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Darr v. Kervick

Decided: February 9, 1960.

EARL A. DARR AND FRANK A. BIBA, SURVIVING EXECUTORS OF THE ESTATE OF KATHERINE KRAFT, DECEASED, APPELLANTS,
v.
JOHN A. KERVICK, TREASURER OF THE STATE OF NEW JERSEY, ACTING AS THE DIRECTOR OF DIVISION OF TAXATION, DEPARTMENT OF THE TREASURY, STATE OF NEW JERSEY, RESPONDENT. IN THE MATTER OF THE TRANSFER INHERITANCE TAX ASSESSMENT IN THE ESTATE OF KATHERINE KRAFT



On appeal from Determinations of Acting Director of Division of Taxation, Department of the Treasury.

For affirmance -- Chief Justice Weintraub, and Justices Burling, Jacobs, Francis, Proctor, Hall and Schettino. For reversal -- None. The opinion of the court was delivered by Burling, J.

Burling

The appellants, executors of the estate of Katherine Kraft, prosecuted an appeal to the Superior Court, Appellate Division, from an assessment of the Acting Director of the Division of Taxation holding the corpus of a trust created by decedent inter vivos subject to the state transfer inheritance tax. While the cause was pending in the Superior Court, Appellate Division, and prior to arguments there, we certified it on our own motion. R.R. 1:10-1.

On May 26, 1924 decedent and her husband were possessed of 715 shares of stock in a corporation known as A. Schrader & Sons, and four lots of land owned in the husband's name located in the State of New York; of this property, 350 shares of the stock belonged to decedent absolutely and the remainder to her husband absolutely (including the land). On that date Kraft's Corporation was created and 100 shares of capital stock were issued by it. Fifty-one of these shares were given to the husband in exchange for his property described above. Forty-nine of these shares were given to decedent in exchange for her property described above. On [31 NJ Page 480] the same day both decedent and her husband executed trust instruments with respect to the stock. By the instrument executed by her, decedent, as settlor, declared herself trustee of the 49 shares of Kraft's Corporation stock which she had only just acquired. The net income from the corpus was to be paid to decedent's husband for his life. Upon the husband's death, the principal was to be divided into as many shares as there were children surviving him and children not surviving him but leaving issue living at the husband's death. If the husband died without children or issue of children surviving him, the corpus was to revert to decedent. Otherwise, however, that portion of the principal representing shares of surviving issue of deceased children was to be distributed outright to such issue on the death of the life tenant. The shares of the children surviving the life tenant were to be held in further trust, the income of their respective shares to be paid to them for life. If these children should reach 35 years of age before dying, they were given a power of appointment, exercisable by will, with respect to their shares. Failing a valid exercise of such power, the share of the child so dying was to go to its living lawful heirs "as if such child had died intestate, a resident of the State of New York, and as if all of said property were real estate." All other trust property not otherwise disposed of was to be distributed to the living lawful heirs of decedent's husband as if he had died on the date of decedent's death intestate and a resident of the State of New York and as if such property were real estate. On the same date, decedent's husband executed a trust instrument creating a trust identical to that described above except that the life tenant was decedent. The corpus of this trust was the 51 shares of Kraft's Corporation stock owned by the husband. The transfers of the corporation's stock from decedent to herself as trustee and from the husband to himself as trustee were noted on the books of the corporation. It is the corpus of the first trust described above, that created by decedent, which the State seeks to tax.

At the time these trusts were created, decedent's husband was aware that he was suffering from pernicious anemia and would likely not recover. He did die within three months of the creation of the trusts described above. The transfer of the corpus of the trust created by him was taxed by the State as a transfer made in contemplation of death and this tax was sustained in the Prerogative Court. In re Kraft's Estate, 103 N.J. Eq. 543 (Prerog. 1928). Besides decedent, her husband was survived by three daughters. One of these died prior to her thirty-fifth birthday and without issue. Consequently the trust in her benefit created by decedent, consisting of one-third of 49 shares of Kraft's Corporation stock, lapsed and decedent took title to the property in accordance with the trust instrument. This property decedent transferred in her individual capacity to the trustees of the trust created by her husband (of which she was life beneficiary) to be retained and distributed according to the provisions of the instrument executed by her husband. This portion of the original corpus of 49 shares, amounting to 16-1/3 shares, was conceded by appellants to be taxable inasmuch as decedent received the income from these shares for her life, i.e., as a transfer intended to take effect in possession or enjoyment at or after decedent's death. R.S. 54:34-1(c) as amended. In an effort to divest herself of any interest which might remain in her by virtue of the trust which she created, decedent transferred to the New York Community Trust by gift on May 25, 1951 "all her present and future rights, property, claims and demands in anywise reserved to * * *" the decedent in the trust created by her. This transfer, of course, did not affect the trust created by her husband of which she was life beneficiary.

The questions raised by this appeal are: (1) whether the corpus of the trust created by decedent on May 26, 1924 is taxable other than to the limited extent conceded by appellants; (2) if so, whether the tax ought to be reduced to account for consideration received by decedent in exchange for the creation of the trust; (3) if the entire corpus of

the trust is held taxable, whether such tax violates the New Jersey and Federal Constitutions; (4) whether interest was properly assessed on the tax due; and (5) whether certain payments made to the Division of Taxation were properly applied by the Division. These matters will be treated in the order in which they are listed.

The facts show, and the appellants appear to concede, that the trusts created by decedent and her husband fall within the class of trusts denominated for tax purposes as reciprocal trusts. Under this doctrine, discussed and applied by this court in Newberry v. Walsh, 20 N.J. 484, 491-494 (1956), "the person who furnishes consideration for the creation of the trust is considered the settlor, although nominally another is the settlor." Hill's Estate v. Commissioner of Internal Revenue, 229 F.2d 237, 240 (2 Cir. 1956). The primary effect of this doctrine is to cause to be included within the decedent's gross estate (to use Federal Estate Tax terms) the corpus of a trust created by another which gives decedent an interest in the corpus which would cause it to be taxed to decedent had the interest been one reserved by decedent instead of granted to him, provided the trust was created by the other person as part of a plan whereby decedent creates a similar trust in favor of the other person in exchange for the trust created by him. Lehman v. Commissioner of Internal Revenue, 109 F.2d 99 (2 Cir. 1940), certiorari denied 310 U.S. 637, 60 S. Ct. 1080, 84 L. Ed. 1406 (1940); Commissioner of Internal Revenue v. Warner, 127 F.2d 913 (9 Cir. 1942); 1 Bowe, Estate Planning and Taxation, ยง 12.40 (1957). Some federal courts, dealing with problems arising under the Federal Estate Tax, have stated that trusts will not be considered reciprocal unless they were the result of a bargained for agreement. See, e.g., Newberry's Estate v. Commissioner of Internal Revenue, 201 F.2d 874, 38 A.L.R. 2 d 514 (3 Cir. 1953); McLain v. Jarecki, 232 F.2d 211 (7 Cir. 1956). This court, however, has declined to adopt such a proof requirement in connection with the state transfer inheritance tax, demanding

only that it be proved that the trusts arose out of an informed and intended exchange of similar property causing a situation where some elements of ownership of the property are not lost to either party, even though the transfers, examined individually and without relation to each other, appear to divest the donor of any taxable incident of ownership. Newberry v. Walsh, supra, 20 N.J., at pages 491-494. The doctrine is in essence nothing more than an application of the rule that for tax purposes the substance and not the form of the transaction will be controlling. Id., 20 N.J., at pages 493-494.

Appellants argue that the reciprocal trust doctrine can have no application here where the trust created by decedent herself is sought to be made subject to taxation. They contend that since the corpus sought to be taxed, i.e., that affected by the trust instrument executed by decedent, was the subject of a complete and absolute inter vivos gift, no transfer inheritance tax should apply. We cannot agree with this conclusion, however, and we hold that, under the ...


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