Appeal from the United States Board of Tax Appeals.
Before MARIS, CLARK, and BIDDLE, Circuit Judges.
In its initial and, we think, fundamental, aspect the case at bar is simple. A transfers property to B in trust to pay its income to C for life. The trust is irrevocable and A retains no control over the income. Who, then, must pay the tax on that income? The statute, arbitrarily, perhaps, but explicity, taxes it to C, the beneficiary, or B, the trustee, as the case may be, but never to A, the grantor, 26 U.S.C.A. §§ 161, 162, cf. §§ 166, 167. That would be the short and easy answer were it not for certain factual complications in the establishment of the trust - the prior marriage of A and C, their contemporaneous separation agreement, and their subsequent divorce. These lead to a consideration of not only the pragmatic command of the statute, but also the contrary implications of a word used in its interpretation by the ultimate authority. For the Supreme Court has declared that where irrevocable trust income is used to discharge an "obligation" of the settlor, operation of the statute is not intended, and the settlor must bear the tax, Douglas v. Willcuts, 296 U.S. 1. 56 S. Ct. 59, 80 L. Ed. 3, 101 A.L.R. 391.
Just where the "obligation" ends and the intendment of the statute begains has been the subject of much learned explanation (and/or conjecture), see, 4 Paul & Mertens, Law of Federal Income Taxation § 34.168 (1939 Supp.); Magill, Taxable Income 207, 208; 52 Harvard Law Review 480 (note); 87 University of Pennsylvania Law Review 337 (note); Bloomenthal, Income Tax Aspects of Alimony Trusts, 17 Taxes 455; Hines, Tax Aspects of Property Settlement Agreements, 12 Southern California Law Review 386; Paul, Five Years With Douglas v. Willcuts, 53 Harvard Law Review 1. The dividing line may soon receive further binding delineation, see Helvering v. Fitch, certiorari granted October 9, 1939, 60 S. Ct. 103, 84 L. Ed. - reported below, 8 Cir., 103 F.2d 702; Helvering v. Leonard, petition for certiorari filed, 60 S. Ct. 511, 84 L. Ed. - reported below, 2 Cir., 105 F.2d 900. However, we think an accurate demarcation in the instant cause may be accomplished by testing our peculiar circumstance against the two main factors which pervade the controlling decisions.
The first is the nature of the "obligation" ruled upon. In all cases it has been "preexisting", i.e., alimony decreeable by court, Douglas v. Willcuts, above cited, the support of minor children, Helvering v. Schweitzer, 296 U.S. 551, 56 S. Ct. 304, 80 L. Ed. 389, a pre-existing debt, Helvering v. Blumenthal, 296 U.S. 552, 56 S. Ct. 305, 80 L. Ed. 390. The second, cognate to the first, is the element of tax avoidance.
As Professor Magill puts it:
" * * * the debtor has created a trust, the income of which is to be used to pay off the principal and interest of his obligations, remainder to himself or persons of his choice. If he paid off the debts directly out of his own income, he would have no deduction for the sums paid in discharge of principal. By useof the trust device he seeks to reduce his own taxable income by the amount of the income from the corpus of the trust; and thus in effect to obtain a partial deduction from his income for the amounts used to discharge his debts.
"Had the husband been required to pay the same amount of alimony directly, he would have been taxable upon the total amount of his net income with no deduction therefor. His income tax liability should not be changed by his creation of a trust to take care of his obligation for him."
Magill, above cited, pp. 213, 243.
A like possibility of sidestepping the nondeductibility of a capital outlay inheres, of course, in the application of trust income to the support of wives and minor children. What, therefore, is the "obligation", if any, and the avoidance, if any, implicit in the case at bar?
The income sought to be taxed arises from an irrevocable trust established in 1921 by petitioner-appellant for his wife, both residents of Pennsylvania. The trust is part of a separation agreement, which recites the marital differences of the parties, their living apart, and as consideration for the transfer in trust, the wife's release of her downer etc. rights. A fixed portion of trust income of if, need be, principal is payable in instalments to her for her support for life, subject to reduction if she remarries, while the balance of income, if any, goes to her husband.On her death the remaining principal reverts to him. As long as she lives, however, he must, if the total income falls below her portion, assign certain securities (comprising his interest in three decedent's estates) to the trust in order to make up the deficiency. The specific payment which the Board has found to be taxable to the husband is one made in 1934, thirteen years from the inception of the trust after the wife had obtained an absolute divorce and remarried (twice).
The divorce occurred in 1921 twenty days after the separation agreement was reached. At that time the statutes of Pennsylvania allowed alimony pendente lite, and on limited divorce (a.m.t.), see 23 P.S. §§ 46, 47. Provision for alimony on absolute divorce was made in but two cases: first, where the husband divorces the wife for "cruel and barbaroud treatment or indignities to his person", 1895, P. L. 308*fn1; second, where the divorced spouse, husband or wife, is insane, 1905, P.L. 211, 212.*fn2 As a consequence the courts were without power to decree alimony in any other circumstance to one freed from the bonds of matrimony. The theoretically indispensable sanction of express statutory authority was lacking, 17 Am. Jur. § 513; 2 Schouler on Marriage, Divorce, Separation, and Domestic Relations § 1757; 2 Vernier, American Family Laws § 104, p. 255. The rationale of that requirement has been tersely stated: "Diivorces a vinculo matrimonii were not decreed in ecclesiastical courts. Hence alimony was granted by them only as an incident to a divorce a mensa et thoro * * * . Except where the common law rule has been changed by statute, alimony cannot be awarded upon a divorce a vinculo matrimonii or sentence of nullity." Moore v. Moore, 64 Pa.Super. 192, 194. So the lawgivers of Pennsylvania have refused to advance a step beyond the medieval notion of alimony as an incident to limited divorce, see Shoop's Appeal, 34 Pa. 233. At the same time they have recognized the moern concept of absolute divorce. But no matter how great the wickedness of the husband - be he bigamist, bully, philanderer, or worse, see 23 P.S. § 10 - his innocent wife must risk the poorhouse to be rid of him. The miscreant must go on feeding her only if she is of mind to quit his bed and board alone, and, correspondingly, if his villainy is less, see 23 P.S. § 11. We may say that this rather unchivalrous anomaly is unique among the forty-eight states, see 2 Vernier, above cited, § 104, p. 263, § 105, Table 53, p. 272. Nevertheless, it is the law, Moore v. Moore, above cited, and see Moore v. Moore, 3 Cir., 255 F. 497; Myers v. Myers, 17 Pa. Dist. & Co. R. 236; Henry Oliver Rea v. Commissioner of Internal Revenue, 35 B.T.A. 1132; Robert Glendinning v. Commissioner of Internal Revenue, 36 B.T.A. 486.
By hypothesis, then the "obligation" here can have nothing to do with alimony, either decreed or decreeable. The conceded fact that the wife obtained the divorce establishes the petitioner-appellant as the offending party and rules out (anomalously again) any application of the divorce statute. It will not do, therefore, to play Hamlet without Hamlet and echo the reasoning of the leading case: "In the present case, the net income of the trust fund, which was paid to the wife under the decree, stands substantially on the same footing as though he had received the income personally ...