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C. C. ALBRIGHT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Albright v. Commissioner

Docket No. 47193.

United States Board of Tax Appeals

28 B.T.A. 82; 1933 BTA LEXIS 1191;

May 11, 1933, Promulgated

*1191 SECTION 704(b), REVENUE ACT 1928 - TAXABILITY OF INCOME TO THE BENEFICIARY OF A TRUST FILING AN ELECTION TO BE TAXED THEREUNDER. - Where the trustee under a declaration of trust which was created and operated for the sole purpose of liquidating real property as a single venture, distributing the proceeds therefrom in due course to or for the benefit of the beneficiaries and discharging indebtedness secured by the trust property, elected to be taxed under section 704(b) of the Revenue Act of 1928, the net income of the trust is taxable within the year when such income is earned by the trust, to the beneficiaries of the trust who are entitled to its ultimate distribution, whether actually distributed or not; and this is true whether a beneficiary makes his income tax returns on an accrual basis or on the cash receipts and disbursements basis.

George M. Thompson, C.P.A., for the petitioner.

Albert C. Baird, Esq., and R. W. Wilson, Esq., for the respondent.

BLACK

*83 In this proceeding respondent has determined against petitioner deficiencies as follows:

1924	$4,535.04
1925	25,920.69

The petitioner, during the years 1924*1192 and 1925, was a realtor, engaged in the business of subdividing and selling real estate and acting as sales agent for two real estate subdivision trusts designated as Trust No. 2 - 1569, Security Trust and Savings Bank, Trustee (sometimes hereinafter referred to as Trust No. 2 - 1569), and Trust No. S - 5925, Cahuena Park Title Insurance and Trust Company, Trustee (sometimes hereinafter referred to as Trust No. S - 5925). The trustee in each of these trusts filed notice of election to have the trust income taxed to the beneficiaries, for the taxable years involved in this proceeding, in accordance with the provisions of section 704(b) of the Revenue Act of 1928, which election was recognized by respondent and the income treated accordingly. The errors which petitioner claims the respondent has committed in his treatment of the distributable income of the trust in so far as it affects petitioner will be stated in the opinion.

The parties have filed a stipulation of facts to which were attached certain exhibits designated as Exhibits A, B, and C. Reports of internal revenue agents, adopted by the respondent in his determination of the deficiencies and referred to in the deficiency*1193 notice, were introduced in evidence for the purpose of showing the details of respondent's determination of the deficiencies.

From the stipulation filed, the exhibits attached thereto, and the internal revenue agents' reports we make the following findings of fact.

FINDINGS OF FACT.

The petitioner, C. C. Albright, resides in the city of Los Angeles, State of California.

During the years 1924 and 1925 he owned a 26.425/150ths beneficial interest in Trust No. 2 - 1569. Respondent determined that petitioner owned a 28.125/150ths beneficial interest.

Petitioner's distributive share of the net income of Trust No. 2 - 1569 for the year 1924 is $2,705.45 and not $2,879.50 as determined by respondent.

Petitioner's distributive share on account of his beneficial interest in Trust No. 2 - 1569 for the year 1925 is $15,103.01 and not $16,074.64 as determined by respondent.

Petitioner, in addition to being entitled to a pro rata share of the earnings of Trust No. 2 - 1569 based upon his beneficial ownership therein, was entitled, in accordance with an agreement entered into under date of November 1, 1923, between C. C. Albright (petitioner), *84 Harry H. Culver, and*1194 the syndicate holders of the said Trust No. 2 - 1569 (which agreement was submitted as petitioner's Exhibit B of the stipulation), to the payment of a further sum of $75,000, said sum to be paid at the time and in the manner set forth in the November 1, 1923, agreement, paragraph eight of which agreement is hereinafter quoted.

The proceeds of Trust No. 2 - 1569 were to be distributed in accordance with the agreement dated November 1, 1923, which is submitted as petitioner's Exhibit B of the stipulation. This agreement, which provides for the distribution of the trust proceeds, provides that all funds which are distributed to the sales agent and/or beneficiaries shall be distributed in the manner and with the order of priority listed in the agreement. Several of these priorities are not needed here and we think it is only necessary to quote paragraph eight thereof, which reads as follows:

Eighth: After all of the foregoing payments have been made, the balance shall be called "The General Profit", which said General Profit shall be distributed as available for distribution as follows:

(a) Forty per cent. (40%) thereof to the Syndicate Holders until Three Hundred Thousand ($300,000.00) *1195 Dollars, plus interest thereon at the rate of seven per cent (7%) per annum from January 1, 1924, to respective dates of realization, the Three Hundred Thousand Dollars and interest being hereinafter called the "Syndicate Profit", thereof has been so distributed to the Syndicate Holders;

(b) Twenty per cent (20%) thereof to Albright until Seventy-five Thousand [75,000.00) Dollars, plus interest thereon at the rate of seven per cent (7%) per annum from January 1, 1924, to respective dates of realization thereof, the Seventy-five Thousand Dollars and interest being hereinafter called "Albright's Profit," has been so distributed to said Albright.

(d) All, however, subject to the following conditions and limitations:

(1) No distributions of "Culver's Profit" shall be made to Culver while taking the cash then distributable under Subdivision Eighth, plus the unpaid portions of the sales price on outstanding contracts of sale, upon which the buyers are not in default, does not equal an aggregate figure sufficient to pay the Syndicate Profit and Albright's Profit, as well as Culver's Profit. But while*1196 such aggregate is so sufficient, Culver shall participate in such division on the forty per cent (40%) basis, but while it is not sufficient the distribution under this subdivision Eighth shall be made, one-third (1/3) to Albright and two-thirds (2/3) to the Syndicate Holders to apply on the Syndicate Profit and Albright's Profit, respectively; but, while the condition permitting distribution hereunder to Culver does exist, than if Culver is short in his forty per cent (40%) due to such one-third and two-third distributions to the Syndicate and Albright, he shall get all distributions until his distributions equal forty per cent of the total amount distributed under this subdivision Eighth;

(2) After the Syndicate Profit and Albright's Profit have been paid in full, then and thereafter all distributions under this Subdivision Eighth shall be made to Culver, even though they exceed the forty per cent.

*85 The sum of $75,000 to which the petitioner was entitled in accordance with the agreement dated November 1, 1923, marked "Petitioner's Exhibit B," from which above quotations are taken, was paid to him as soon as funds were available, said payments being made as follows: *1197

1926	$44,625
1927	19,000
1928	11,375

Respondent has allocated the sum of $75,000 to which the petitioner was entitled in accordance with the agreement dated November 1, 1923, as follows:

1924	$7,678.66
1925	46,200.71
1926	21,120.63

During the years 1924 and 1925, petitioner was one of the beneficiaries designated as first beneficiaries in Trust No. S - 5925, and owned a 15/126ths beneficial interest therein. In addition to being designated as one of the first beneficiaries of Trust No. S - 5925, petitioner was also designated in said trust instrument as one of the second beneficiaries and entitled to one half of the profits, if any, remaining after all other payments had been made as provided for in the declaration of trust creating Trust No. S - 5925.

The proceeds of Trust No. S - 5925 were to be distributed as provided in section 3 of said declaration of trust. This section provides for several priorities, but paragraph six seems to be the only one relevant to the issue to be decided here. It reads as follows:

6th: After payment in full of said debt secured hereunder, the surplus not required for either or any of the foregoing*1198 distributions - of the proceeds from such sale shall be disbursed by said trustee as follows:

First: To the return of advances if any advanced by the First Beneficiaries together with interest thereon.

Second: To the repayment of commissions.

Third: "Then to the payment, to the First Beneficiaries hereunder as their interests under this Trust then appear, of the following:

(a) Interest at the rate of six per cent (6%) per annum, payable quarterly, on the amount from time to time remaining unpaid of the $126,000.00 mentioned in the next paragraph as payable under this Trust to the First Beneficiaries hereunder; excepting such portion (if any) thereof as shall have been paid;

Which said interest - but not the principal - the Second Beneficiaries hereunder, by their approval of this Declaration, do promise and agree to pay;

(b) One Hundred Twenty-Six Thousand Dollars ($126,000.00) hereby declared payable solely under this Trust to the First Beneficiaries hereunder, as their interests appear.

*86 Fourth: After payment in full of all amounts mentioned in the foregoing distributions 'First,' 'Second,' and 'Third' then to the payment of another sum of One Hundred Twenty-six*1199 Thousand Dollars ($126,000.00) - without interest - also hereby declared payable solely under this Trust to the First Beneficiaries hereunder, as their interests under this Trust then appear.

Fifth: And the surplus, if any, of the proceeds from such sale shall be paid to said Second Beneficiaries hereunder as their interests under this Trust then appear.

IT IS EXPRESSLY UNDERSTOOD, that, upon payment in full to the First Beneficiaries hereunder of the hereinbefore mentioned two sums of One Hundred Twenty-six Thousand Dollars ($126,000.00) with said interest only upon the first thereof, all interest in and to this Trust of said First Beneficiaries - as such - thereupon immediately shall cease and determine."

Respondent in determining petitioner's net income for the year 1925 has, pursuant to section 3 of the declaration of trust designated No. S - 5925 (just quoted above), included in income the sum of $59,828.54 as second beneficiary's profit.

No distributions were made to the first beneficiaries, other than interest pursuant to the terms of section 3 of the declaration of trust designated No. S - 5925, by the trustee prior to December 31, 1925.

The trustee did not pay, *1200 and the petitioner did not receive during the years 1924 and 1925, any sum or sums representing amounts due second beneficiaries in accordance with section 3 of Trust No. S - 5925.

Petitioner's books of account during the years 1924 and 1925 were kept on the cash receipts and disbursements basis and his income tax returns were filed on the same basis.

OPINION.

BLACK: Section 704(b) of the Revenue Act of 1928, which is involved in this proceeding, is printed in the margin. ¹

*1201 The Commissioner in his determination of the deficiencies has determined the net income of the two trusts for each of the taxable years and has also determined the beneficiaries to whom it was distributable and in what amounts it was distributable to each. Petitioner does not contest the determination which the Commissioner has made of the net income of the trusts, but he does contest respondent's determination of the amount of such income which was distributable to petitioner in each of the taxable years.

*87 We think it will make for clarity if we discuss the trusts separately.

Trust No. 2 - 1569.

The Commissioner has determined the net income of this trust for the taxable years to be: 1924, $23,035.99; 1925, $146,932.11. Of the above amounts he has allocated, for the year 1924, to the petitioner the sum of $2,879.50 as his share of the profits distributable to the beneficiaries, and $7,678.66 designated as residuary profit. For the year 1925 the Commissioner has allocated to petitioner $16,074.64 as his share of the profits distributable to the beneficiaries, and $46,200.71 designated as residuary profit.

Petitioner does not contest respondent's allocation*1202 to him of his distributable share of the income for each of the respective taxable years on account of his being one of the beneficiaries of the trust. It has been stipulated, however, that this part of petitioner's share for each of the taxable years was somewhat smaller than that which respondent determined and effect will be given to this stipulation in a recomputation under Rule 50.

Petitioner does, however, contest the action of respondent in adding $7,678.66 to his income for 1924, and $46,200.71 to his income for 1925, under the designation of residuary profits from Trust No. 2 - 1569. Petitioner's assignment of error in this respect is stated in his petition as follows:

Petitioner, in addition to owning a 26.425/150ths interest in Trust 2 - 1569, is also entitled, in the nature of a commission or bonus under the terms of said trust to the sum of $75,000. This sum is not received on account of his beneficial interest and is therefore not taxable in accordance with section 704(b), Revenue Act of 1928, whether distributed or not, but is taxable in the year received.

We do not agree with this contention. Section 704(b) provides that the income of a trust coming within*1203 its provisions shall be taxable (whether distributed or not) to the beneficiaries.

As we view it, the question we have to decide is not whether the two amounts in question, $7,678.66 for 1924 and $46,200.71 for 1925, were actually distributed to petitioner during the taxable years, but whether such amounts were distributable income to him as a beneficiary of the trust in those years. If such profits were distributable income to him as a beneficiary of the trust, they are taxable income to him whether actually distributed or not.

H.R. 1, when it first passed the House of Representatives in 1928, did not contain any section 704(b). An amendment was added in the Senate as section 704(a) and (b). Section 704(b), as added by the Senate, gave these real estate trusts the option to file their election to be taxed as a trust and not as an association, but did not *88 make clear that the income of the trust was to be taxed to the beneficiaries whether distributed or not. The bill was amended in conference as follows: "On page 41 of the Senate engrossed amendments, line 21, after 'taxable' insert 'whether distributed or not'." In the statement accompanying the conference*1204 report to the House of Representatives, the managers on the part of the House had the following to say regarding section 704(b) as amended by the conference report:

Under existing law there is considerable confusion as to the proper distinction to be drawn between a trust and an association, particularly certain so-called real estate trusts. While it is not deemed advisable at this time to write into the statutes a more explicit definition of a trust and an association, it was desired by the Senate to make specific provision retroactively to make definite and certain the tax liability in the past of these organizations.

The House recedes with a clarifying amendment making it certain that the amounts will be taxable to the beneficiaries whether or not such amounts are actually distributed. [Italics supplied.]

Cf. ; .

An examination of the agreement entered into November 1, 1923, will show that the profits designated as general profits were to be divided (a) 40 percent to the syndicate holders until they should receive $300,000; (b) 20 percent to Albright (petitioner) *1205 until he should receive $75,000; (c) 40 percent to Culver.

There was no agreement that the syndicate holders should receive their 40 percent of the profits to a limit of $300,000 ahead of petitioner's 20 percent of the profits to a limit of $75,000. It was Culver's profits which were to be postponed and the agreement specifically provided that, when the profits were insufficient to make distribution of profits to Culver, the division of the profits should be made on the basis of one third to Albright and two thirds to syndicate holders.

This is what the respondent has done in his determination of the distributable income of the trust for the years 1924 and 1925, and we think it is in accordance with the agreement of the parties.

It is true that in the agreement of November 1, 1923, petitioner was designated as agent for the sale of the property when subdivided into lots and of course any commissions which were paid for the sale of lots were deductions from the gross income of the trust and do not constitute a part of the net income of the trust which the Commissioner has determined for the two taxable years. There is no contention that the Commissioner has refused to allow, *1206 as a deduction in determining the net income of the trust, any of the commissions paid for the sale of lots.

*89 In addition to the 20 percent commissions which were to be paid for the sale of each lot, Albright was to receive a division of what were designated general profits. This amount, as we have already stated, was to be 20 percent of said general profits not to exceed $75,000. These general profits were not deductible as a part of the expense of selling the lots.

It seems to us that this part of the agreement constituted Albright a beneficiary of the trust within the meaning of section 704(b), Revenue Act of 1928, and the amounts of these general profits which were his distributable share during the two taxable years in question were taxable to him, although he did not receive them until a later date and although he filed his income tax return on the cash receipts and disbursements basis. Respondent's action in this respect is approved.

Trust No. S - 5925.

Respondent in his determination of the deficiencies increased the petitioner's distributable share of the trust income as one of the first beneficiaries for the year 1924, from $7,876, as reported*1207 by petitioner in his return, to $11,319.86. Respondent added nothing to petitioner's income for the year 1924 on account of his being one of the second beneficiaries of the trust.

For 1925 respondent decreased petitioner's distributable share of income as one of the first beneficiaires of the trust from $6,999.16 to $3,680.15 and added to petitioner's income $59,828.54 as petitioner's share of the distributable income of the trust due the second beneficiaries. This latter item petitioner contests in his brief on the following ground: "Petitioner is not taxable upon any sums purporting to represent 'second beneficiary' profits from Title Insurance and Trust No. S - 5925, Cahuena Park, until such sums are actually received by the petitioner." An examination of the petition does not disclose any assignment of error corresponding to the above quotation from petitioner's brief.

The Board has held that unless an issue is raised by the pleadings, it is too late to raise it for the first time in the brief. However, even if it be conceded that petitioner's allegations in the petition are sufficient to raise the question as presented by his brief, we think he must fail.

As we have*1208 already pointed out in our discussion under Trust No. 2 - 1569, section 704(b) requires that the income of the trust described therein shall be taxable to the beneficiaries whether distributed or not. All that is required is to ascertain the beneficiaries to whom such income is distributable and what share each is entitled to receive. Upon the ascertainment of these facts, the income which *90 each beneficiary is entitled to receive is taxable to him whether distributed or not and whether he files his income tax return on an accrual basis or on the cash receipts and disbursements basis.

An examination of the revenue agent's report, which was approved by the Commissioner in his determination of the deficiencies, discloses that the revenue agent determined that the distributable net income of Trust No. S - 5925 for 1924 was $95,086.79, and for 1925, $150,570.31. The petition filed herein assailed this determination upon several grounds, but evidently these assignments of error have all been abandoned, because the stipulation contains no facts with reference to them and nothing is said about them in petitioner's brief. The only reason which petitioner urges as to why the*1209 $59,828.54, determined by respondent to be petitioner's distributable share for the year 1925 as one of the second beneficiaries of the trust, should not be added to his taxable income for that year, is that he did not receive that amount in 1925 and under the terms of the trust agreement could not possibly have received it in that year.

It must be remembered that we are dealing here with income and not the corpus of the trust estate. It is true that section 3 of the trust agreement, quoted in full in our findings of fact, provided that the first beneficiaries should first recover their full principal; viz, $126,000, and interest thereon at 6 percent, and then the first $126,000 of profits should be distributed to them, after which all their interest in the trust should cease. Then the second beneficiaries, of whom petitioner is one, were entitled to receive the balance of earnings. It is plain that the above agreement, under the facts stipulated, postponed the actual receipt of petitioner's share in these surplus earnings beyond the taxable year 1925, but that fact does not affect petitioner's right to their ultimate distribution.

The total profits of the trust in question*1210 for the years 1924 and 1925, as determined by respondent, were $245,657.10. Manifestly only $126,000 of this income belonged to the first beneficiaries under the terms of the agreement, and the balance was ultimately distributable to the two second beneficiaries, of whom petitioner was one. Because he was a second beneficiary of the trust makes him none the less a beneficiary. It is true that the payment to these second beneficiaries of their share of the profits had to be postponed until the first beneficiaries had not only received $126,000 in profits, but a return of their capital of $126,000, but this capital payment has nothing to do with the taxability of income - it simply affects the time of payment to the second beneficiaries of their share of the profits. The respondent has so treated it.

The first $126,000 of the $245,657.10 income of the trust for 1924 and 1925 respondent has held to be distributable to the first beneficiaries. *91 This resulted in none of the distributable income of the trust for 1924 being allocated to the second beneficiaries, but resulted in $119,657.07 of 1925 income being allocated to second beneficiaries. Of this, petitioner was held*1211 to be entitled to one-half, or $59,828.54, and it is this amount which respondent has added to petitioner's income for 1925 as income of second beneficiary. We think respondent's action in this respect is in accord with the contract agreement between the parties and the law which is applicable to the case. Cf. Trust No. 5522 and Trust No. 5654, , allegation (d) therein.

Respondent's determination in this respect is approved.

Reviewed by the Board.

Decision will be entered under Rule 50.

Footnotes

1. (b) For the purpose of the Revenue Act of 1926 and prior Revenue Acts, a trust shall, at the option of the trustee exercised within one year after the enactment of this Act be considered as a trust the income of which is taxable (whether distributed or not) to the beneficiaries, and not as an association, if such trust (1) has a single trustee, and (2) was created and operated for the sole purpose of liquidating real property as a single venture (with such powers of administration as are incidental thereto, including the acquisition, improvement, conservation, division, and sale of such property), distributing the proceeds therefrom in due course to or for the benefit of the beneficiaries, and discharging indebtedness secured by the trust property, and (3) has not made a return for the taxable year as an association. ↩

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