United State v. ByrumAnnotate this Case
408 U.S. 125 (1972)
U.S. Supreme Court
United State v. Byrum, 408 U.S. 125 (1972)
United State v. Byrum
Argued March 1, 1972
Decided June 26, 1972
408 U.S. 125
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
Decedent transferred to an irrevocable trust for the benefit of his children (and if they died before the trust ended, their surviving children) stock in three unlisted corporations that he controlled, retaining the right to vote the transferred stock, to veto the transfer by the trustee (a bank) of any of the stock, and to remove the trustee and appoint another corporate trustee as successor. The right to vote the transferred stock, together with the vote of the stock decedent owned at the time of his death, gave him a majority vote in each of the corporations. The Commissioner of Internal Revenue determined that the transferred stock was includable in decedent's gross estate under § 2036(a) of the Internal Revenue Code of 1954, which requires the inclusion in a decedent's gross estate of the value of any property he has transferred by inter vivos gift, if he retained for his lifetime
"(1) the . . . enjoyment of . . . the property transferred, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall . . . enjoy . . . the income therefrom."
The Commissioner claimed that decedent's right to vote the transferred shares and to veto any sale by the trustee, together with the ownership of other shares, made the transferred shares includable under § 2036(a)(2), because decedent retained control over corporate dividend policy and, by regulating the flow of income to the trust, could shift or defer the beneficial enjoyment of trust income between the present beneficiaries and remaindermen, and under § 2036(a)(1) because, by reason of decedent's retained control over the corporations, he had the right to continue to benefit economically from the transferred shares during his lifetime.
Held: 1. Decedent did not retain the "right," within the meaning of § 2036(a)(2), to designate who was to enjoy the trust income. Pp. 408 U. S. 131-144.
(a) A settlor's retention of broad management powers did not necessarily subject an inter vivos trust to the federal estate tax. Pp. 408 U. S. 131-135.
(b) In view of legal and business constraints applicable to the payment of dividends, especially where there are minority stockholders, decedent's right to vote a majority of the shares in these corporations did not give him a de facto position tantamount to the power to accumulate income in the trust. Pp. 408 U. S. 135-144.
2. Decedent's voting control of the stock did not constitute retention of the enjoyment of the transferred stock within the meaning of § 2036(a)(1), since the decedent had transferred irrevocably the title to the stock and right to the income therefrom. Pp. 408 U. S. 145-150.
440 F.2d 949, affirmed.
POWELL, J., delivered the opinion of the Court, in which BURGER, C.J., and DOUGLAS, STEWART, MARSHALL, and REHNQUIST, JJ., joined. WHITE, J., filed a dissenting opinion, in which BRENNAN and BLACKMUN, JJ., joined, post, p. 408 U. S. 151.
MR. JUSTICE POWELL delivered the opinion of the Court.
Decedent, Milliken C. Byrum, created in 1958 an irrevocable trust to which he transferred shares of stock in three closely held corporations. Prior to transfer, he owned at least 71% of the outstanding stock of each corporation. The beneficiaries were his children or, in the event of their death before the termination of the trust, their surviving children. The trust instrument specified that there be a corporate trustee. Byrum designated as sole trustee an independent corporation, Huntington National Bank. The trust agreement vested
in the trustee broad and detailed powers with respect to the control and management of the trust property. These powers were exercisable in the trustee's sole discretion, subject to certain rights reserved by Byrum: (i) to vote the shares of unlisted stock held in the trust estate; (ii) to disapprove the sale or transfer of any trust assets, including the shares transferred to the trust; (iii) to approve investments and reinvestments; and (iv) to remove the trustee and "designate another corporate Trustee to serve as successor." Until the youngest living child reached age 21, the trustee was authorized in its "absolute and sole discretion" to pay the income and principal of the trust to or for the benefit of the beneficiaries, "with due regard to their individual needs for education, care, maintenance and support." After the youngest child reached 21, the trust was to be divided into a separate trust for each child, to terminate when the beneficiaries reached 35. The trustee was authorized in its discretion to pay income and principal from these trusts to the beneficiaries for emergency or other "worthy need," including education. [Footnote 1]
When he died in 1964, Byrum owned less than 50% of the common stock in two of the corporations and 59% in the third. The trust had retained the shares
transferred to it, with the result that Byrum had continued to have the right to vote not less than 71% of the common stock in each of the three' corporations. [Footnote 2]
There were minority stockholders, unrelated to Byrum, in each corporation.
Following Byrum's death, the Commissioner of Internal Revenue determined that the transferred stock was properly included within Byrum's gross estate under § 2036(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 2036(a). That section provides for the inclusion in a decedent's gross estate of all property which the decedent has transferred by inter vivos transaction, if he has retained for his lifetime "(1) the possession or enjoyment of, or the right to the income from, the property" transferred, or "(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income
therefrom." [Footnote 3] The Commissioner determined that the stock transferred into the trust should be included in Byrum's gross estate because of the rights reserved by him in the trust agreement. It was asserted that his right to vote the transferred shares and to veto any sale thereof by the trustee, together with the ownership of other shares, enabled Byrum to retain the "enjoyment of . . . the property," and also allowed him to determine the flow of income to the trust, and thereby "designate the persons who shall . . . enjoy . . . the income."
The executrix of Byrum's estate paid an additional tax of $13,202.45, and thereafter brought this refund action in District Court. The facts not being in dispute, the court ruled for the executrix on cross-motions for summary judgment. 311 F.Supp. 892 (SD Ohio 1970). The Court of Appeals affirmed, one judge dissenting. 440 F.2d 949 (CA6 1971). We granted the Government's petition for certiorari. 404 U.S. 937 (1971).
The Government relies primarily on its claim, made under § 2036(a)(2), that Byrum retained the right to
designate the persons who shall enjoy the income from the transferred property. The argument is a complicated one. By retaining voting control over the corporations whose stock was transferred, Byrum was in a position to select the corporate directors. He could retain this position by not selling the shares he owned and by vetoing any sale by the trustee of the transferred shares. These rights, it is said, gave him control over corporate dividend policy. By increasing, decreasing, or stopping dividends completely, it is argued that Byrum could "regulate the flow of income to the trust," and thereby shift or defer the beneficial enjoyment of trust income between the present beneficiaries and the remaindermen. The sum of this retained power is said to be tantamount to a grantor-trustee's power to accumulate income in the trust, which this Court has recognized constitutes the power to designate the persons who shall enjoy the income from transferred property. [Footnote 4]
At the outset, we observe that this Court has never held that trust property must be included in a settlor's gross estate solely because the settlor retained the power
to manage trust assets. On the contrary, since our decision in Reinecke v. Northern Trust Co.,278 U. S. 339 (1929), it has been recognized that a settlor's retention of broad powers of management does not necessarily subject an inter vivos trust to the federal estate tax. [Footnote 5] Although there was no statutory analogue to § 2036(a)(2) when Northern Trust was decided, several lower court decisions decided after the enactment of the predecessor of § 2036(a)(2) have upheld the settlor's right to exercise managerial powers without incurring estate tax liability. [Footnote 6] In Estate of King v. Commissioner, 37 T.C. 973 (1962), a settlor reserved the power to direct the trustee in the management and investment of trust assets. The Government argued that the settlor was thereby empowered to cause investments to be made in such a manner as to control significantly the flow of income into the trust. The Tax Court rejected this argument, and held for the taxpayer. Although the court recognized that the settlor had reserved "wide latitude in the exercise of his discretion as to the types of investments to be made," id. at 980, it did not find this control over the flow of income to be equivalent
to the power to designate who shall enjoy the income from the transferred property.
Essentially, the power retained by Byrum is the same managerial power retained by the settlors in Northern Trust and in King. Although neither case controls this one -- Northern Trust because it was not decided under § 2036(a)(2) or a predecessor; and King because it is a lower court opinion -- the existence of such precedents carries weight. [Footnote 7] The holding of Northern Trust, that the settlor of a trust may retain broad powers of management without adverse estate tax consequences, may have been relied upon in the drafting of hundreds of inter vivos trusts. [Footnote 8] The modification of this principle now sought by the Government could have a seriously adverse impact, especially upon settlors (and their estates) who happen to have been "controlling" stockholders
of a closely held corporation. Courts properly have been reluctant to depart from an interpretation of tax law which has been generally accepted when the departure could have potentially far-reaching consequences. When a principle of taxation requires reexamination, Congress is better equipped than a court to define precisely the type of conduct which results in tax consequences. When courts readily undertake such tasks, taxpayers may not rely with assurance on what appear to be established rules lest they be subsequently overturned. Legislative enactments, on the other hand, although not always free from ambiguity, at least afford the taxpayers advance warning.
The Government argues, however, that our opinion in United States v. O'Malley,383 U. S. 627 (1966), compels the inclusion in Byrum's estate of the stock owned by the trust. In O'Malley, the settlor of an inter vivos trust named himself as one of the three trustees. The trust agreement authorized the trustees to pay income to the life beneficiary or to accumulate it as a part of the principal of the trust in their "sole discretion." The agreement further provided that net income retained by the trustees, and not distributed in any calendar year, "shall become a part of the principal of the Trust Estate."' Id. at 383 U. S. 629 n. 2. The Court characterized the effect of the trust as follows:
"Here Fabrice [the settlor] was empowered, with the other trustees, to distribute the trust income to the income beneficiaries or to accumulate it and add it to the principal, thereby denying to the beneficiaries the privilege of immediate enjoyment and conditioning their eventual enjoyment upon surviving the termination of the trust."
Id. at 383 U. S. 631. As the retention of this legal right by the settlor, acting as a trustee "in conjunction" with the other trustees,
came squarely within the language and intent of the predecessor of § 2036(a)(2), the taxpayer conceded that the original assets transferred into the trust were includable in the decedent's gross estate. Id. at 383 U. S. 632. The issue before the Court was whether the accumulated income, which had been added to the principal pursuant to the reservation of right in that respect, was also includable in decedent's estate for tax purposes. The Court held that it was.
In our view, and for the purposes of this case, O'Malley adds nothing to the statute itself. The facts in that case were clearly within the ambit of what is now § 2036(a). That section requires that the settlor must have "retained for his life . . . (2) the right . . . to designate the persons who shall possess or enjoy the property or the income therefrom." O'Malley was covered precisely by the statute for two reasons: (1) there, the settlor had reserved a legal right, set forth in the trust instrument; and (2) this right expressly authorized the settlor, "in conjunction" with others, to accumulate income, and thereby "to designate" the persons to enjoy it.
It must be conceded that Byrum reserved no such "right" in the trust instrument or otherwise. The term "right," certainly when used in a tax statute, must be given its normal and customary meaning. It connotes an ascertainable and legally enforceable power, such as that involved in O'Malley. [Footnote 9] Here, the right ascribed to Byrum was the power to use his majority position and influence over the corporate directors to "regulate the flow of dividends" to the trust. That "right" was
neither ascertainable nor legally enforceable, and hence was not a right in any normal sense of that term. [Footnote 10]
Byrum did retain the legal right to vote shares held by the trust and to veto investments and reinvestments. But the corporate trustee alone, not Byrum, had the right to pay out or withhold income, and thereby to designate who among the beneficiaries enjoyed such income. Whatever power Byrum may have possessed with respect to the flow of income into the trust was derived not from an enforceable legal right specified in the trust instrument, but from the fact that he could elect a majority of the directors of the three corporations. The power to elect the directors conferred no legal right to command them to pay or not to pay dividends. A majority shareholder has a fiduciary duty not to misuse his power by promoting his personal interests at the expense of corporate interests. [Footnote 11] Moreover,
the directors also have a fiduciary duty to promote the interests of the corporation. [Footnote 12] However great Byrum's influence may have been with the corporate directors, their responsibilities were to all stockholders, and were enforceable according to legal standards entirely unrelated to the needs of the trust or to Byrum's desires with respect thereto.
The Government seeks to equate the de facto position of a controlling stockholder with the legally enforceable "right" specified by the statute. Retention of corporate control (through the right to vote the shares) is said to be "tantamount to the power to accumulate income" in the trust which resulted in estate tax consequences in O'Malley. The Government goes on to assert that,
"[t]hrough exercise of that retained power, [Byrum] could increase or decrease corporate dividends . . . and thereby shift or defer the beneficial enjoyment of trust income. [Footnote 13]"
This approach seems to us
not only to depart from the specific statutory language, [Footnote 14] but also to misconceive the realities of corporate life.
There is no reason to suppose that the three corporations controlled by Byrum were other than typical small businesses. The customary vicissitudes of such enterprises -- bad years; product obsolescence; new competition; disastrous litigation; new, inhibiting Government regulations; even bankruptcy -- prevent any certainty or predictability as to earnings or dividends. There is no assurance that a small corporation will have a flow of net earnings or that income earned will in fact be available for dividends. Thus, Byrum's alleged de facto "power to
control the flow of dividends" to the trust was subject to business and economic variables over which he had little or no control.
Even where there are corporate earnings, the legal power to declare dividends is vested solely in the corporate board. In making decisions with respect to dividends, the board must consider a number of factors. It must balance the expectation of stockholders to reasonable dividends when earned against corporate needs for retention of earnings. The first responsibility of the board is to safeguard corporate financial viability for the long term. This means, among other things, the retention of sufficient earnings to assure adequate working capital, as well as resources for retirement of debt, for replacement and modernization of plant and equipment, and for growth and expansion. The nature of a corporation's business, as well as the policies and long-range plans of management, are also relevant to dividend payment decisions. [Footnote 15] Directors of a closely held, small corporation must bear in mind the relatively limited access of such an enterprise to capital markets. This may require a more conservative policy with respect to dividends than would be expected of an established corporation with securities listed on national exchanges. [Footnote 16]
Nor do small corporations have the flexibility or the opportunity available to national concerns in the utilization of retained earnings. When earnings are substantial, a decision not to pay dividends may result only in the accumulation of surplus, rather than growth through internal or external expansion. The accumulated earnings may result in the imposition of a penalty tax. [Footnote 17]
These various economic considerations are ignored at the directors' peril. Although vested with broad discretion in determining whether, when, and what amount of dividends shall be paid, that discretion is subject to legal restraints. If, in obedience to the will of the majority stockholder, corporate directors disregard the interests of shareholders by accumulating earnings to an unreasonable extent, they are vulnerable to a derivative suit. [Footnote 18] They are similarly vulnerable if they make an unlawful payment of dividends in the absence of net earnings or available surplus, [Footnote 19] or if they fail to exercise
the requisite degree of care in discharging their duty to act only in the best interest of the corporation and its stockholders.
Byrum was similarly inhibited by a fiduciary duty from abusing his position as majority shareholder for personal or family advantage to the detriment of the corporation or other stockholders. There were a substantial number of minority stockholders in these corporations who were unrelated to Byrum. [Footnote 20] Had Byrum and the directors violated their duties, the minority shareholders would have had a cause of action under Ohio law. [Footnote 21] The Huntington National Bank, as trustee, was one of the minority stockholders, and it had both the right and the duty to hold Byrum responsible for any wrongful or negligent action as a controlling stockholder or as a director of the corporations. [Footnote 22] Although Byrum had reserved the right to remove the trustee, he would have been imprudent to do this when confronted by the
trustee's complaint against his conduct. A successor trustee would succeed to the rights of the one removed.
We conclude that Byrum did not have an unconstrained de facto power to regulate the flow of dividends to the trust, much less the "right" to designate who was to enjoy the income from trust property. His ability to affect, but not control, trust income was a qualitatively different power from that of the settlor in O'Malley, who had a specific and enforceable right to control the income paid to the beneficiaries. [Footnote 23] Even had Byrum managed to flood the trust with income, he had no way of compelling the trustee to pay it out, rather than accumulate it. Nor could he prevent the trustee from making payments from other trust assets, [Footnote 24] although admittedly there were few of these at the time of Byrum's death. We cannot assume, however, that no other assets would come into the trust from reinvestments or other gifts. [Footnote 25]
We find no merit to the Government's contention that Byrum's de facto "control," subject as it was to the economic and legal constraints set forth above, was tantamount to the right to designate the persons who shall enjoy trust income, specified by § 2036(a)(2). [Footnote 26]
The Government asserts an alternative ground for including the shares transferred to the trust within Byrum's gross estate. It argues that, by retaining control, Byrum guaranteed himself continued employment and remuneration, as well as the right to determine whether and when the corporations would be liquidated or merged. Byrum is thus said to have retained "the . . . enjoyment of . . . the property," making it includable within his gross estate under § 2036(a)(1). The Government concedes that the retention of the voting rights of an "unimportant minority interest" would not require inclusion of the transferred shares under § 2036(a)(1). It argues, however,
"where the cumulative effect of the retained powers and the rights flowing from the shares not placed in trust leaves the grantor in control of a close corporation, and assures that control for his lifetime, he has retained the 'enjoyment' of the transferred stock. [Footnote 27]"
Brief for United States 23.
It is well settled that the terms "enjoy" and "enjoyment," as used in various estate tax statutes, "are not terms of art, but connote substantial present economic benefit, rather than technical vesting of title or estates." Commissioner v. Estate of Holmes,326 U. S. 480, 326 U. S. 486
(1946). [Footnote 28] For example, in Reinecke v. Northern Trust Co.,278 U. S. 339 (1929), in which the critical inquiry was whether the decedent had created a trust "intended . . . to take effect in possession or enjoyment at or after his death,'" [Footnote 29] id. at 278 U. S. 348, the Court held that reserved powers of management of trust assets, similar to Byrum's power over the three corporations, did not subject an inter vivos trust to the federal estate tax. In determining whether the settlor had retained the enjoyment of the transferred property, the Court said:
"Nor did the reserved powers of management of the trusts save to decedent any control over the economic benefit or the enjoyment of the property. He would equally have reserved all these powers and others had he made himself the trustee, but the transfer would not, for that reason, have been incomplete. The shifting of the economic interest in the trust property which was the subject of the tax was thus complete as soon as the trust was made. His power to recall the property and of control over it for his own benefit then ceased, and, as the trust were not made in contemplation
of death, the reserved powers do not serve to distinguish them from any other gift inter vivos not subject to the tax."
278 U.S. at 278 U. S. 346-347.
The cases cited by the Government reveal that the terms "possession" and "enjoyment," used in § 2036(a)(1), were used to deal with situations in which the owner of property divested himself of title but retained an income interest or, in the case of real property, the lifetime use of the property. Mr. Justice Black's opinion for the Court in Commissioner v. Estate of Church,335 U. S. 632 (1949), traces the history of the concept. In none of the cases cited by the Government has a court held that a person has retained possession or enjoyment of the property if he has transferred title irrevocably, made complete delivery of the property and relinquished the right to income where the property is income-producing. [Footnote 30]
The Government cites only one case, Estate of Holland v. Commissioner, 1 T.C. 564 (1943), [Footnote 31] in which a decedent had retained the right to vote transferred shares of stock and in which the stock was included
within the decedent's gross estate. In that case, it was not the mere power to vote the stock, giving the decedent control of the corporation, which caused the Tax Court to include the shares. The court held that,
"'on an inclusive view of the whole arrangement, this withholding of the income until decedent's death, coupled with the retention of the certificates under the pledge and the reservation of the right to vote the stock and to designate the company officers,'"
subjects the stock to inclusion within the gross estate. Id. at 565. The settlor in Holland retained a considerably greater interest than Byrum retained, including an income interest. [Footnote 32]
As the Government concedes, the mere retention of the "right to vote" shares does not constitute the type of "enjoyment" in the property itself contemplated by § 2036(a)(1). In addition to being against the weight of precedent, the Government's argument that Byrum retained "enjoyment" within the meaning of § 2036(a)(1) is conceptually unsound. This argument implies, as it must under the express language of § 2036(a), that Byrum "retained for his life . . . (1) the possession or enjoyment" of the "property" transferred to the trust or the "income" therefrom. The only property he transferred was corporate stock. He did not transfer "control" (in the sense used by the Government) as the trust never owned as much as 50% of the stock of any corporation. Byrum never divested himself of control, as he was able to vote a majority of the shares by virtue of what he owned and the right to vote those placed in
the trust. Indeed, at the time of his death, he still owned a majority of the shares in the largest of the corporations, and probably would have exercised control of the other two by virtue of being a large stockholder in each. [Footnote 33] The statutory language plainly contemplates retention of an attribute of the property transferred -- such as a right to income, use of the property itself, or a power of appointment with respect either to income or principal. [Footnote 34]
Even if Byrum had transferred a majority of the stock, but had retained voting control, he would not have retained "substantial present economic benefit," 326 U.S. at 326 U. S. 486. The Government points to the retention of two "benefits." The first of these, the power to liquidate or
merge, is not a present benefit; rather, it is a speculative and contingent benefit which may or may not be realized. Nor is the probability of continued employment and compensation the substantial "enjoyment of . . . [the transferred] property" within the meaning of the statute. The dominant stockholder in a closely held corporation, if he is active and productive, is likely to hold a senior position and to enjoy the advantage of a significant voice in his own compensation. These are inevitable facts of the free enterprise system, but the influence and capability of a controlling stockholder to favor himself are not without constraints. Where there are minority stockholders, as in this case, directors may be held accountable if their employment, compensation, and retention of officers violate their duty to act reasonably in the best interest of the corporation and all of its stockholders. [Footnote 35] Moreover, this duty is policed, albeit indirectly, by the Internal Revenue Service, which disallows the deduction of unreasonable compensation paid to a corporate executive as a business expense. [Footnote 36] We conclude that Byrum's retention of voting control was not the retention of the enjoyment of the transferred property within the meaning of the statute.
For the reasons set forth above, we hold that this case was correctly decided by the Court of Appeals, and accordingly the judgment is
The Trust Agreement in pertinent part provided:
"Article IV. Irrevocable Trust."
"This Trust shall be irrevocable, and Grantor reserves no rights, powers, privileges or benefits either as to the Trust estate or the control or management of the trust property, except as set forth herein."
"Article V. Powers Of The Trustee."
"The Trustee shall have and possess and may exercise at all times not only the rights, powers and authorities incident to the office or required in the discharge of this trust, or impliedly conferred upon or vested in it, but there is hereby expressly conferred upon and vested in the Trustee all the rights, powers and authorities embodied in the following paragraphs in this Article, which are shown by way of illustration but not by way of limitation:"
"* * * *"
"Sell. 5.02 To sell at public or private sale, to grant options to sell, to exchange, re-exchange or otherwise dispose of all or part of the property, real or personal, at any time belonging to the Trust Estate, upon such terms and conditions and for such consideration as said Trustee shall determine, and to execute and deliver all instruments of sale or conveyance necessary or desirable therefor."
"* * * *"
"Investments. 5.05 To invest any money in the Trust Estate in stocks, bonds, investment trusts, common trust funds and any other securities or property, real or personal, secured or unsecured, whether the obligations of individuals, corporations, trusts, associations, governments, expressly including shares and/or obligations of its own corporation, or otherwise, either within or outside of the State of Ohio, as the Trustee shall deem advisable, without any limitation whatsoever as to the character of investment under any statute or rule of law now or hereafter enacted or existing regarding trust fund or investments by fiduciaries or otherwise."
"Voting. 5.06 To vote by proxy or in person any stock or security comprising a part of the Trust Estate, at any meeting, except that, during Grantor's lifetime, all voting rights of any stocks which are not listed on a stock exchange, shall be exercised by Grantor, and after Grantor's death, the voting rights of such stocks shall be exercised by Grantor's wife during her lifetime."
"* * * *"
"Leases. 5.09 To make leases for any length of time, whether longer or shorter than the duration of this Trust, to commence at the present time or in the future; to extend any lease; to grant options to lease or to renew any lease; it being expressly understood that the Trustee may grant or enter into ninety-nine year leases, renewable forever."
"* * * *"
"Income Allocation. 5.13 To determine in its discretion how all receipts and disbursements, capital gains and losses, shall be charged, credited or apportioned between income and principal."
"* * * *"
"Limitation. 5.15 Notwithstanding the powers of the Trustee granted in paragraphs 5.02, 5.05, 5.09 and 5.11 above, the Trustee shall not exercise any of the powers granted in said paragraphs unless (a) during Grantor's lifetime said Grantor shall approve of the action taken by the Trustee pursuant to said powers, (b) after the death of the Grantor and as long as his wife, Marian A. Byrum, shall live, said wife shall approve of the action taken by the Trustee pursuant to said powers."
"Article VI. Distribution Prior To Age 21."
"Until my youngest living child reaches the age of twenty-one (21) years, the Trustee shall exercise absolute and sole discretion in paying or applying income and/or principal of the Trust to or for the benefit of Grantor's child or children and their issue, with due regard to their individual needs for education, care, maintenance and support and not necessarily in equal shares, per stirpes. The decision of the Trustee in the dispensing of Trust funds for such purposes shall be final and binding on all interested persons."
"Article VI. Division At Age 21."
"* * * *"
"Principal Disbursements. 6.02 If prior to attaining the age of thirty-five (35), any one of the children of Grantor shall have an emergency such as an extended illness requiring unusual medical or hospital expenses, or any other worthy need including education of such child, the Trustee is hereby authorized and empowered to pay such child or use for his or her benefit such amounts of income and principal of the Trust as the Trustee in its sole judgment and discretion shall determine."
"* * * *"
"Article VIII. Removal of Trustee."
"If the Trustee, The Huntington National Bank of Columbus, Columbus, Ohio, shall at any time change its name or combine with one or more corporations under one or more different names, or if its assets and business at any time shall be purchased and absorbed by another trust company or corporation authorized by law to accept these trusts, the new or successor corporation shall be considered as the said The Huntington National Bank of Columbus, Ohio, and shall continue said Trusts and succeed to all the rights, privileges, duties and obligations herein conferred upon said The Huntington National Bank of Columbus, Columbus, Ohio, Trustee."
"Grantor, prior to his death, and after the death of the Grantor, the Grantor's wife, Marian A. Byrum, during her lifetime, may remove or cause the removal of The Huntington National Bank of Columbus, Ohio, or any successor Trustee, as Trustee under the Trusts and may thereupon designate another corporate Trustee to serve as successor Trustee hereunder."
"Artlcle IX. Miscellaneous Provisions."
"* * * *"
"Discretion. 9.02 If in the opinion of the Trustee it shall appear that the total income of any beneficiary of any Trust fund created hereunder is insufficient for his or her proper or suitable support, care and comfort, and education and that of said beneficiary's children, the Trustee is authorized to pay to or for such beneficiary or child such additional amounts from the principal of the Trust Estate as it shall deem advisable in order to provide suitably and properly for the support, care, comfort, and education of said beneficiary and of said beneficiary's children, and the action of the Trustee in making such payments shall be binding on all persons."
The actual proportions were:
Percentage Percentage Owned by
Owned by Owned by Decedent
Decedent Trust and Trust
Co.,Inc. 59 12 71
Graphic Realty, Inc. 35 48 83
Bychrome Co. 42 46 88
926 U.S.C. § 2036 provides:
"(a) General rule."
"The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death --"
"(1) the possession or enjoyment of, or the right to the income from, the property, or"
"(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom."
United State v. O'Malley,383 U. S. 627 (1966).
It is irrelevant to this argument how many shares Byrum transferred to the trust. Had he retained in his own name more than 50% of the shares (as he did with one corporation), rather than retaining the right to vote the transferred shares, he would still have had the right to elect the board of directors and the same power to "control" the flow of dividends. Thus, the Government is arguing that a majority shareholder's estate must be taxed for stock transferred to a trust if he owned at least 50% of the voting stock after the transfer or if he retained the right to vote the transferred stock and could thus vote more than 50% of the stock. It would follow also that if a settlor controlled 50% of the voting stock and similarly transferred some other class of stock for which the payment of dividends had to be authorized by the directors, his estate would also be taxed. Query: what would happen if he had the right to vote less than 50% of the voting stock, but still "controlled" the corporation? Seen 10, infra.
The Court has never overturned this ruling. See McCormick v. Burnet,283 U. S. 784 (1931); Helvering v. Duke, 290 U.S. 591 (1933) (affirmed by an equally divided Court). In Commissioner v. Estate of Church,335 U. S. 632 (1949), and Estate of Spiegel v. Commissioner,335 U. S. 701 (1949), the Court invited, sua sponte, argument of this question, but did not reach the issue in either opinion.
See, e.g., Old Colony Trust Co. v. United States, 423 F.2d 601 (CA1 1970); United States v. Powell, 307 F.2d 821 (CA10 1962); Estate of Ford v. Commissioner, 53 T.C. 114 (1969), aff'd, 450 F.2d 878 (CA2 1971); Estate of Wilson v. Commissioner, 13 T.C. 869 (1949) (en banc), aff'd, 187 F.2d 145 (CA3 1951); Estate of Budd v. Commissioner, 49 T.C. 468 (1968); Estate of Pardee v. Commissioner, 49 T.C. 40 (1967); Estate of King v. Commissioner, 37 T.C. 973 (1962).
The dissenting opinion attempts to distinguish the cases, holding that a settlor-trustee's retained powers of management do not bring adverse estate tax consequences, on the ground that management of trust assets is not the same as the power retained by Byrum because a settlor-trustee is bound by a fiduciary duty to treat the life tenant beneficiaries and remaindermen as the trust instrument specifies. But the argument that, in the "reserved power of management" cases, there was "a judicially enforceable strict standard capable of invocation by the trust beneficiaries by reference to the terms of the trust agreement," post at 408 U. S. 166, ignores the fact that trust agreements may and often do provide for the widest investment discretion.
Assuming arguendo that MR. JUSTICE WHITE is correct in suggesting that, in 1958, when this trust instrument was drawn, the estate tax consequences of the settlor's retained powers of management were less certain than they are now, this Court's failure to overrule Northern Trust, plus the existence of recent cases such as King and the cases cited in n 6 have undoubtedly been relied on by the draftsmen of more recent trusts with considerable justification. Our concern as to this point is not so much with whether Byrum properly relied on the precedents, but with the probability that others did rely thereon in good faith.
Although MR. JUSTICE WHITE's dissent argues that the use of the word "power" in O'Malley implies that the Court's concern was with practical reality, rather than legal form, an examination of that opinion does not indicate that the term was used other than in the sense of legally empowered. At any rate, the "power" was a right reserved to the settlor in the trust instrument itself.
The "control" rationale, urged by the Government and adopted by the dissenting opinion, would create a standard -- not specified in the statute -- so vague and amorphous as to be impossible of ascertainment in many instances. Seen 13 infra. Neither the Government nor the dissent sheds light on the absence of an ascertainable standard. The Government speaks vaguely of drawing the line between "an unimportant minority interest" (whatever that may be) and "voting control." The dissenting opinion does not address this problem at all. See Comment, Sale of Control Stock and the Brokers' Transaction Exemption -- Before and After the Wheat Report, 49 Tex.L.Rev. 475, 479-481 (1971).
Such a fiduciary relationship would exist in almost every, if not every, State. Ohio, from which this case arises, is no exception:
"[I]f the majority undertakes, either directly or indirectly, through the directors, to conduct, manage, or direct the corporation's affairs, they must do so in good faith, and with an eye single to the best interests of the corporation. It is clear that the interests of the majority are not always identical with the interests of all the shareholders. The obligation of the majority or of the dominant group of shareholders acting for, or through, the corporation is fiduciary in nature. A court of equity will grant appropriate relief where the majority or dominant group of shareholders act in their own interest or in the interest of others so as to oppress the minority or commit a fraud upon their rights."
13 Ohio Jur.2d, Corporations § 662, pp. 90-91 (footnotes omitted). See Overfield v. Pennroad Corp., 42 F.Supp. 586 (ED Pa. 1941), rev'd on other grounds, 146 F.2d 889 (CA3 1944).
"The directors of the corporation represent the corporation, not just one segment of it, but all of it. The fiduciary nature of the directors' obligation requires that, in the management of the corporation's affairs, they do not presume to play favorites among the shareholders or among classes of shareholders."
12 Ohio Jur.2d, Corporations § 497, p. 618.
The Government uses the terms "control" and "controlling stockholder" as if they were words of art with a fixed and ascertainable meaning. In fact, the concept of "control" is a nebulous one. Although, in this case, Byrum possessed "voting control" of the three corporations (in view of his being able to vote more than 50% of the stock in each), the concept is too variable and imprecise to constitute the basis per se for imposing tax liability under § 2036(a). Under most circumstances, a stockholder who has the right to vote more than 50% of the voting shares of a corporation "controls it" in the sense that he may elect the board of directors. But such a stockholder would not control, under the laws of most States, certain corporate transactions such as mergers and sales of assets. Moreover, control -- in terms of effective power to elect the board under normal circumstances -- may exist where there is a right to vote far less than 50% of the shares. This will vary with the size of the corporation, the number of shareholders, and the concentration (or lack of it) of ownership. See generally 2 L. Loss, Securities Regulation 770-783 (1961). Securities law practitioners recognize that possessing 10% or more of voting power is a factor on which the Securities and Exchange Commission relies as one of the indicia of control. SEC, Disclosure to Investors -- The Wheat Report 245-247 (1969).
In advocating this de facto approach, the Government relies on our opinion in Commissioner v. Sunnen,333 U. S. 591 (1948). Sunnen was a personal income tax case in which the Court found the taxpayer had made an assignment of income. The reasoning relied on the de facto power of a controlling shareholder to regulate corporate business for his personal objectives. This case is an estate tax case, not an income tax case. Moreover, unlike assignment of income cases, in which the issue is who has the power over income, this case concerns a statute written in terms of the "right" to designate the recipient of income. The use of the term "right" implies that restraints on the exercise of power are to be recognized, and that such restraints deprive the person exercising the power of a "right" to do so.
The spectrum of types of corporate businesses, and of permissible policies with respect to the retention of earnings, is broad indeed. It ranges from the public utility with relatively assured and stable income to the new and speculative corporation engaged in a cyclical business or organized to exploit a new patent or unproved technology. Some corporations pay no dividends at all, as they are organized merely to hold static assets for prolonged periods (e.g., land, mineral resources, and the like). Corporations which emphasize growth tend to low dividend payments, whereas mature corporations may pursue generous dividend policies.
Thomas v. Matthews, 94 Ohio St. 32, 55-56, 113 N.E. 669, 675 (1916):
"[I]t is the duty of the directors, in determining the amount of net earnings available for the payment of dividends, to take into account the needs of the company in its business and sums necessary in the operation of its business until the income from further operations is available, the amount of its debts, the necessity or advisability of paying its debts or at least reducing them within the limits of the company's credit, the preservation of its capital stock as represented in the assets of the company as a fund for the protection of its creditors and the character of its surplus assets, whether cash, credits or merchandise."
Internal Revenue Code of 1954, Subc. G, pt. I, §§ 531-537, 26 U.S.C. §§ 531-537.
Had Byrum caused the board to follow a dividend policy, designed to minimize or cut off income to the trust, which resulted in the imposition of the penalty for accumulated earnings not distributed to shareholders, there might have been substantial grounds for a derivative suit. A derivative suit also would have been a possibility had dividends been paid imprudently to increase the trust's income at the expense of corporate liquidity. Minority shareholders in Ohio may bring derivative suits under Ohio Rule Civ.Proc. 23.1.
In most States, the power to declare dividends is vested solely in the directors. 11 W. Fletcher, Cyclopedia Corporations, c. 58, § 5320. Ohio is no exception, and it limits the authority of directors to pay dividends depending on available corporate surplus. Ohio Rev.Code Ann. § 1701.33. Although liability generally exists irrespective of a statute, nearly all States have statutes regulating the liability of directors who participate in the payment of improper dividends. 12 Fletcher, supra, c. 58, § 5432. Again, Ohio is no exception. Ohio Rev.Code Ann. § 1701.95.
App. 30-32. In Byrum Lithographing Co., Inc., none of the other 11 stockholders appears to be related by name to Byrum. In Bychrome Co., five of the eight stockholders appear to be unrelated to the Byrums; and in Graphic Realty Co., 11 of the 14 stockholders appear to be unrelated.
See Wilberding v. Miller, 90 Ohio St. 28, 42, 106 N.E. 665, 669 (1914):
"An arbitrary disregard of the rights of stockholders to dividends or other improper treatment of the assets of the company would be relieved against."
The trust instrument explicitly granted the trustee the power
"[t]o enforce, abandon, defend against, or have adjudicated by legal proceedings, arbitration or by compromise, any claim or demand whatsoever arising out of or which may exist against the Trust Estate."
The Government cites two other opinions of this Court, in addition to O'Malley, to support its argument. In both Commissioner v. Estate of Holmes,326 U. S. 480 (1946), and Lober v. United States,346 U. S. 335 (1953), the grantor reserved to himself the power to distribute to the beneficiaries the entire principal and accumulated income of the trust at any time. This power to terminate the trust, and thereby designate the beneficiaries at a time selected by the settlor, is not comparable to the powers reserved by Byrum in this case.
While the trustee could not acquire or dispose of investments without Byrum's approval, he was not subject to Byrum's orders. Byrum could prevent the acquisition of an asset, but he could not require the trustee to acquire any investment. Nor could he compel a sale, although he could prevent one. Thus, if there were other income-producing assets in the trust, Byrum could not compel the trustee to dispose of them.
In purporting to summarize the basis of our distinction of O'Malley, the dissenting opinion states:
"Now the majority would have us accept the incompatible position that a settlor seeking tax exemption may keep the power of income allocation by rendering the trust dependent on an income flow he controls because the general fiduciary obligations of a director are sufficient to eliminate the power to designate within the meaning of § 2036(a)(2)."
Post at 408 U. S. 157. This statement, which assumes the critical and ultimate conclusion, incorrectly states the position of the Court. We do not hold that a settlor "may keep the power of income allocation" in the way MR. JUSTICE WHITE sets out; we hold, for the reasons stated in this opinion, that this settlor did not retain the power to allocate income within the meaning of the statute.
The dissenting opinion's view of the business world will come as a surprise to many. The dissent states:
"Thus, by instructing the directors, he elected in the controlled corporations that he thought dividends should or should not be declared, Byrum was able to open or close the spigot through which the income flowed to the trust's life tenants."
Post at 408 U. S. 152. This appears to assume that all corporations, including the small family type involved in this case, have a regular and dependable flow of earnings available for dividends, and that, if there is a controlling stockholder, he simply turns the "spigot" on or off as dividends may be desired. For the reasons set forth in this opinion, no such dream world exists in the life of many corporations. But whatever the situation may be generally, the fallacy in the dissenting opinion's position here is that the record simply does not support it. This case was decided on a motion for summary judgment. The record does not disclose anything with respect to the earnings or financial conditions of these corporations. We simply do not know whether there were any earnings for the years in question, whether there was an earned surplus in any of the corporations, or whether -- if some earnings be assumed -- they were adequate in light of other corporate needs to justify dividend payments. Nor can we infer from the increase in dividend payments in the year following Byrum's death that higher dividends could have been paid previously. The increase could be explained as easily by insurance held by the corporations on Byrum's life.
At one point, MR. JUSTICE WHITE seems to imply that Byrum also retained the enjoyment of the right to the income from the transferred shares:
"When Byrum closed the spigot by deferring dividends of the controlled corporations, thereby perpetuating his own 'enjoyment' of these funds, he also, in effect, transferred income from the life tenants to the remaindermen."
(Emphasis added.) Post at 408 U. S. 152. But, of course, even if dividends were deferred, the funds remained in the corporation; Byrum could not use them himself.
See 26 CFR § 20.2036-1(b)(2):
"The 'use, possession, right to the income, or other enjoyment of the transferred property' is considered as having been retained by or reserved to the decedent to the extent that the use, possession, right to the income, or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent, or otherwise for his pecuniary benefit."
Although MR. JUSTICE WHITE questions the Court.'s failure to interpret "possession or enjoyment" with "extreme literalness," post at 408 U. S. 154 n. 3, apparently the Commissioner does not do so either. Reflection on the expansive nature of those words, particularly "enjoyment," will demonstrate why interpreting them with "extreme literalness" is an impossibility.
Northern Trust was decided under the Revenue Act of 1921, § 402(c), 42 Stat. 278.
Helvering v. Hallock,309 U. S. 106 (1940); Commissioner v. Estate of Church,335 U. S. 632 (1949); Lober v. United States,346 U. S. 335 (1953); United States v. Estate of Grace,395 U. S. 316 (1969); Estate of McNichol v. Commissioner, 265 F.2d 667 (CA3), cert. denied, 361 U.S. 829 (1959); Guynn v. United States, 437 F.2d 1148 (CA4 1971). In all of these cases, as in Church, the grantor retained either title or an income interest or the right to use real property for his lifetime.
Despite MR. JUSTICE WHITE'S suggestion, post at 408 U. S. 154, we have not "ignore[d] the plain language of the statute which proscribes enjoyment' as well as `possession or . . . the right to income.'" Rather, the cases we have cited clearly establish that the terms "possession" and "enjoyment" have never been used as the dissent argues.
The cited opinion supplemented an earlier opinion of the Board of Tax Appeals in the same case, 47 B.T.A. 807 (1942).
A more analogous case is Yeazel v. Coyle, 68-1 U.S.T.C.