Samuel P. Hunt Trust v. USA

2003 DNH 223

• Court: District Court, D. New Hampshire
• Decided: December 30, 2003
• Docket: CV-02-375-JD
• Status: Published

Opinion

Samuel P. Hunt Trust v . USA CV-02-375-JD 12/30/03 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Samuel P. Hunt Trust F/B/O Mary C . Russell, by its Trustee, Citizens Bank, N H , and Samuel P. Hunt Trust F/B/O Elizabeth Marston, by its Trustee Citizens Bank, NH v. N o . 02-375-JD Opinio n N o . 2003 DNH 223 United States of America

O R D E R

The plaintiffs, two Samuel P. Hunt Trusts, bring suit

through their Trustee, Citizens Bank, N H , to recover taxes paid

on capital gains received in 1993 and 1996, together with

interest, contending that the gains were exempt as permanently

set aside for the Samuel P. Hunt Foundation, within the

requirements of 16 U.S.C. § 642(c)(2). The government asserts

that because the trust instrument, Samuel P. Hunt’s will (“the

Will”), gave the trustees broad powers to designate income and

principal, the gains in question do not qualify as exempt under §

642(c)(2). Both the plaintiffs and the government have moved for

summary judgment on an essentially undisputed factual record. Background

Samuel P. Hunt executed his last will and testament on

September 1 9 , 1951. Among other dispositions, Hunt established

three testamentary trusts, one for each of his nieces, Mary

Russell, Elizabeth Marston, and Constance McWhinney, and their

respective issue. The nieces and their issue were income

beneficiaries of their trusts. Hunt named Merchants National

Bank and Ralph A . McIninch as the trustees. Citizens Bank is the

successor to Merchants and became the sole trustee of the two

remaining trusts when McIninch died in 1993.1

At the same time that he executed the Will, Hunt created the

Samuel P. Hunt Foundation, a well-known New Hampshire charitable

organization, which received a tax exempt ruling from the

Internal Revenue Service (“IRS”) in 1953. The Foundation is the

remainder beneficiary of the testamentary trusts. The same

trustees served as trustees of the Foundation. Therefore, at present, Citizens is the only trustee of the Foundation, as well

as of the testamentary trusts, and is referred to in this order

as “Trustee.”

1 Only the Samuel P. Hunt Trust F/B/O Mary C . Russell (“Russell Trust”) and the Samuel P. Hunt Trust F/B/O Elizabeth Marston (“Marston Trust”) are plaintiffs because M s . McWhinney died without issue in 1980, and the Foundation received the principal from her trust at that time.

2 Hunt died on August 1 4 , 1958. In 1960, each of the three

testamentary trusts was funded with a corpus of $354,222.11. In

Articles 6 and 7 , the Will provided for distribution of Trust

income to the beneficiaries of each Trust. The Will also granted

the trustees “the broadest possible powers effectively to carry

out [Samuel Hunt’s] purposes as herein expressed, and without limiting their general application, such powers shall include,

among other things, the right, in their sole discretion . . .

[t]o decide what is income and what is principal.” P l . Ex. A ,

Will at Art. 9 ( s ) .

During the lifetime of the Trusts and up to the present, the

Trustee always has allocated all capital gains to the principal

of each trust and has made no distribution of principal to any

income beneficiary of the Trusts. The Trustee is required to and

does file probate accounts with and is subject to the supervision of the Director of Charitable Trusts, New Hampshire Office of the

Attorney General. The Director has never investigated or

questioned the Trustee’s administration of the trusts.

The Trustee filed federal income tax returns for the Trusts

from 1960 to the present. Except for 1996, 1997, and 1998, the

Trustee deducted capital gains earned by the trusts from taxable

income, based on the Trustee’s understanding that capital gains

earned by the Trusts were permanently assigned to principal. The

3 IRS disallowed the capital gains deduction for 1993, because of

the Trustee’s discretion to elect whether to allocate capital

gains as income or principal. The IRS did not audit the Trusts’

1994 and 1995 returns, when the Trusts took the same deductions.

In the returns filed in 1996 through 1998, the Trustee did not

take the deduction for capital gains earned but instead later filed amended returns claiming the deductions and requesting

refunds. The IRS allowed the deductions and issued refunds for

1997 and 1998 but refused the requested refund for 1996.

On April 5 , 1999, the IRS made assessments of $309,745

against the Marston Trust and $302,231 against the Russell Trust

for taxes owed on the disallowed 1993 deduction. The IRS also

assessed interest. In amended returns for 1996, the Trustee

claimed charitable deductions of $102,716 and $260,354.

Discussion

The Trustee filed suit to recover the taxes and interest the

Trusts paid for the IRS assessment on the 1993 returns and the

amount paid but then claimed as a deduction in the amended 1996

returns. Both the government and the Trustee have moved for

summary judgment.

4 I. Standard of Review

Summary judgment is appropriate when “the pleadings,

depositions, answers to interrogatories, and admissions on file,

together with the affidavits, if any, show that there is no

genuine issue as to any material fact and that the moving party

is entitled to a judgment as a matter of law.” Fed. R. Civ. P. 56(c). The party seeking summary judgment must first demonstrate

the absence of a genuine issue of material fact in the record.

See Celotex Corp. v . Catrett, 477 U.S. 3 1 7 , 323 (1986). All

reasonable inferences and all credibility issues are resolved in

favor of the nonmoving party. See Anderson v . Liberty Lobby,

Inc., 477 U.S. 2 4 2 , 255 (1986).

Ordinarily when parties file cross-motions for summary

judgment, the court must consider the motions separately.

Bienkowski v . Northeastern Univ., 285 F.3d 1 3 8 , 140 (1st Cir. 2002). This is because in considering cross motions, the court

must separately draw factual inferences against each movant in

turn. Reich v . John Alden Life Ins. Co., 126 F.3d 1 , 6 (1st Cir.

1997). Here, however, the parties’ dispute raises a legal issue,

the interpretation of the trust instrument and the application of

26 U.S.C. § 642 to the undisputed facts of this case, rather than

5 a factual question.2 See In re Pack Monadnock, 147 N.H. 419, 423

(2002); In re Clayton J. Richardson Trust, 138 N.H. 1 , 3 (1993).

Therefore, because factual inferences are not at issue, the

motions need not be considered separately. Philip Morris Inc. v .

Harshbarger, 122 F.3d 5 8 , 62 n.4 (1st Cir. 1997).

The Trusts do not identify the legal basis for their cause

of action claiming refunds. The government asserts that the suit

is a civil action for a refund pursuant to 26 U.S.C. § 7422(a),

and the Trusts do not dispute that characterization of their

claim. The Trusts, therefore, bear the burden of showing that

the IRS’s assessments in 1993 and 1996 were erroneous under 26

U.S.C. § 642. Quijano v . United States, 93 F.3d 2 6 , 28 n.1 (1st

Cir. 1996).

II. Application of Section 642

Section 642(c)(2) provides that certain trusts, including

the Trusts at issue here, are “allowed as a deduction in

computing [their] taxable income any amount of the gross income,

without limitation, which pursuant to the terms of the governing

instrument i s , during the taxable year, permanently set aside for

2 In contrast, the duties of a trustee are determined based upon the intentions of the trust settlor, and the issue of the settlor’s intentions is factual not legal. See Bartlett v . Dumaine, 128 N.H. 4 9 7 , 404-05 (1986).

6 a purpose specified in section 170(c) . . . .” The Will names

the Foundation as the remainder beneficiary of the Trusts, and

this purpose qualifies under § 642(c). The question raised in

this case is whether the capital gain income was permanently set

aside for that purpose as is required by § 642(c). IRS

regulation, 26 C.F.R. § 1.642(c)-2(d) explains that “[n]o amount will be considered to be permanently set aside . . . unless under

the terms of the governing instrument and the circumstances of

the particular case the possibility that the amount set aside . .

. will not be devoted to such purpose . . . is so remote as to be

negligible.”

The government argues that the capital gain income realized

by the Trusts in 1993 and 1996 was not permanently set aside for

purposes of § 642(c) because of the Trustee’s discretionary

authority to elect whether to allocate such income as Trust principal or Trust income under Article 9(s) of the Will. The

government contends that even if such income were allocated to

principal it could later be used for non-charitable purposes

under provisions in the Will. The Trustee argues that because

the Will does not permit it to invade principal on behalf of the

income beneficiaries or to distribute capital gain income to the

beneficiaries after it has been allocated to principal, the

capital gain income earned in 1993 and 1996 and allocated to

7 principal was permanently set aside within the meaning of § 642.

The Trustee also argues that capital gains are required by law to

be allocated to principal so that the government’s interpretation

of the Will to allow allocation to income is contrary to the

governing standards.

IRS Revenue Ruling 73-95 examined the effect on a charitable

contribution deduction under § 642 of a trustee’s discretionary

authority to allocate capital gains between income and

principal.3 1973 WL 33646. The IRS concluded that when gains

were set aside as principal under such discretionary authority,

they were not permanently set aside because later discretionary

allocations of gains as income at times when the trust also

suffered losses could diminish gain previously set aside as

principal. Such allocations would diminish the amount that was

previously available to charity. As a result, Revenue Ruling 73-

95 held that if “a trustee has discretionary power under the will to allocate gains from the sale or other disposition of property

constituting principal either to principal or to income, any

amount the trustee elects to set aside will not qualify for a

3 Revenue Rulings that reflect the IRS’s longstanding and reasonable interpretation of its own regulations are entitled to deference. See United States v . Cleveland Indians Baseball Co., 532 U.S. 2 0 0 , 220 (2001). The Trusts distinguish Revenue Ruling 73-95 on its facts, but do not argue that it is not entitled to deference.

8 deduction under section 642(c) of the Code since it has not been

permanently set aside for a charitable purpose.” Id.

The Trustee contends that Revenue Ruling 73-95 does not

apply to this case because the trustee there exercised his

discretionary power to allocate capital gain to income which has

not happened in this case. Revenue Ruling 73-95, however, is based on the trustee’s power under the trust instrument to elect

and the governing law which permitted the trustee to allocate

capital gain to income, rather than principal. That is

consistent with § 1.642(c)-2(d) which requires that the

possibility that the amount set aside would not be used for

charitable purposes be negligible. See, e.g., Phi Delta Theta

Fraternity v . Comm’r of Internal Revenue, 887 F.2d 1302, 1306

(6th Cir. 1989). Therefore, the fact that the trustee discussed

in Revenue Ruling 73-95 exercised that power is not a material distinction from the circumstances of this case.

The Trustee also contends that unlike the circumstances in

Revenue Ruling 73-95, it is barred from exercising its discretion

to elect to allocate capital gain to income under New Hampshire

law and more specifically under Massachusetts law. The Trustee

first points to certain tenets of trust administration in Austin

W . Scott, The Law of Trusts Vol. 11 § 236.14 p . 1322 (1939),

discussing the law of Pennsylvania and Massachusetts. While the

9 cited part of the section in Scott on Trusts might be persuasive

in the proper context, it does not appear to be relevant to New

Hampshire law as it exists or existed at the time in question.

The Trustee also contends that the version of Rule 49 of the

New Hampshire Rules of Practice and Procedure in the Probate

Courts applicable in 1993 and 1996 would not permit allocation of capital gains to income and that the same principle is also

supported by case law.4 The Trustee is apparently relying on

Rule 49(A)(4) (1996) which required that “[g]ains and losses on

disposition of property shall be netted and reported with

receipts of principal” for probate court accounts. That

accounting requirement, which is for reporting fiduciary accounts

to the probate court, does not necessarily prevent a trustee from

exercising discretionary power provided in a trust instrument.

The Trustee cites In re LaTour Estate, 110 N.H. 49 (1969), to show that New Hampshire adopted a rule that capital gains from

mutual funds must be allocated to principal. In that case,

however, the trust instrument “contain[ed] no provision expressly

or impliedly which would control the capital gains distributions

from mutual funds.” Id. at 5 1 . The Will in this case does

include a provision that allows the Trustee to decide what is

4 The Probate Rules were amended in 2001.

10 income and what is principal.5 The Trustee does not dispute that

New Hampshire law has shown a particular “regard for the

intention of the settlor of a trust.” Indian Head Nat’l Bank v .

Rawls, 105 N.H. 1 4 2 , 144 (1963). Therefore, the holding in

LaTour is inapposite. Page v . D’Amours, 99 N.H. 4 4 1 , 443 (1955),

cited by the Trustee, is also inapposite as it states only a

general proposition that taxes on capital gains would be paid

from principal. C f . LaTour, 110 N.H. at 52 (noting no New

Hampshire decision on issue of whether distributions from capital

gains were income or principal).

The government notes that other parts of Article 9 of the

Will could also affect the principal that would be available to

the Foundation. Specifically, part (t) allows the trustees to

“make a distinction between principal and income and to deal with

them separately or otherwise, i f , at any time, such distinction

appears to them to be necessary or desirable.” Part (f) provides

that the trustees may “charge to income or to principal or partly

to each, as the trustees shall deem to be appropriate” listed

expenses and costs including “obligations and liabilities of

5 Although that provision, Article 9 at part ( s ) , does not specifically mention capital gains, given the broad grant of power that prefaces Article 9, part (s) would include the authority to decide whether capital gains should be allocated to income or principal.

11 every kind that may become due from or on account of the trust

estate or of any part thereof incidental to the execution of

these trusts, including a reasonable compensation to the trustees

for their services.” Part (j) allows the trustees to buy or sell

“bonds, notes, debentures, or other obligations, either at a

premium above or at a discount from the face value or par value

thereof, (1) to credit or charge the amount of such premium or

discount to either income or principal or partly to each, in such

proportions as they shall determine . . . ” and to make other

determinations as to the premium or discount.6 These further

broad discretionary powers undermine the eligibility of the

deduction under § 642 because they also provide means by which

the principal might not be permanently set aside for charitable

purposes.

Perhaps realizing the lack of applicable authority to

support its theory under New Hampshire law, the Trustee relies heavily on precedent established by the Massachusetts Supreme

Judicial Court. In Old Colony Trust C o . v . Silliman, 223 N.E.2d

6 The Trustee argues that the specificity of parts (j) and ( n ) , which deal with particular kinds of dispositions and allocation between principal and income means that part (s) could not have granted general authority to make the same allocation but instead demonstrates that part (s) was merely a savings clause for dealing with circumstances not otherwise covered by rules of trust administration. The court finds no inconsistency or unnecessary redundancy in the cited provisions.

12 504 (Mass. 1967), the executors and trustee under the will of

Amelia Silliman sought direction as to the power of the trustee

pursuant to an article that allowed the trustee to “decide

whether accretions to the trust property shall be charged to

principal or income and whether expenses shall be charged to

principal or income.”7 Id. at 505. The will provided that at

the end of the individual income interests, the principal of the

trust would be transferred by the trustee to charitable purposes.

Id. at 505-06. Because of the eventual charitable purposes, the

executors had claimed a charitable deduction on their federal tax

return which was disallowed. Id. at 506.

The court determined that the intent of the will, taken as a

whole, was that “the entire principal of the trust go eventually

to charity,” and that “[t]his intent will not be effectuated if

the trustee can substitute for established rules its decision

made in good faith as to what to do as between principal and income.” Id. at 507. In light of that intent, the court

concluded that “even very broad discretionary powers are to be

exercised in accordance with fiduciary standards and with

reasonable regard for usual fiduciary principles.” Id. The

court held that the general power could not be used to favor

7 The Trustee in this case apparently has not attempted to gain direction from the New Hampshire courts on this issue.

13 either the charitable interests or the private beneficiaries so that the trustee and executors were to apply known and established rules to compute the present value of the charitable remainder. Id. at 508. In summary, “under Massachusetts law, a trustee is restricted in the exercise of even broad discretionary powers by the terms of the trust viewed as a whole, and by the trustee’s fiduciary duty to use his or her best judgment in good faith.” Markham v . Fay, 74 F.3d 1347, 1358 (1st Cir. 1996).

Even if the restrictions found in Old Colony were pertinent under the terms of the Will in this case and if this court were to conclude that the New Hampshire Supreme Court would follow the Massachusetts rule, such a result would not affect the present tax dispute. It is undisputed that at the time in question, 1993 and thereafter, New Hampshire law did not clearly prohibit the Trustee from exercising the broad discretion granted in the Will without limitations. As such, the possibility that the Trustee could exercise its discretionary power in a way that could change the designation of capital gain from a charitable purpose to another purpose was not so remote as to be negligible under New Hampshire law. Therefore, the court need not decide whether New Hampshire would now follow Massachusetts precedent.8

8 The court also need not analyze the federal cases cited that apply Massachusetts law.

14 III. Equitable Considerations

The Trustee also argues that justice and equity support

allowing the charitable deduction to preserve the principal

available for the Foundation, and, in particular, because the IRS

did not apply its taxing scheme uniformly. The Trustee cites no

authority to support a theory that the court may order a tax deduction based on justice and equity. To the extent the Trustee

is suggesting a theory of equitable estoppel against the IRS, it

has not adequately presented such an argument. See, e.g., Morgan

v . C.I.R., 345 F.3d 563, 566-67 (8th Cir. 2003); Fredericks v .

C.I.R., 126 F.3d 433, 447-48 (3d Cir. 1997). The Trustee has not

carried its burden of showing that the IRS assessments in 1993

and 1996 were erroneous under § 642.

Conclusion

For the foregoing reasons, the defendant’s motion for

summary judgment (document n o . 18) is granted. The plaintiffs’

motion for summary judgment (document n o . 13) is denied. The

plaintiffs’ claim to recover taxes paid is denied.

The clerk of court shall enter judgment accordingly and

close the case.

SO ORDERED.

Joseph A . DiClerico, J r . United States District Judge December 3 0 , 2003 cc: Thomas P. Cole, Esquire Wilbur A . Glahn I I I , Esquire