Fayen v. Commissioner

34 T.C. 630, 1960 U.S. Tax Ct. LEXIS 110

• Court: United States Tax Court
• Decided: June 30, 1960
• Docket: Docket No. 68428
• Status: Published

Opinions

Muuroney, Judge:

The respondent determined a deficiency in income tax against petitioners for the year 1953 in the amount of $1,366.10. Petitioner Carl F. Fayen was the trustee and life beneficiary of a trust and the only issue in the case is whether the amount of $4,664.37 which he paid into the principal of the trust, pursuant to a judicial settlement of a surcharge suit brought by remaindermen of the trust, is an allowable deduction under section 23(a) (1) (A) or section 23(a) (2), I.R.C. 1939.¹

FINDINGS OF FACT.

The stipulated facts are found accordingly. Carl F. Fayen (hereinafter sometimes referred to as petitioner) and Nancy P. Fayen were husband and wife during the year 1953 and they filed their joint Federal income tax return for said year with the district director of internal revenue at Richmond, Virginia. Nancy died and the only reason her estate and the administrator thereof, Robert W. T. Purchas, of Philadelphia, are involved in this proceeding is by virtue of the joint return which decedent filed with her husband.

Petitioner’s father, Frederick George Herman Fayen, died a resident of New Jersey on July 7, 1930. His will appointed his wife, Minnie, and his two sons, George and petitioner, and a bank (later discharged) as executors of his will and trustees of certain trusts created by the will. The will placed the residuary estate in. trust with income to be paid to Minnie for life and upon her death the trust property was to be divided into two equal portions, one to be held in trust for George and the other to be held in trust for petitioner Carl, with the net income therefrom to be payable to George and Carl during their lives with remainder over to their children. There were also provisions for contingent remainders.

Minnie Fayen died December 29, 1943, and on March 6, 1945, the Orphan’s Court of Essex County, New Jersey, confirmed division of the trust corpus into two equal parts as suggested by the surviving trustees. Each part was to be held in trust with George the life beneficiary of one trust and petitioner the life beneficiary of the other. The court also approved the resignations of Carl as cotrustee of the George S. Fayen Trust and George as cotrustee of the Carl F. Fayen Trust. This left petitioner Carl as sole trustee of a trust with assets of a market value of approximately $437,731 in 1945, of which he was the life beneficiary, with remainder over to his children.

The Fifth paragraph of the Frederick George Herman Fayen will provided, in part, as follows:

I empower my said Executors and Trustees to sell any or all of my real estate at their discretion, and to give good and sufficient deeds therefor, and to make leases of the same for such consideration and upon such terms as they shall deem to the interest of my estate; including the power to take, purchase money mortgages in part payment for any real estate sold by them.

I authorize my Executors and Trustees to continue any investment of my estate which I may leave at my death, and I direct that in making investments they shall not be limited to the class of securities prescribed by law for Trustees, but may invest in such good sound dividend paying stocks or interest bearing bonds, but preferably in First Mortgages on Montclair and environs real estate, as they may reasonable [sic] believe to be provident investments for my Estate, and I direct that they shall not be held responsible for loss arising without neglect or fault on their part.

On March 1, 1950, petitioner filed an intermediate accounting of his administration of the Carl F. Fayen Trust, with the Essex County Court, Probate Division, of New Jersey. The accounting covered the period from March 6, 1945, to November 30, 1949. Petitioner requested an allowance of $4,055.30 as commissions on the corpus of the trust fund, representing 1 per cent of $322,007.99, the amount of cash and securities taken over, plus $83,522.95 profits realized.

George H. Renton, as guardian ad litem for petitioner’s sons, remaindermen of the Carl F. Fayen Trust, filed exceptions to the aforesaid accounting, and requested that the trustee (petitioner herein) be surcharged in the amount of $64,973.94 (later reduced to $54,306.16 by an amended exception) for losses and depreciation alleged to have been sustained by reason of securities sold at a loss and securities which had depreciated below their purchase price. As grounds for the exceptions taken it was alleged (a) that the trustee’s primary concern in making investments had not been to preserve the value of the corpus of the trust estate; “rather he has jeopardized its preservation in an endeavor to increase income or corpus”; (b) that be bad speculated with the property in his charge; (c) that he had failed to diversify the investments, having invested less than 5 per cent in bonds and cash, iy2 per cent in preferred stocks, and 931/2 per cent in common stocks; and (d) that the stocks enumerated were not of the character “prescribed by law for Trustees” or “good sound dividend paying stocks” which the will of Frederick George Herman Fayen had authorized the trustee to invest in. The guardian for the’-contingent remaindermen filed exceptions to a smaller number of investments. The trustees of the George S. Fayen Trust, the other trust created by subdivision II, paragraph Third, of Frederick Fayen’s will, joined in these exceptions.

The issues in the accounting proceeding were settled during the hearing on the exceptions. The court approved the settlement and on January 8, 1952, entered a judgment in accordance therewith, directing Carl F. Fayen, as life beneficiary and trustee, from income to be received by him from the trust, to reimburse and pay into the principal of the trust the amount of $10,045, at least one-half of the said amount to be paid on or before December 31, 1952, and the remainder on or before December 31, 1953. Subject to the payment of such amount, the trustee’s account covering the period from March 6, 1945, to November 30, 1949, was “in all things allowed as reported.” The claim for trustee’s commissions was waived as part of the settlement. Petitioner was credited with undistributed income of $716.25 which reduced the amount to be paid by him from $10,045 to $9,328.75. The court further directed that certain allowances be made by the trustee from the principal of the trust for guardian ad litem and attorneys’ fees and costs, including a counsel fee and reimbursement for disbursements to the attorneys for the trustee, Carl F. Fayen. The last paragraph of the judgment states:

7. As part of the foregoing settlement, all of the excepted securities remaining in the hands of Carl F. Fayen, as trustee as aforesaid, shall be sold with all convenient speed.

In the year 1952 petitioner paid into the trust the sum of $4,664.37, and in 1953 he paid into the trust the balance due, or $4,664.37, thereby satisfying his liability under the consent judgment.

During the period 1945 through 1949, and during the year 1953, petitioner was a manufacturer’s representative selling technical and industrial material to utility companies. In the process of representation petitioner traveled to various cities and was away from home approximately 15 to 20 weeks in 1953 and for even longer periods during the years 1945 to 1949. Petitioner also owned a farm of about 613 acres at Leesburg, Virginia, which he managed and on which he worked.

During the year 1953 petitioner devoted an average of 13 hours per week to the management of the Carl F. Fayen Trust. He worked on the trust at least some part of each day during the average week. He subscribed to and read, in connection with his activities as trustee, numerous financial and business magazines. During 1953 petitioner made three trips to New York during which he consulted with Jorgenson, a stockbroker and partner in Hay dock, Schreiber and Company, concerning the trust investments. His time spent in managing the trust during the average week was as follows: 10 hours per week reading investment services and 3 hours per week writing letters and making telephone calls, traveling to consult a stockbroker, and consulting with a stockbroker. In 1953 petitioner paid $297 for subscriptions to investment services.

Petitioner bought and sold securities for the following number of trading days during the period set forth below:

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In his administration of the trust during the period from March 6, 1945, to November 30, 1949, petitioner made 50 separate sales of securities at a profit and 14 separate sales of securities at a loss. During the same period petitioner, in his administration of the trust, made 83 purchases of securities and sold 2 parcels of real estate in which he personally owned a one-half interest. In addition, 3 mortgages owned by the trust were sold in 1945 and 2 mortgages owned by the trust were sold in 1946.

During the years indicated in the schedule below, petitioner received income from the following sources:

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During the years 1945, 1947, 1948, and 1949 petitioner received no net income from his farming activities. During the year 1953 petitioner’s farm was operated at a net loss of $13,250.55.

During the year 1953 petitioner was not engaged in the carrying on of a trade or business as trustee.

OPINION.

The first question is whether the amount of $4,664.37 which petitioner paid in compromise of the surcharge suit is an allowable deduction under section 23(a)(1)(A). Since the cited statute allows as deductions “ordinary and necessary expenses paid * * * in carrying on any trade or business,” the question is whether petitioner was, in fact, carrying on a trade or business while acting as trustee of the Carl F. Fayen Trust. We hold he was not.

It cannot be said petitioner was one who regularly engages in the business of serving as executor or trustee. This seems to be the only occasion for his acting as trustee. Petitioner was a manufacturer’s representative selling technical equipment to various utilities and he was also engaged in managing and working on a cattle farm of approximately 613 acres that he owned. He testified he devoted “[o]n the average, about 13 hours a week” in the management of the trust and in the reading of various financial magazines and investment service publications. Upon the whole record we hold petitioner was not carrying on a trade or business while acting as trustee of the Carl F. Fayen Trust and his claim for deduction under section 23(a) (1) (A) is therefore denied. Estate of Hyman Y. Josephs, 12 T.C. 1069.

Petitioner’s alternative argument is that the $4,664.37 petitioner paid in settlement of the surcharge suit is deductible under section 23(a)(2). This statute allows as deductions certain nonbusiness expenses in the following language:

SEO. 23. DEDUCTIONS FROM GROSS INCOME.

In computing net income there shall be allowed as deductions:

(a) Expenses.—

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(2) Non-tbade ob non-business expenses. — In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.

Petitioner in his argument relies entirely upon the first part of the quoted statute, that the payment was an expense “for the production or collection of income.” No argument is made that the payment was for expense “for the management, conservation, or maintenance of property held for the production of income.”

In order to prevail petitioner must show the expenditure was for the production or collection of income. It is our view that on the record before us the expenditure to settle the surcharge suit is not an. expense paid for the production or collection of income. The case of Estate of Edward W. Clark, III, 2 T.C. 676, was based upon facts substantially similar to those in the instant case. There petitioner paid legal expenses in opposing a claim of mismanagement as trustee. In holding the expenditure for said legal expenses not deductible under the quoted statute, we said: “Obviously the expense was not paid or incurred ‘for the production or collection of income.’ No income was produced by the expenditure, nor was any collected. * * *”

The facts in Commissioner v. Heide, 165 F. 2d 699 (C.A. 2), reversing 8 T.C. 314, are much the same as those in the present case. There petitioner trustee waived his commissions on income and principal of the trusts and paid $3,000 in settlement of litigation in which the amount of his claimed commission was disputed and he was sought to be surcharged for negligence in handling the trust funds. He attempted to deduct the $3,000 under both the first and second parts of section 23(a)(2). In holding against petitioner’s contention, the court said:

In the case at bar however, it is not enough that the expense be incurred in carrying on the trust; it must be necessary to “the production of income,” or possibly to the “management, conservation, or maintenance” of the fund, and it seems to us impossible to regard it as such. True, restoration does become necessary, once the fund has been depleted; but obviously that cannot be the test, else it would cover deliberate invasions, which nobody maintains. The depletion itself must be necessary to the production of the income, or the management of the trust, and that it cannot be, unless we hold that, when one who engages to become a trustee and fails in his duty, his failure is “necessary” to the discharge of his office: surely, it takes hardihood to suppose that, when Congress chose that word, it meant to subsidize delinquent trustees in this way. Delinquent they are; for, although they undertake no more than reasonable care in the circumstances,9 by hypothesis they have failed even in that. * * * [Footnote 9 omitted.]

A similar case reaching the same result as the Heide case is Commissioner v. Josephs, 168 F. 2d 233 (C.A. 8), reversing 8 T.C. 583. There petitioner and his coadministrator settled suits in which they were charged with mismanagement and petitioner sought to deduct the share he paid in connection with said settlement and litigation expenses under the quoted statute. In holding the deduction was not sanctioned by the statute, the court stated:

It is not enough that an expense be paid or incurred in connection with an income-producing activity in order to fall within the first class of deductions allowed by 23(a) (2); as plainly provided by the statute, the expense must be necessary to and paid or incurred for the production or collection of income, * * *

Petitioner cites Bingham's Trust v. Commissioner, 325 U.S. 365, affirming 2 T.C. 853, and John Abbott, 38 B.T.A. 1290. In the latter case, decided before 23(a)(2) was added to section 23(a) by the Revenue Act of 1942, we held petitioner, who engaged in the business of acting as trustee, could deduct the amount he paid in settlement of a suit charging him with improper investment of trust funds. In the Bingham case, decided after the enactment of section 23(a)(2), it was held certain legal expenses paid by the trustees involving litigation in which the trustees unsuccessfully contested a deficiency claim based on taxable gain to the estate, and legal advice relating to tax and other problems arising from the expiration of the trust and the disposition of its assets, were all deductible under section 23(a)(2).

In the course of the opinion in the Bingham case' it is stated:

Section 23(a) (2) is comparable and in pari materia with § 23(a) (1), authorizing the deduction of business or trade expenses. Such expenses need not relate directly to the production of income for tbe business. It is enough that the expense, if “ordinary and necessary,” is directly connected with or proximately results from the conduct of the business. Kornhauser v. United States, supra, 276 U.S. 152, 153, 48 S. Ct. 219, 72 L. Ed. 505; Commissioner v. Heininger, supra, 320 U.S. 470, 471, 64 S. Ct. 252, 88 L. Ed. 171. The effect of § 23(a) (2) was to provide for a class of non-business deductions coextensive with the business deductions allowed by § 23(a) (1), except for the fact that, since they were not incurred in connection with a business, the section made it necessary that they be incurred for the production of income or in the management or conservation of property held for the production of income. McDonald v. Commissioner, supra, 323 U.S. 61, 62, 66, 65 S. Ct. 96, 97, 98, 100; and see H. Rep. No. 2333, 77th Cong., 2d Sess., pp. 46, 74-76; S. Rep. No. 1631, 77th Cong., 2d Sess., pp. 87-88.

An argument that is advanced is that the Abbott case held that an amount paid in settlement of a surcharge suit was deductible as an ordinary and necessary expense under section 23(a) by one who was engaged in the business of acting as trustee and the Bingham case, decided under the amendment or what is now section 23(a) (2)-, provides that an expenditure which would be deductible if the taxpayer were in the business of acting as trustee will now be deductible as a nonbusiness deduction if he is not in the business of acting as trustee.

This is the argument that we upheld in Julius A. Heide, 8 T.C. 314, and Hyman Y. Josephs, 8 T.C. 583. As stated earlier, both cases were reversed on appeal. The reversing opinions concluded that the Bmgham case did not hold section 23(a) (2) provided for nonbusiness deductions which are coextensive with the business deductions allowed by section 23(a) (1) (A) when the business character of the expenditure is lacking. As pointed out in Commissioner v. Josephs, supra, in the Bingham case the court was dealing with the second class of deductions mentioned in section 23(a)(2) “for the management, conservation, or maintenance of property held for the production of income.” It is not argued in the instant case that the expenditure made is of this class.

The opinion in the Bingham, case clearly points out that section 23(a) (2) provides for two classes of nonbusiness expenditures that would be deductible: Expenses for production or collection of income and expenses for management, conservation, or maintenance of property. Where the Bingham opinion states the effect of section 23(a) (2) was to provide for a class of nonbusiness deductions “coextensive” with the business deductions allowed by section 23 (a) (1) it adds “except for the fact that, since they were not incurred in connection with a business, the section [23(a)(2)] made it necessary that they be incurred for the production of income” or for managerial services.

While the facts here are somewhat different from those in the Heide case and the Josephs case we agree with the conclusions reached by the Courts of Appeals of the Second and Eighth Circuits in those cases that an amount paid by a trustee or administrator in settlement of a surcharge suit is not deductible under 23(a) (2). Any holding to the contrary in our opinions in Julius A. Heide, supra, and Hyman Y. Josephs, supra, will no longer be followed.

We do not feel that the Bingham case is a mandate requiring a holding that an expenditure which might be deductible under section 23(a) (1) (A), if its business character is established, must be held deductible under section 23(a)(2) when the business character is not established, without first satisfying the conditions of section 23(a) (2) that it be an expenditure for the production or collection of income or an expenditure for the management, conservation, or maintenance of property, held for the production of income.

Petitioner mentions often in his brief that there was no judicial finding of his culpability. We cannot see how this fact adds anything to the argument when the question is whether the payment was for the collection or production of income. Petitioner admits the expenditure was for settlement of the surcharge suit as were the expenditures in the Heide and Josephs cases. Petitioner, if he seeks to have the deduction sanctioned under the first class of expenditures in section 23(a) (2), must first establish that the expenditure satisfies the condition of being for the collection or production of income. Whether the payment is made after a finding of mismanagement or in settlement of the surcharge suit is immaterial when the quest is whether it was for the production or collection of income.

We hold the $4,664.37 which petitioner paid in the year in question in compromise of the surcharge suit is not deductible under section 23(a) (1) (A) or section 23(a) (2).

Reviewed by the Court.

Decision will be entered for the respondent.

TURNER, J., dissents.

1 All section reference» aro to the Internal Revenue Code of 1939.