 667">*675 We cannot accept the government's contention that in this case Swanson, the grantor of the grantor-trusts, is not deemed the owner of the trusts for any purpose other than that of taxing trust income to him, and trusts, therefore, retain their identity as a separate tax entity under Section 101(a)(2)(B). 1985 U.S. Tax Ct. LEXIS 94">*110 [
When a grantor or other person has certain powers in respect of trust property that are tantamount to dominion and control over such property, the Code "looks through" the trust form and deems such grantor or other person to be the 1985 U.S. Tax Ct. LEXIS 94">*111 owner of the trust property and attributes the trust income to such person. See
Petitioners also rely upon
We need not comment on the result reached by the Second Circuit in
84 T.C. 667">*677 In the instant 1985 U.S. Tax Ct. LEXIS 94">*114 case, there is an interplay between
This scheme of taxation is frustrated here if petitioners are allowed to escape recapture through a formalistic, piecemeal application of the law. The trusts were created with a built-in defect, causing them to be grantor trusts. The trusts then invested in a limited partnership interest that produced significant paper losses for the grantor. At the "cross-over" point, when the partnership began to 1985 U.S. Tax Ct. LEXIS 94">*115 generate income, the defect in the trusts was cured, and the tax burden was placed on the lower bracket beneficiaries. A formalistic approach, as suggested by petitioners, would result in a finding that ownership never changed hands -- since the trusts have technically been the owners of the partnership interests -- which would then allow petitioners to escape recapture.
Although
The grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.
Because the trustee, the nonadverse party, has a power of disposition over all of the corpus and income, the grantor must be considered owner of the whole trust, both income and corpus.
Petitioners also contend that even if the grantor is the owner of the trust assets, a mere change in the trust's status is not a disposition triggering the recognition of gain. On brief, petitioners argue that a sale or other disposition did not occur, noting 1985 U.S. Tax Ct. LEXIS 94">*117 that no transfer documents were ever executed, nor was there any other method of conveyance at the time of trust perfection. While this is true in form, a different event took place in substance.
The situation at hand is analogous to cases dealing with part-sale, part-gift transactions. Under
84 T.C. 667">*679 Petitioners finally contend that, applying
We do not agree with respondent's contention that an examination of the ownership test of the family partnership rules is inappropriate in a grantor trust situation.
Except 1985 U.S. Tax Ct. LEXIS 94">*119 as provided in such subpart E, income of a trust is not included in computing the taxable income and credits of a grantor or another person solely on the grounds of his dominion and control over the trust. However, the provisions of subpart E do not apply in situations involving an assignment of future income, whether or not the assignment is to a trust. * * *
In addition, this Court has noted that the language of
We do agree, however, with respondent that the grantor trust provisions result in the grantor's being treated as the owner of the partnership interest. We do not accept petitioners' contention that the application of
84 T.C. 667">*680 We do not think that a detailed analysis of the interrelationship of the grantor trust provisions and
Petitioners argue that if example (
In the Treasury explanation accompanying the regulation, the Government stated that the regulation would have retroactive effect by reasoning that "these amendments merely clarify the existing regulations by setting forth the long-established ruling and litigating position of the Internal Revenue Service."
Generally, regulations are applied retroactively unless the Secretary provides otherwise.
We find no abuse of the Secretary's discretion in the instant case. This is not a case where the regulation in question alters settled prior law upon which the taxpayer justifiably relied and the alteration causes the taxpayer to suffer 1985 U.S. Tax Ct. LEXIS 94">*123 inordinate harm. See
As previously noted, the trusts invested in Saintly via another partnership, Metro. Metro did not have any unrealized receivables or substantially appreciated inventory. Saintly, however, did have unrealized receivables. 15 As a result, respondent determined that the gain on the disposition of the partnership interest by petitioners should be taxed as ordinary income.
Petitioners argue that because the trusts' investments were in Metro, and not in Saintly, directly, 1985 U.S. Tax Ct. LEXIS 94">*124 the disposition that 84 T.C. 667">*682 occurred was a disposition of a partnership interest in Metro, not Saintly. Accordingly, they conclude that the gain should be taxed as capital gain and not ordinary income. We disagree.
Legislative intent in enacting
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the year in question.↩
2. All Rule references are to the Tax Court Rules of Practice and Procedure.↩
3.
"In 1975 C, an individual, creates T, an irrevocable trust. Due to certain powers expressly retained by C, T is a 'grantor trust' for purposes of subpart E of part 1 of subchapter J of the Code and therefore C is treated as the owner of the entire trust. T purchases an interest in P, a partnership. C, as owner of T, deducts the distributive share of partnership losses attributable to the partnership interest held by T. In 1978, when the adjusted basis of the partnership interest held by T is $ 1,200, C renounces the powers previously and expressly retained that initially resulted in T being classified as a grantor trust. Consequently, T ceases to be a grantor trust and C is no longer considered to be the owner of the trust. At the time of the renunciation all of P's liabilities are liabilities on which none of the partners have assumed any personal liability and the proportionate share of which of the interest held by T is $ 11,000. Since prior to the renunciation C was the owner of the entire trust, C was considered the owner of all the trust property for Federal income tax purposes, including the partnership interest. Since C was considered to be the owner of the partnership interest, C not T, was considered to be the partner in P during the time T was a 'grantor trust.' However, at the time C renounced the powers that gave rise to T's classification as a grantor trust, T no longer qualified as a grantor trust with the result that C was no longer considered to be the owner of the trust and trust property for Federal income tax purposes. Consequently, at that time, C is considered to have transferred ownership of the interest in P to T, now a separate taxable entity, independent of its grantor C. On the transfer, C's share of partnership liabilities ($ 11,000) is treated as money received. Accordingly, C's amount realized is $ 11,000 and C's gain realized is $ 9,800 ($ 11,000 - $ 1,200)."
4. Respondent claims petitioners' 1978 taxable income was understated by $ 49,919.24. (We view as irrelevant the $ 0.76 difference between this amount and that shown in the schedule accompanying the notice of deficiency.) Such amount was determined in the following manner:
Petitioners' share of Saintly's unrealized | |||||||||||||
receivables via Metro | Petitioners' share of Saintly's unrealized receivables via Metro was determined as follows:
| ||||||||||||
Less: | |||||||||||||
Petitioners' adjusted basis in Saintly via Metro | Petitioners' adjusted basis in Saintly via Metro was determined as follows:
| ||||||||||||
Petitioners' realized gain per sec. 1001 | |||||||||||||
and regulations thereunder | 49,919.24 |
5. S. Rept. 1622, 83d Cong., 2d Sess. 364 (1954); H. Rept. 1337, 83d Cong., 2d Sess. A211 (1954).↩
6. S. Rept. 1622,
7. S. Rept. 1622,
8. Petitioners cite the following authorities in support of their proposition: II American Law Institute Federal Income Tax Statute, secs. X850-X860 (Feb. 1954 draft), and accompanying explanations: B. Bittker, Federal Income, Estate and Gift Taxation, ch. 80 (1981); Kamin, Surrey & Warren, "The Internal Revenue Code of 1954: Trusts, Estates and Beneficiaries,"
"The various sections in this subpart provide that "the grantor shall be treated as the owner" of certain portions of a trust. This seems to be the present rule, giving the grantor the trust's deductions. * * * The
"The scope of the ownership rule is provided in section X850 [corresponding to
[II American Law Institute Federal Income Tax Statute,
We do not find this to be conclusive or convincing proof that Congress intended to use the word "owner" only for the purpose of attributing income, deductions, and credits to the grantor.
9. Prior to the Tax Reform Act of 1976, a trust was not permitted to be a shareholder of a subch. S corporation under
10. While we specifically limited our analysis to an interplay between sec. 678 and other provisions of subch. J, 69 T.C. 175 n. 17, we believe that a similar analysis is appropriate in the instant case.↩
11. The Commissioner has recently announced that the Service will not follow the decision in
12. We noted this result in
13. In
14.
15. Petitioners do not contest respondent's determination that Saintly has unrealized receivables or their amount. We will, therefore, treat these issues that have not been raised by petitioners, as conceded by them. Rule 34(b)(4).↩
16. (1) unrealized receivables of the partnership, or (2) inventory items of the partnership which have appreciated substantially in value,↩
17. S. Rept. 1622, 83d Cong., 2d Sess. 98 (1954); H. Rept. 1337, 83d Cong., 2d Sess. 70 (1954).↩
18. Under new