Appeal from the District Court of the United States for the Western District of Pennsylvania; Robert M. Gibson, Judge.
Before CLARK and JONES, Circuit Judges, and GANEY, District Judge.
The taxpayer is the sole beneficiary of a trust hereinafter referred to as the Buildings Trust created by Section 6*fn1 of the will of her father, Henry C. Frick, who died December 2, 1919.Under the terms of the trust the entire net income from the trust corpus which consists of two large office buildings in Pittsburgh, Pennsylvania, known as the Frick Building and the Frick Building Annex, was to be paid to the taxpayer during her lifetime and after her death to such persons as she should appoint by will. The Union Trust Company of Pittsburgh was named trustee and has acted in that capacity ever since. Under Section 7*fn2 of his will, the testator, Henry C. Frick, created a trust known as the Endowment Trust, the purpose of which was the financing of extraordinary repairs to the Frick Building and the Frick Building Annex hereinabove referred to, which formed the corpus of the trust. The pertinent portions of the Revenue Acts of 1928 and 1932 covering taxation of trust income as between trustee and beneficiary in Section 162, 26 U.S.C.A.Int.Rev. Code, § 162.*fn3
In 1920 the first year of the operation of the said Buildings Trust, in addition to paying the local real estate taxes on the two buildings in question for that year, the trustee withheld from distribution and set aside in a separate bank account, hereinafter known as Account No. 2, the Reserve for Taxes Account, funds out of the 1920 income of the trust for the purpose of paying the real estate taxes on the buildings for the following year 1921. In 1921 and in each subsequent year, including those involved here (1930 to 1933 inclusive), the trustee used a part or all of the money in this reserve fund for the payment of real estate taxes on the said buildings and replenished the reserve fund by payments from current receipts, so that at the end of each year the amount in the reserve fund was substantially the same as the year before. In other words, the trustee had at the beginning of the year 1921 in Account No. 2, known as Reserve for Taxes Account, the taxes for that year which as has been indicated had been set up in 1920, and he then paid the real estate taxes for 1921 from this fund so set up, and had transferred from Account No. 1, known as the Rent Account, in which was deposited all receipts of rent, to Account No. 2, known as Reserve for Taxes Account enough to replenish Account No. 2, so that at the end of the year 1921, there was a sufficient fund set aside in this Account No. 2 to pay the taxes for the following year 1922. Accordingly then beginning in the year 1920, if we assume that the income of the trust, before any deduction for real estate taxes, was $1,000,000.00, and the trustee deducted $100,000. for real estate taxes for the current year 1920 and then created also from current receipts a fund of $100,000.00 for taxes for the year 1921, there was distributable to the taxpayer in the year 1920 a fund of $800,000.00 for which she was properly taxable and $200,000.00 properly taxable to the trustee. However, it is the contention of counsel for the taxpayer that every succeeding year, including the years in question, 1931-32-33, the taxpayer should by reason of this method of accounting not be taxable for the amount in Account No. 2, Reserve for Taxes Account, since it was an accumulation of current income withheld from distribution and taxable to the trustee. In furtherance of this position the taxpayer contends that in Pennsylvania, a trustee may retain or receive as a separate fund a part of a trust income of one year to pay taxes becoming payable the following year in the interest of judicious management, and in support of this contention cites a number of Pennsylvania cases: In re Mathues' Estate, 322 Pa. 358, 185 A. 768; In re Sinnott's Estate, 310 Pa. 463, 165 A. 244; In re Sternberger's Estate, 121 Pa.Super. 50, 182 A. 723.
Assuming the soundness of the Pennsylvania cases so cited, the most that can be said of them is that the trustee is given the right or discretion to withhold temporarily from distribution a sufficient amount of income to meet expenses falling due early in the following year. The statute here in question, Revenue Acts of 1928 and 1932, Sec. 161(a)(1), 26 U.S.C.A.Int.Rev. Code § 161(a)(1),*fn4 noted makes the only provision which deals specifically with accumulated income and when read in its entirety indicates that it is the only type of accumulated income that Congress intended should be known as trust income taxable to the trustee. An examination of Section 6 of the testator's will, Henry C. Frick, shows no direction to the trustee to withhold any part of the income or does it mention any discretion in the trustee to accumulate any part thereof, but provides clearly that the entire balance after payment of expenses is to be distributed to the taxpayer. The nub of the question therefore presented seems to be whether the temporary holding by the trustee, let us say in the year 1931, for real estate taxes, which are to be paid in 1932 is such a withholding and accumulation as to make the same taxable to the trustee rather than to the beneficiary. An accumulation has been defined in Bogert, Trusts and Trustees, vol. 1, chapter 13, § 217, as follows:
"An accumulation is an addition of income to the capital of the trust so that when it is disbursed, it will be paid out as a part of the corpus and not as current revenue. IF THE TRUSTEE SETS APART SOME INCOME AS A CONTINGENT FUND TO MEET FUTURE DEFICIENCIES IN INCOME OR FUTURE TRUST DEBTS, THERE IS A TEMPORARY WITHHOLDING OF THE INCOME SO TREATED, BUT THERE IS NOT AN ACCUMULATION. The sum set apart has not, and never will become a part of the capital sum"
The city and school taxes in Pittsburgh are payable in quarterly installments, the last payment of which is made in October and the County taxes are payable as early as May 31st, and accordingly the income withheld by the trustee from the preceding year was not therefore payable in January of the following year. As a matter of fact as the Government contends, since the trustee's income was well over a million dollars and the same came to it in rather equal monthly installments, and since total real estate taxes did not for any year exceed $185,000.00, there was no showing by the trustee that he did not have each year sufficient money from current income to meet these taxes when payable.
There is likewise no merit in the contention of the trustee that it had to withhold the money for its own protection lest it become personally liable for taxes in the event of the death of the beneficiary, or the expiration of the trust before the taxes were paid, since the registered owner of the trust property was the "Union Trust Company, Trustee for Helen C. Frick", not the Union Trust Company. Accordingly, only trust assets would be subject to the payment of taxes and not the assets of the trustee.
Since it is well settled that the question of whether trust income is distributable or not depends upon the trust instrument, Freuler v. Helvering, 291 U.S. 35, 54 S. Ct. 308, 78 L. Ed. 634; Baltzell v. Mitchell, 1 Cir., 3 F.2d 428, and since no provision was made in the trust instrument in the instant case, giving the trustee discretion to accumulate earning, but rather on the contrary the instrument shows clearly that the testator, Henry C. Frick, intended the entire net income of the Buildings Trust to be distributed to the taxpayer, we hold there was error in the interpretation by the lower court that the trust instrument gave the trustee discretion to accumulate income within the meaning of the applicable Revenue Statutes.
Even if we are to assume that under the Pennsylvania law the trust instrument by some construction did give the trustee discretion to accumulate income, it is submitted that the position of the lower court is nevertheless erroneous, because an analysis of the stipulations and exhibits offered, demonstrates that the taxpayer not alone received distributions equal to the amount of the total of the net income of the trust, but that the amounts so received were current income.
It was stipulated that all of the current income of the Buildings Trust Fund was paid into the current Rent Account, Account No. 1, and from this account was transferred (1) cash distribution to the taxpayer; (2) transfers to Account No. 2, "Reserve for Taxes Account"; (3) transfers to Account No. 3, the "Reserve for Elevators Account"; and (4) transfers to Account No. 4, the "Working Fund Account", from which all expenses, excepting real estate taxes, were paid.
Keeping in mind this method of handling current income from the Buildings Trust Fund and taking the year 1932 as an illustration (all the other years here in question are the same, except a difference in the amount of the figures), it is quite obvious that the taxpayer received all of the current income for that year. At the beginning of the year the net income of the Buildings Trust for the year 1932, after deduction for real estate taxes paid in that year, was $519,566.72; this amount did not include a balance on hand in Rents Account, No. 1, as of January 1, 1932, which amounted to $117,922.86, for as stipulated this was distributed in cash in February 1932 to the taxpayer and accordingly cannot be considered since it represents income received in the year 1931. As set forth in Defendant's Exhibit 7, total cash distributions to the taxpayer out of the Rent Account, not including the $117,922.86 heretofore referred to, amounted to $400,000.00; it was further stipulated that the income on securities held in Account No. 3, Reserve for Elevators, in the amount of $7,564.82, was distributed to the taxpayer, and also the balance in Account No. 1, being the Rent Account and No. 4, the Working Fund Account, less accounts payable, or $67,812.92; it was further stipulated that transfers to Account No. 3 amounting to $60,000.00 were to be treated as distributed to her; the addition of which amounts shows that the total actual distribution to the taxpayer or conceded to be distributed to her, was $535,377.74, which is $15,811.02 in excess of $519,566.72 the total stipulated net income of the Buildings Trust for the year 1932. Taking into account certain adjustments as shown on Defendant's Exhibit 7, the details of which need not be here gone into, we find the net amount distributed to petitioner to be $519,566.72, which is the stipulated net income both taxable and nontaxable of the Buildings Trust for the year 1932 after the deduction for real estate taxes. It will be noted in the computation as set forth by the Government in Exhibit 7, no amounts actually paid out for real estate taxes, nor the amounts transferred to, or held in Account No. 2, Reserve for Taxes Account, were included in the amounts distributed or distributable to the taxpayer.
In arriving at the income taxable to the trust and not taxable to the beneficiary, the Revenue Acts of 1928-1932, Section 162(c)*fn5 requires that before the net income taxable to the trust is determined, there must first be deducted the amount distributed to the beneficiary and the balance, if any, is taxable to the trust, and if we follow this procedure as set forth in the statute, we find as hereinabove indicated, that after deducting the amount actually distributed to the taxpayer from the amount of the stipulated net income, there is nothing taxable to the trust. The taxpayer on the other hand did not follow the statutory method as just indicated but in computing her taxes for the year 1932 took the sum of $518,343.15, (exclusive of $1223.57 tax for Municipal Bond interest which is included in the Government's computation above) which is the stipulated net income of the trust and deducts therefrom the sum of $147,958.40, the amount held in the Reserve for Taxes Account, for payment of 1933 taxes, which she claims is taxable to the trustee and the balance of $368,186.13 computed after certain adjustments is what she maintains is the amount taxable to her without considering that she actually received the full amount of income as before demonstrated. This we think is the reverse of that prescribed by the statute. It must be remembered that the stipulated net income of the Buildings Trust Fund for 1932 as shown in Plaintiff's Exhibit H of $518,344.15 was arrived at after deducting some ...