# Petition — Commissioner v. Quinlivan

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1979
- **Citation:** 444 U.S. 996

## Text

OCTOBER TERM, 1979

COMMISSIONER OF INTERNAL REVENUE, PETITIONER
Vv.

RICHARD R. QUINLIVAN AND ANN M. QUINLIVAN,
ET AL.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR
THE EIGHTH CIRCUIT

WADE H. MCCREE, JR.
Solicitor General

M. CARR FERGUSON
Assistant Attorney General

STUART A. SMITH
Assistant to the Solicitor General

RICHARD FARBER

MARILYN E. BROOKENS
Attorneys
Department of Justice
Washington, D.C. 20530

a eee a ae ann i in a) sree nen

Page
REE A 1
Jurisdiction aati adil Adaiibindéindlennniacininegine 2
EEE aT 2
Statutes and regulations involved .................... 2
EEL LENSES 3
Reasons for granting the petition -................... 8
RR IL ASSES 16
Ee la
EE A 9a
SEES SS 21a
SIE ETE EE EC 22a

CITATIONS

Cases:

Audano v. United States, 428 F.2d 251.... 11, 12
Brooke v. United States, 468 F.2d 1155... 7,12
Brown v. Commissioner, 180 F.2d 926,

cert. denied, 340 U.S. 814 -..................... 7,12
Butler v. Commissioner, 65 T.C. 32'7........ 12
Chace v. United States, 422 F.2d 292........ 12
Corliss v. Bowers, 281 U.S. 376 .............. 14
Engel v. United States, 400 F. Supp. 5,

an ee eee ee 7,12
Felix v. Commissioner, 21 T.C. 794 ........ 12

Finley v. Commissioner, 255 F.2d 128,
aff'd, 265 F.2d 885, cert. denied, 361

i atti scheipenevennenee 11-12
Furman v. Commissioner, 381. F.2d 22... 12
Gregory v. Helvering, 293 U.S. 466 ........ 14

ee
Cente ee ~— Iu thy Supreme Court of the United States
Griffiths v. Commissioner, 308 U.S. 355.... 14 Cceninn Vote 207%
Knetsch v. United States, 364 U.S. 361... 14 ,
Lerner v. Commissioner, 71 T.C. 290...... 12
Mathews v. Commissioner, 61 T.C. 12,
rev'd, 520 F.2d 323, cert. denied, 424 No.
Wes: WHE sainarbeceanneuaiecvesadinaiial 5, 6, 8, 9, 10, 18
Minnesota Tea Co. v. Helvering, 302 U.S. COMMISSIONER OF INTERNAL REVENUE, PETITIONER
RE ES teat 14
Oakes vy. Commissioner, 44 T. C. 524. Sivan 12 v.
Penn v. Commissioner, 51 T.C. 144 ........ 12
Perry v. United States, 520 F.2d 235, RICHARD R. QUINLIVAN AND ANN M. QUINLIVAN,
cert. denied, 423 U.S. 1052....7, 8, 9, 10, 11, 14 ET AL.
Serbousek v. Commissioner, T.C.M. (P-H)
{77,105 (1977) .- ‘ 12
ee eee. ae PETITION FOR A WRIT OF CERTIORARI TO THE
ie Mey v. Commissioner, 841 F.2d UNITED STATES COURT OF APPEALS FOR
, cert. denied, 382 U.S. 814 -.......... 6, 8,9 THE EIGHTH CIRCUIT
White v. Fitzpatrick, 193 F.2d 398, cert.
denied, 343 U.S. 928 . , 12
Wiles v. Commissioner, 491 F.2d 1406... 12
Zumstein v. Commissioner, T.C.M. (P-H) The Solicitor General, on behalf of the Commis- -
73,045 (1978) ------------enneeeeneeeneeeeeneee 12 sioner of Internal Revenue, petitions for a writ of
Statutes and regulation: certiorari to review the judgment of the United

States Court of Appeals for the Eigh ircuit i
Internal Revenue Code of 1954 (26 af Appens for the ign Circuit in

this case.
seer | OPINIONS BELOW
Section 162 (a) (3) .................--- 2, 4, 5, 6, 7, 14 |
RONNIE ictesisia ncbichosnnttintiatnectcte 2, 7-8, 14 | The opinion of the Tax Court (App. A, infra, 1a-
BGFR IMA) ck 9 8a) is not officially reported. The opinion of the

; court of appeals (App. B, infra, 9a-20a) is reported
Miscellaneous: at 599 F.2d 269.

S. Rep. No. 1622, 88d Cong., 2d Sess.
CRRSG) sn ax as 14 (1)

2

JURISDICTION

The judgment of the court of appeals was entered
on May 24, 1979 (App. C, infra, 21a). By order
dated August 16, 1979, Mr. Justice Blackmun ex-
tended the time for filing a petition for a writ of
certiorari to and including October 21, 1979 (a Sun-
day). The jurisdiction of this Court is invoked
under 28 U.S.C. 1254(1).

QUESTION PRESENTED

Whether respondents are entitled to a business
expense deduction under Section 162(a)(3) of the
Internal Revenue Code of 1954 for purported “rental”
payments made under a prearranged gift and lease-
back transaction having no business purpose other
then to divert income to their children, pursuant to
which they contemporaneously transferred an office
building to short-term trusts for the benefit of their
children and leased the building back from the trustee
throughout the term of the trust, while retaining a
reversionary interest in the property upon the termi-
nation of the trust.

STATUTES AND REGULATION INVOLVED

Section 162(a)(3) and Sections 671 through 678
of the Internal Revenue Code of 1954 (26 U.S.C.) and
Treasury Regulation on Income Tax (1954 Code),
Section 1.671-1(c) (26 C.F.R.) are set forth in
Appendix D, infra, 22a-35a.

8
STATEMENT

1. The facts were fully stipulated and may be
summarized as follows: Respondents: Richard R.
Quinlivan and Robert P. Quinlivan are attorneys who
practice law in St. Cloud, Minnesota. They began
the practice with their father in the 1950s and con-
tinued as members of the same firm following his
death in 1961 (App. A, infra, 2a; App. B, infra,
10a). In 1963, respondents began construction of an
office building in which each owned an undivided one-
half interest. Upon completion of the building, re-
spondents’ law firm became the sole occupant of the
building (App. A, infra, 2a-3a; App. B, infra, 10a).?

On January 2, 1964, each respondent transferred
his one-half interest in the office building to the
Northwestern National Bank of Minneapolis as trus-
tee under a separate trust for the benefit of his chil-
dren. The trusts were established on the same day
and were irrevocable for a term of ten years and six
months. At the conclusion of the term, the trust prop-
erty was to revert to respondents (App. A, infra,
3a; App. B, infra, 10a-1la).

1The term “respondents” refers to Richard and Roger
Quinlivan. Ann and Joyce Quinlivan are parties solely be-
cause they filed joint federal income tax returns with their
husbands during the years in issue (App. A, infra, 2a; App.
B, infra, 10a, note 2).

2 At this time, respondents were the only members of the
law firm. Subsequently, at some time prior to the years in
issue, another partner joined the firm (Exs. 7-G, 12-L).

4

Shortly after the establishment of the trusts, the
trustee and respondents’ law firm entered into a
written lease under which the firm leased back the
building that respondents had transferred to the
trusts.* The initial lease was for three years and
contained a renewal option at the expiration of the
term “at a rental and terms to be agreed upon” (App.
A, infra, 3a; App. B, infra, 1la). Subsequent agree-
ments increased the rent and continued the law
firm’s tenancy; each subsequent lease contained the
same renewal option provision (App. B, infra, 11a).
After the termination of the trusts and the reversion
of the building to respondents on July 2, 1974, the
law firm leased the office space from respondents for
an amount that was not less than the highest rent
paid to the trustee during the period it held the
property (App. A, infra, 3a-4a).

2. In computing their net income from the law
practice for each of the years at issue, respondents
claimed business expense deductions for “rentals”
under Section 162(a)(3) of the Internal Revenue
Code of 1954 equal to their aliquot partnership share
of the payments made by the law firm to the trustee
pursuant to the leaseback arrangement. On audit, the
Commissioner of Internal Revenue disallowed the
rental deductions, increased respondents’ share of
their law firm’s income, and accordingly determined
deficiencies (App. A, infra, 2a; App. B, infra, 12a).

8’ The term of the lease commenced as of January 2, 1964;
however, the lease was executed by the parties three weeks
later (Ex. 12-L).

5

In the Commissioner’s view, the rentals were not an
ordinary and necessary business expense because the
obligation to pay such rentals arose out of a trans-
action serving no business purpose and having the
sole objective of tax avoidance (App. B, infra, 12a).

In this suit brought by respondents for redetermi-
nation of the deficiencies, the Tax Court held that
respondents’ payments to the trustee were deductible
under Section 162(a)(3) as “rentals or other pay-
ments required to be made as a condition to the con-
tinued use or possession, for purposes of the trade
or business, of property to which the taxpayer has
not taken or is not taking title or in which he has
no equity.” Pursuant to the Tax Court’s analysis,
respondents’ gift and leaseback satisfied the four-
part test it announced in Mathews v. Commisioner,
61 T.C. 12 (1973), rev’d, 520 F.2d 323 (5th Cir.
1975), cert. denied, 424 U.S. 967 (1976). First, the
Tax Court concluded that respondents did not retain
substantially the same control over the property that
they had before they made the gift because they em-
ployed an independent trustee. Second, the lease-
back was in writing and required the payment of a
reasonable rental. Third, the court ruled that the
leaseback (as distinguished from the gift) had a
bona fide business purpose because respondents’ con-
tinued use of the building was essential to the con-
duct of their law practice. Fourth, the court con-
cluded that respondents’ reversionary interest in the
property was not a disqualifying “equity” within

6

the meaning of Section 162(a)(3) (App. A, infra,
5a-8a).

3. The court of appeals affirmed on three inde-
pendent grounds (App. B, infra, 9a-20a). It first
concluded that respondents’ payments met the literal
requirements for deductibility as “rentals” under Sec-
tion 162(a)(3) because: (1) the payments were
required to be made for the continued use or posses-
sion of the property; (2) respondents’ continued use
or possession of the property was for purposes of
their trade or business; (3) respondents had not
taken and were not taking title to the property; and
(4) respondents had no equity in the property (App.
A, infra, 18a-15a). As the court of appeals saw the
matter, “[i]t is clear that application of the plain
meaning of section 162(a)(3) to the facts of this
case justifies the deduction” (id. at 15a).

As a second ground for affirmance, the court of
appeals approved the four-part test applied by the
Tax Court and concluded that it complemented its
own analysis based upon the literal meaning of
Section 162(a) (3). In so holding, the court rejected
the rationale of the decisions of the Fifth and Fourth
Circuits upholding the government’s position that a
business deduction for rent is allowable only if there
is a business purpose for the entire transaction, in-
cluding the transfer of the property from the tax-
payer and the leaseback. See, e.g., Van Zandt v.
Commissioner, 341 F.2d 440 (5th Cir.), cert. denied,
382 U.S. 814 (1965) ; Mathews v. Commissioner, 520
F.2d 323 (5th Cir. 1974), cert. denied, 424 U.S. 967

7

(1976); Perry v. United States, 520 F.2d 235 (4th
Cir. 1975), cert. denied, 423 U.S. 1052 (1976).

While the court of appeals acknowledged that “for
tax purposes the overall nature of a transaction must
be considered” (App. B, infra, 17a), it observed that
“in addition to all recent cases of the Tax Court not
appealable to the Fifth Circuit, several courts have
adopted positions inconsistent with the Commission-
er’s contentions and consistent with our holding in
this case” (App. B, infra, 15a). See Brooke v. United
States, 468 F.2d 1155 (9th Cir. 1972); Brown v.
Commissioner, 180 F.2d 926 (8d Cir.), cert. denied,
340 U.S. 814 (1950) ; Engel v. United States, 400 F.
Supp. 5 (W.D. Pa. 1975), aff’d by an equally divided
en bane court, 562 F.2d 41 (3d Cir. 1977). As its
second basis for affirmance, the court of appeals con-
cluded that “to the extent that there may be a split
in the courts on this issue, we adopt the majority
view as applied by the Tax Court below” (footnote
omitted) (App. B, infra, 17a-18a).

Even if it had not held that Section 162(a) (3)
expressly authorized respondents’ deductions or
adopted “the majority view as applied by the Tax
Court * * *” (App. B, infra, 17a-18a), the court of
appeals would nevertheless have affirmed on the third
independent ground that the income from the trusts
was taxable to the beneficiaries under the grantor
trust rules of Sections 671-678, App. D, infra, 22a-
35a (App. B, infra, 18a-20a). In the court of ap-
peals’ view, the rental deduction provision of Section
162(a)(3) and the grantor trust rules of Sections

8

671-678 must be read in pari materia. It accordingly
ruled that the taxation of the income of the trusts
to the beneficiaries and not to respondents necessarily
required the conclusion that respondents were entitled
to the rental deduction for the payments to the trust
(App. B, infra, 20a).

REASONS FOR GRANTING THE PETITION

The decision below holding that respondents are
entitled to a business expense deduction for “rentals”
paid to a trustee of a short-term trust for the benefit
of their children in a gift and leaseback arrangement
conflicts with Van Zandt v. Commissioner, 341 F.2d
440 (5th Cir.), cert. denied, 382 U.S. 814 (1965);
Mathews v. Commissioner, 520 F.2d 323 (5th Cir.
1975), cert. denied, 424 U.S. 967 (1976); and Perry
v. United States, 520 F.2d 235 (4th Cir. 1975), cert.
denied, 423 U.S. 1052 (1976). In those cases, the
Fourth and Fifth Circuits have rejected similar at-
tempts by taxpayers to split their income with their
children by creating rental deductions for the use of
business property by means of gift and leaseback
arrangements with short-term trusts. This Court
should resolve the conflict and establish a national
rule with respect to this type of transaction.

1. The typical gift and leaseback device contains
the following elements: The grantor-taxpayer owns
a building which he occupies in the conduct of his
trade or business. He transfers the building to a
trust with a term slightly in excess of ten years for
the benefit of his children, with a reversion to him

9

upon termination of the trust. Simultaneously with
the transfer, the grantor leases the building back
from the trust, for a total period that is usually
coextensive with the term of the trust. The grantor
thereafter claims business expense deductions for the
“rentals” paid to the trust, thereby reducing his high-
bracket taxable income, and shifting the taxation of
the “rentals” to his children, who are typically low-
bracket taxpayers. If the arrangement is given effect —
for tax purposes, the gift and leaseback device enables
high-bracket taxpayers owning realty that they put
to business use to reduce their taxable income by
what are in fact non-deductible payments to the natu-
ral objects of their bounty.

Contrary to the decision below, the Fifth and
Fourth Circuits have refused to permit business ex-
pense deductions for purported rentals in similar
arrangements. Those courts have upheld the Com-
missioner’s position that “rentals” paid pursuant to
a gift and leaseback transaction are not deductible
business expenses unless the taxpayer shows a busi-
ness purpose for the transaction as a whole. Thus,
in Van Zandt v. Commissioner, supra, which involved
a similar trust device for diverting income to the tax-
payer’s children, the Fifth Circuit emphatically re-
jected the notion, adopted by the court below, that
it is sufficient if there is a business purpose for the
leaseback. In holding that the taxpayer’s payments
to the trust were not deductible, Van Zandt concluded
that (341 F.2d at 443) “inevitably we must look at

10

the original conveyance of the property together with
the execution of the lease-back as a single transaction.
Thus reviewing it, we conclude that the obligation to
pay rent resulted not as an ordinary and necessary
incident in the conduct of the business but was in
fact created solely for the purpose of permitting a
division of the taxpayer’s income tax” (emphasis in
original).

Although the taxpayer in Van Zandt named him-
self trustee, the Fifth Circuit subsequently held in
Mathews v. Commissioner, supra, 520 F.2d at 323,
that “[t]he outcome would not have differed had there
been an outside independent trustee” (id. at 325). In
ruling in favor of the government in a case involving
an independent trustee, the court in Mathews em-
phasized that the “[t]axpayers’ effective control of
the property for the duration of the term was prac-
tically assured, notwithstanding the trustee’s inde-
pendence * * *. In short, before the trust’s creation
Taxpayer operated his business on and with necessary
property—all under his complete control. The same
was true afterward—except he hoped some of his in-
come had been siphoned off to his children. As in
Van Zandt what was carefully planned to achieve a
total result cannot be split into separate parts”
(ibid.). Accord: Perry v. United States, supra, 520
F.2d at 239.

Thus, as matters now stand, respondents’ transac-
tion, employing an independent trustee, would pass
muster in the Eighth Circuit but not in the Fourth
or Fifth Circuits. There is accordingly a square con-

11
flict between the decision below and Mathews and
Perry.‘

Finally, the question presented is important to the
proper administration of the revenue laws. It has
produced substantial litigation in recent years and it
is expected that the number of cases will increase
unless the conflict among the circuits is resolved. The
deductibility of rental payments arising out of gift
and leaseback arrangements has been involved in at
least 19 decided cases." Moreover, we are advised by

* Although the court of appeals stated that “to the extent
that there may be a split in the courts on this issue, we adopt
the majority view as applied by the Tax Court below” (App.
B, infra, 17a-18a), it also expressed doubt as to whether
“there exists a true split among the courts of appeals” (App.
B, infra, 17, note 4). The court there recognized that the
Fifth Circuit’s Mathews decision conflicts with its own and
is unpersuasive in suggesting that the pre-Mathews Fifth
Circuit decision in Audano v. United States, 428 F.2d 251,
which also held for the government, somehow suggests that
“the real conflict may be among cases in the Fifth Circuit.”
Moreover, the court’s attempted reconciliation of Perry with
what it characterized as the “majority view’ on the basis of
the “tightly drawn leases” in Perry ignores the Fourth Cir-
cuit’s own analysis in that case. In Perry, the court observed
that “[w]le think our cases are indistinguishable from Van
Zandt, that the latter was correctly decided, and that it should
be applied here” (520 F.2d at 237). The court there further
rejected the bifurcation of the overall transaction (id. at 238-
239) upon which the decision below relies (App. B, infra,
14a, 16a). See pages 12-14, infra. There is thus a clear con-
flict between Van Zandt, Perry and Mathews, on the one hand,
and the decision below.

5 Skemp v. Commissioner, 168 F.2d 598 (7th Cir. 1948) ;
Brown Vv. Commissioner, supra; Brooxe v. United States,
supra; Van Zandt v. Commissioner, supra; Perry v. United
States, supra; Mathews v. Commissioner, supra; Engel v.
United States, supra; Finley v. Commissioner, 255 F.2d 128

12

the Internal Revenue Service that there are currently
15 docketed cases pending in the Tax Court and 45
additional cases pending at various administrative
levels in the Service presenting the issue.

2. The fundamental error by the court below, as
well as by the decisions in Brooke v. United States,
468 F.2d 1155 (9th Cir. 1972); Brown v. Commis-
sioner, 180 F.2d 926 (3d Cir.), cert. denied, 340 U.S.
814 (195c); Engel v. United States, 400 F. Supp. 5
(W.D. Pa. 1975), affd. by an equally divided en banc
court, 562 F.2d 41 (3d Cir. 1977); and Skemp v.
Commissioner, 168 F.2d 598, upon which it relied
(App. B, infra, 15a-16a), was to bifurcate these
integrated gift and leaseback devices into two un-
related transactions of gift and leaseback having
separate and independent status. After breaking
down the transaction into separate components, the
court below concluded the grantor’s rental pay-
ments served a business purpose because they were
required to be made to permit the continued use of
the building for his business.

(10th Cir. 1958), aff’d, 265 F.2d 885, cert. denied, 361 U.S.
834 (1959) ; Audano v. United States, supra; Wiles v. Com-
missioner, 491 F.2d 1406 (5th Cir. 1974); Chace v. United
States, 422 F.2d 292 (5th Cir. 1970); Furman v. Com-
missioner, 381 F.2d 22 (5th Cir. 1967); Felix v. Commis-
sioner, 21 T.C. 794 (1954); Oakes v. Commissioner, 44
T.C. 524 (1965) ; Penn v. Commissioner, 51 T.C. 144 (1968) ;
Butler v. Commissioner, 65 T.C. 327 (1975); Zumstein v.
Commissioner, T.C.M. (P-H) {73,045 (1973); Serbousek
v. Commissioner, T.C.M. (P-H) {77,105 (1977); Lerner
v. Commissioner, 71 T.C. 290 (1978), appeal pending, No. 79-
4129 (2d Cir.). Cf. White v. Fitzpatrick, 198 F.2d 398 (2d
Cir. 1951), cert. denied, 8343 U.S. 928 (1952).

13

But splitting the transaction into separate com-
ponents blinks at the reality inherent in these cases
that the gift and leaseback are integral parts of a
prearranged plan. Unlike the situation where two
independent parties enter into a lease arrangement
pursuant to which rent is paid in exchange for the
occupation of realty, here the taxpayers have them-
selves temporarily created the obligation to pay rent
on property that they themselves owned outright and
will continue to own outright after the termination
of the trust. As the Fifth Circuit succinctly put it in
Mathews v. Commissioner, supra, 520 F.2d at 325,
“Ti]f we stood at the top of the world and looked down
on this transaction—ignoring the flyspeck of legal
title under state law—we would see the same state of
affairs the day after the trust was created that we
saw the day before.”

Since respondents’ short-term trusts and the lease
were essential elements of a prearranged plan,° there
is no basis for the bifurcation of the overall trans-
action by the decision below. Indeed, this Court long

® Although the Tax Court stated in its opinion that “the
leaseback” was not prearranged (App. A, infra, 7a), it made
no finding to this effect and the fully stipulated facts do not
support such an inference. To the contrary, the close prox-
imity in time between the gift and leaseback, coupled with
the fact the building housed respondents’ law practice, sup-
ports the conclusion that respondents intended to lease back
the property at the time they conveyed it to the trusts. In-
deed, in affirming the Tax Court, the court of appeals did not
adopt its conclusion that there was no prearrangement but
relied upon Brown and Skemp in which the fact of prear-
rangement was undisputed.

14

ago established the fundamental principle that trans-
actions designed and executed as integral parts of a
single plan will not be given independent tax signifi-
cance but will be regarded together in determining
the tax consequences of the overall transaction. See,
e.g., Gregory v. Helvering, 293 U.S. 465, 469-470
(1935); Minnesota Tea Co. v. Helvering, 302 U.S.
609, 613-614 (1938) ; Griffiths v. Commissioner, 308
U.S. 355, 357-358 (1939). See also Corliss v. Bowers,
281 U.S. 376, 378 (1939) ; Knetsch v. United States,
364 U.S. 361 (1960). “To hold otherwise would be to
exalt artifice above reality and to deprive the statu-
tory provision in question of all serious purpose.”
Gregory v. Helvering, supra, 293 U.S. at 470.

3. The decision below also erred in concluding, as
its third ground of decision, that the fact that the
income of the trusts was taxable to the beneficiaries
and not to respondents under the grantor trust rules
of Sections 671-678 justified respondents’ rental de-
duction under Section 162(a)(3) (App. B, infra,
18a-20a). There is, however, no necessary correlation
between the taxation of the income from the trusts
and the deductibility of the payments to the trusts.
Indeed, in enacting the grantor trust provisions, Con-
gress specified that they were to have “no applica-
tion in determining the right of a grantor to deduc-
tions for payments to a trust under a transfer and
leaseback arrangement.” S. Rep. No. 1622, 83d Cong.,
2d Sess. 365 (1954). See Perry v. United States,
supra, 520 F.2d at 237, n. 2. In ruling that the
grantor trust rules and Section 162(a) (3) are to be

15

construed in pari materia (App. B, infra, 20a), the
court of appeals disregarded the clearly expressed
intent of Congress.’

In sum, viewing the creation of the trust and the
leaseback as a single integrated transaction, it is
plain that respondents’ “obligation to pay rent” was
not an ordinary and necessary incident to a transac-
tion with a real business purpose. Hence, they were
not entitled to a business expense deduction for such
payments.

™The decision below found the statement in the Senate
Report not authoritative because it was not also set forth in
the House Report (see App. B, infra, 19a). But the Senate
considers revenue measures after the House and the two
bodies thereafter confer on such legislation. There is accord-
ingly no justification for the court of apeals’ conclusion that
the views expressed in the Senate Finance Committee Report
do not represent the intent of Congress.

16
CONCLUSION

The petition for a writ of certiorari should be
granted.

Respectfully submitted.

WADE H. McCrEE, Jr.
Solicitor General

M. CARR FERGUSON
Assistant Attorney General

STUART A. SMITH
Assistant to the Solicitor General

RICHARD FARBER
MARILYN E. BROOKENS
Attorneys

OCTOBER 1979

la

APPENDIX A

T. C. Memo. 1978-70
UNITED STATES TAX COURT

Docket Nos. 8921-75
8922-75

Filed February 23, 1978
RICHARD R. QUINLIVAN and ANN M. QUINLIVAN,
PETITIONERS
Vv.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
ROGER P. QUINLIVAN and JOYCE E. QUINLIVAN,
PETITIONERS
v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Clinton A. Schroeder and Frederick J. Gerhart, for
the petitioners.
Dale L. Newland, for the respondent.

MEMORANDUM OPINION

Fay, Judge: Respondent determined the following
deficiencies in petitioners’ Federal income taxes:

Dkt. No. Petitioner Year Deficiency

8921-75 Richard R. 1967 $5,919.89
and Ann M. 1968 7,011.31
Quinlivan 1969 8,640.70

8922-75 Roger P. and 1967 8,809.91
Joyce E. 1968 4,987.97

Quinlivan 1969 3,580.34

2a

These cases were consolidated for purposes of trial,
briefing, and opinion. Richard R. Quinlivan and
Roger P. Quinlivan will be hereinafter referred to
individually as Richard or Roger and referred to
collectively as the petitioners.

Petitioners are lawyers and were members of the
same law firm during all relevant times herein. Un-
til its incorporation as a professional association in
1969, the law firm operated as a partnership.

Due to concessions, the remaining issue for decision
is whether in computing petitioners’ share of income
from their law practice, a rental expense deduction
under section 162(a) (3), should be allowed for pay-
ments made for the use of property which petitioners
had previously transferred to two short-term trusts.

All of the facts in this case have been stipulated
and are so found.

At the time their petitions in this case were filed,
petitioners and their wives resided in St. Cloud, Minn.
Each petitioner and his spouse filed a joint Federal
income tax return for 1967, 1968, and 1969 with the
Internal Revenue Service Center in Kansas City, Mo.

In 1962 petitioners were engaged in the active
practice of law. In that year, they began construc-
tion of a building designed for general purpose office
space. Richard and Roger each owned an undivided
one-half interest in the building which, upon its com-
pletion, contained some 8,275 square feet of office
space. In April 1963 the law firm of which petition-

* Unless otherwise indicated, all statutory references are
to the Internal Revenue Code of 1954, as amended.

8a

ers are members became the sole occupant of the
building.

On January 2, 1964, Richard and Roger each
executed, as grantors, a 10-year 6-month irrevocable
Trust Agreement creating two trusts for the benefit
of their respective children. Richard and Roger each
retained a reversionary interest in their respective
trusts.

On that same day, Richard and Roger, as grantors,
together with their wives, conveyed the realty to the
Northwestern National Bank of Minneapolis, trustee.’
After the creation of the trusts, the law firm, as
lessee, and the trustee, as lessor, entered into a lease
of the realty held by the trusts. The initial lease was
for a three-year term and was dated January 2, 1964.
At the end of the three-year term, the lessee had the
option of renewing the lease “at a rental and terms
to be agreed upon.” *

Throughout the existence of the trusts, the law
firm remained as the sole tenant of the building.
During the years in issue, the rent paid by the law
firm was reasonable in amount and represented the
fair rental value of the office space. After the termi-
nation of the trusts on July 2, 1974, the law firm
leased the office space from petitioners for an amount

2 Petitioners were not in any way connected with the
trustee bank as a shareholder, officer, depositor, or employee
during any of the years involved.

3 Subsequent to the initial term, the law firm and the
trustee periodically negotiated new written leases of the office
space. For each of the years in issue, a one-year written

lease was agreed upon.

4a

which was not less than the highest rent paid to the
trustee during the period it held the property.

The following is a summary of the rent paid by the
law firm during the years in issue:

Taxable Monthly Yearly

Year Ended Payment Total
December 31, 1967 $ 925 $11,000
December 31, 1968 950 11,400
October 31, 1969 + 1,000 10,000

Upon receipt of the monthly payments, the trustee
allocated one-half the rental income to each trust.*

The issue presented is whether the rental payments
made pursuant to the lease during the years in issue
may be deducted as an ordinary and necessary busi-
ness expense under section 162(a) (3).°

4 After its incorporation in 1969, the law firm elected to
be governed by the provisions of subchapter S of the Code. It
also adopted a fiscal year ending October 31.

5 None of the rent paid by the law firm to the trustee was
ever expended either for the benefit of Richard or Roger or
for the support of any of the beneficiaries of the two trusts.
All of such rent was invested for the sole benefit of the
beneficiaries. :

* Sec. 162(a) (3) provides:

(a) In General.—There shall be allowed as a deduction
all the ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or
business, including—

(3) rentals or other payments required to be
made as a condition to the continued use or posses-
sion, for purposes of the trade or business, of
property to which the taxpayer has not taken or is
not taking title or in which he has no equity.

5a

In Mathews v. Commissioner, 61 T.C. 12 (1973),
revd. 520 F.2d 323 (5th Cir. 1975), cert. denied 424
U.S. 967 (1976), we set forth our view as to the
appropriate test for deductibility of rental payments
by the grantor in a gift and leaseback arrangement.
In so doing, we held that such payments are deduct-
ible if the following requirements are met: (1) “The
grantor must not retain ‘substantially the same con-
trol over the property that he had before’ he made the
gift.” (2) “The leaseback should normally be in
writing and must require payment of a reasonable
rental.” (3) “The leaseback (as distinguished from
the gift) must have a bona fide business purpose.”
(4) In addition, the taxpayer must not possess a
disqualifying “equity” in the property within the
meaning of the statute.’

Based on a careful examination of the facts as
presented, we find these requirements have been met.

First, a fundamental prerequisite to the deducti-
bility of rental payments in a gift and leaseback
arrangement is the relinquishment by the grantor of
a quantum of control over the property which is not

7 Respondent urges, in essence, that we abandon the require-
ments set forth in Mathews v. Commissioner, 61 T.C. 12
(1973), revd. 520 F.2d 328 (5th Cir. 1975), cert. denied, 424
U.S. 967 (1976), in favor of an overall business purpose
test. Specifically, respondent argues that there must be a busi-
ness purpose for the gift as well as the leaseback. We have
previously considered and rejected this contention, and see
no compelling reason to alter our position at this time. See
Serbousek v. Commissioner, T.C. Memo. 1977-105, appeal to
the Eighth Circuit dismissed per stipulation of the parties
(Jan. 12, 1978).

6a

insignificant in comparison to the control that he
enjoyed prior to making the gift. In this regard, we
stated in Mathews that this requirement “is usually
met through a transfer to an independent trustee who
has the right and the opportunity to negotiate regard-
ing the leaseback and who acts for the primary bene-
fit of the beneficiaries, rather than the grantor.”

In the instant case, it is undisputed that the trusts
were valid and irrevocable under Minnesota law.
The trustee was a corporate entity in which the
petitioners were not in any way connected as a share-
holder, director, officer, depositor, or employee. Nor
was the leaseback prearranged. Coupling these fac-
tors with the fiduciary obligations imposed upon
local law, we conclude that the trustee acted inde-
pendently of the petitioners-grantors. Moreover, un-
der the terms of the trusts, the trustee had broad
powers and, of particular import, it had the un-
fettered power to “sell, lease, exchange or otherwise
dispose of the property” held in the trusts, including
the building. We believe the evidence sufficient to
infer that the trustee carried out its fiduciary duties
in accordance with these broad powers granted to it
under the trust agreements. Nor does respondent
seriously dispute this. Furthermore, as in Mathews,
the trustee periodically renegotiated the lease of the
property which was renewable only under mutually
agreeable terms. Specifically, for each of the years
in issue, the trustee negotiated a one-year written
lease of the office building in what we, based on the
evidence, believe were arm’s-length transactions. In

Ta

addition to negotiating renewals, the trustee collected
the rents due under tne lease and applied the net in-
come of the trusts for the benefit of the income
beneficiaries. In light of these facts, we cannot say
that the trustee’s functions and independence were
illusory. See Penn v. Commissioner, 51 T.C. 144
(1968); Van Zandt v. Commissioner, 40 T.C. 824
(1963), affd. 341 F.2d 440 (5th Cir. 1965), cert.
denied 382 U.S. 814 (1965). Thus, we hold that pe-
titioners relinquished sufficient control over the realty
to satisfy the first requirement in Mathews.

As to the second requirement, the lease in question
was in writing, and the parties have agreed that the
rent thereunder was reasonable for the property.

Petitioners likewise satisfy the third requirement:
a business purpose for the lease. Petitioners’ con-
tinued use of the realty was essential to their law
practice. After the petitioners conveyed the realty to
the trustee, their continued possession of the premises
was wholly conditioned upon the payment of rent.
Under such circumstances, the execution of the lease
was a matter of business necessity. Oakes v. Com-
missioner, 44 T.C. 524 (1965); compare Wiles v.
Commissioner, 59 T.C. 289 (1972), affd. 491 F.2d
1406 (5th Cir. 1974).

With respect to the fourth requirement in Mathews
we cannot agree with respondent’s contention that
petitioners possessed an equitable interest or “equity”
in the realty within the meaning of section 162(a)
(3). Briefly stated, petitioners’ reversionary interest
was not derived from the lease or the lessor and

8a

would only become possessory after the termination
of the trusts. Therefore, such interest is not within
the prohibition of section 162(a)(3). Mathews v.
Commissioner, supra, at 23.

Accordingly, on the basis of the particular facts
and circumstances involved herein, we hold the rental
payments in question are deductible as ordinary and
necessary business expenses.

Decisions will be
entered under Rule 155.

|
|

9a
APPENDIX B

UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT

No. 78-1653

RICHARD R. QUINLIVAN and ANN M. QUINLIVAN,
ROGER P. QUINLIVAN and JOYCE E. QUINLIVAN,
APPELLEES

Vv.

COMMISSIONER OF INTERNAL REVENUE, APPELLANT

Appeal from the United States Tax Court

Submitted: February 14, 1979
Filed: May 24, 1979

Before GIBSON, Chief Judge, HENLEY, Circuit Judge,
and HANSON, Senior District Judge.*

* The Honorable William C. Hanson, Senior United States
District Judge, Southern District of Iowa, sitting by desig-
nation.

10a

GIBSON, Chief Judge.

The Government appeals from a decision of the
Tax Court* holding that Richard and Roger Quin-
livan * are entitled te deduct rental payments made to
a short-term, so-called Clifford trust set up in accord-
ance with sections 671 through 678 of the Internal
Revenue Code of 1954, 26 U.S.C. §§ 671-678. The
payments were made for the use of an office building
previously owned by the taxpayers and transferred
by them to a trustee for the benefit of the taxpayers’

children. After carefully considering the arguments —

of the parties and the pertinent statutory and case
authority, we affirm.

Richard and Roger Quinlivan are attorneys who
reside in St. Cloud, Minnesota. They began the prac-
tice of law with their father in the 1950s and con-
tinued as members of the same. firm following his
death in 1961. In 1963, the firm moved into an office
building owned by the two brothers as tenants in
common. Then on January 2, 1964, each taxpayer
transferred his one-half interest in the property to
Northwestern National Bank of Minneapolis as trus-
tee under separate trusts for the benefit of the chil-
dren of each taxpayer.

1 The Honorable William M. Fay, United States Tax Court.

? Ann M. Quinlivan and Joyce E. Quinlivan are the wives
of Richard and Roger, respectively. They are involved in this
action by virtue of their having filed joint income tax returns
with their husbands. References to “taxpayers” in this
opinion mean Richard and Roger, whose legal business gen-
erated the challenged deductions.

lla

The trust documents were executed January 2,
1964, and were irrevocable for a period of ten years
and six months; at the end of that time trust property
reverted to the grantor-taxpayers. Neither the tax-
payers nor their wives were connected with the trus-
tee during the years here involved as a shareholder,
director, officer, depositor, or employee. All parties
agree that under sections 671 through 678 of the
Internal Revenue Code of 1954, the income of the
trusts was properly taxed to the beneficiaries. Nor
is there any question that the taxpayers treated the
establishment of the trust properly under the gift tax
laws and the laws of Minnesota.

Shortly after January 2, 1964, the trustee and the
taxpayers’ law firm entered into a written lease of
the premises to the law firm. The initial lease was
for three years and contained a renewal option “at a
rental and terms to be agreed upon.” Subsequent
agreements increased the rent and continued the law
firm’s tenancy; each agreement contained the same
renewal option. It is stipulated that reasonable rental
payments were made to the trustee. During the
1967, 1968, and 1969 taxable years involved in this
case, the law firm was composed of Richard and
Roger Quinlivan and Gerald Williams.’ The law
firm deducted from its income the rental payments
made to the trustee.

* During 1967 and 1968 the law firm was a partnership.
In 1969, it was converted to a corporation and chose a tax-
able year ending October 81, 1969.

Ee

12a

In 1975, the Commissioner issued notices of de-
ficiency to the taxpayers and their wives. This was
based in part on computation of an increased dis-
tributive share of law firm income for each taxpayer
after the Commissioner disallowed the rental deduc-
tions. Petitions contesting the deficiency notices were
filed in the Tax Court. After other issues were
settled, the rent deduction issue was submitted to the
court on an agreed statement of facts. The Tax Court
held the rent deductions were allowable. The Com-
missioner appeals, positing the issue of “whether the
rentals paid are a necessary and ordinary business
expense notwithstanding the fact that the obligation
to pay such rentals arose out of a transaction serving
no business purpose and having tax avoidance as its

sole objective.”
I

In analyzing the correctness of the conclusions of
the Tax Court, we first look at the statutory basis for
this deduction. Section 162 of the Internal Revenue
Code of 1954 provides, in pertinent part:

(a) In general—There shall be allowed all
the ordinary and necessary expenses paid or in-
curred during the taxable year in carrying on
any trade or business, including—

* * * *

(3) rentals or other payments required to
be made as a condition to the continued use or
possession, for purposes of the trade or busi-
ness, of property to which the taxpayer has not
taken or is not taking title or in which he has

no equity.

13a

In applying tax statutes, including the Internal
Revenue Code, the literal meaning of the words chosen
by Congress is most important. Masonite Corp. v.
Fly, 194 F.2d 257, 260-61 (5th Cir. 1952). Mr.
Justice Douglas noted and elaborated on this concept
when he wrote:

Congress may be strict or lavish in its allowance
of deductions or tax benefits. The formula it
writes may be arbitrary and harsh in its appli-
cations. But where the benefit claimed by the
taxpayer is fairly within the statutory language
and the construction sought is in harmony with
the statute as an organic whole, the benefits will
not be withheld from the taxpayer though they
represent an unexpected windfall.

Lewyt Corp. v. Commissioner, 349 U.S. 237, 240
(1955).

Examining section 162(a)(3) from this perspec-
tive, we find that Congress has expressly provided for
the deduction of rental expenses where:

(1) the payments are required to be made for
the continued use or possession of the prop-
erty;

(2) the continued use or possession of the prop-
erty is for purposes of the trade or busi-
ness;

(3) the taxpayer has not taken and is not
taking title to the property; and

(4) the taxpayer has no equity in the property.

l4a

If all four requirements are met, the law firm is
entitled to the deduction and the Tax Court’s decision
must be affirmed.

It is clear that the first requirement has been
established. The law firm was required to pay rent
under the written leases for the years in question.
Had the payments not been made, it is undisputed
that the bank as trustee would have been under a
fiduciary obligation to evict the law firm and rent
the property to others or to sue the law firm for the
rent. The trusts were valid and enforceable under
Minnesota law. There is no reason to believe that
the independent trustee in this case would have vio-
lated its fiduciary duties and permitted the law firm
to remain in the building without paying rent.

Similarly, it is clear that the continued use of the
property was for the purposes of the law firm’s busi-
ness. It could not function without the office space
it rented. In like manner, the third requirement is
met by title being in the trustee; certainly the law
firm was not purchasing the office building.

The fourth requirement in section 162(a) (3) is
that the taxpayer have no equity in the property.
On appeal, the Government has not argued that the
taxpayers have a disqualifying equity here. The Tax
Court noted the taxpayers’ “reversionary interest was
not derived from the lease or the lessor and would
only become possessory after the termination of the
trusts. Therefore, such interest is not within the
prohibition of section 162(a)(3).” Memorandum
opinion at 9. We agree. The prohibition on equitable

15a

interests seems designed to fill the gaps around the
third requirement dealing with title to the property.
Taken together, they were intended to prevent the
taxpayer from receiving or improperly benefiting
from the deducted rental payments.

It is clear that application of the plain meaning
of section 162(a)(3) to the facts of this case jus-
tifies the deduction. This is a sufficient basis for
affirmance of the Tax Court.

II

Despite the clear application of the statute, the
Government has contended for many years that rental
deductions should not be allowed where the leased
property was previously owned by the lessee and
given by him to the lessor. The Government urges
that a deduction is allowable only if there was a
“business purpose” for the “entire transaction,” in-
cluding the transfer of the property from the tax-
payer and the leaseback. Years of litigation has re-
sulted in a few cases adopting the Government’s
rationale. See, e.g., Mathews v. Commissioner, 520
F.2d 323 (5th Cir. 1974), cert. denied, 424 U.S. 967
(1976); Perry v. United States, 520 F.2d 285 (4th
Cir. 1975), cert. denied, 423 U.S. 1052 (1976); Van
Zandt v. Commissioner, 341 F.2d 440 (5th Cir.),
cert. denied, 382 U.S. 814 (1965). On the other
hand, in addition to all recent cases of the Tax Court
not appealable to the Fifth Circuit, several courts
have adopted positions inconsistent with the Commis-
sioner’s contentions and consistent with our holding
in this case. Brooke v. United States, 468 F.2d 1155
(9th Cir. 1972); Brown v. Commissioner, 180 F.2d

16a

926 (3d Cir.), cert. denied, 340 U.S. 814 (1950);
Skemp v. Commissioner, 168 F.2d 598 (7th Cir.
1948) ; Engel v. United States, 400 F. Supp. 5 (W.D.
Pa. 1975), aff'd by evenly divided en banc court,
No. 76-1889 (3d Cir. Aug. 3, 1977).

Following the decisions in Brown and Skemp, the
Tax Court has taken the lead in developing a con-
sistent body of law in this area. In the present case
the Tax Court stated four requirements which it had
previously applied in Mathews v. Commissioner, 61
T.C. 12 (1973), rev’d, 520 F.2d 328 (5th Cir. 1975),
cert. denied, 424 U.S. 967 (1976). The four require-
ments were:

(1) “The grantor must not retain ‘substan-
tially the same control over the property that he
had before’ he made the gift.” (2) “The lease-
back should normally be in writing and must
require payment of a reasonable rental.” (3)
“The leaseback (as distinguished from the gift)
must have a bona fide business purpose.” (4)
In addition, the taxpayer must not possess a dis-
qualifying “equity” in the property within the
meaning of the statute.

Memorandum opinion at 6.

These tests complement the statutory standards
discussed above. They provide a specific approach
for application of the statute in gift-leaseback situa-
tions. We are satisfied that any expenditure which
fails these requirements would also fail the statutory
standards.

17a

We recognize that for tax purposes the overall
nature of a transaction must be considered. Cer-
tainly in these situations of gifts and leasebacks, the
gift aspect is a relevant factor to consider in several!
respects. If no independent trustee is present, then
the existence of a gift brings into question whether
there was in fact any “requirement” that rent be
paid and also suggests the possible existence of a
disqualifying equity. However, the Congress has
specified that the business purpose test is concerned
with the “continued use or possession” of the prop-
erty. There is no justification for adding an in-
quiry into the origin of the lessor’s title in applying
this requirement.

In short, to the extent that there may be a split
in the courts on this issue,* we adopt the majority

4It is not clear that there exists a true split among the
courts of appeals. The Government primarily relies on
Mathews, Perry, and Van Zandt involved a situation in which
the settlor-taxpayer was also the trustee. Similarly, in Perry,
the Fourth Circuit found that the trustee’s independence was
illusory due to tightly drawn leases; this result may have
been consistent with the majority view. Mathews did take a
position more hostile to taxpayers in a similar situation. Van
Zandt and Mathews were decided by the Fifth Circuit as
was Audano v. United States, 428 F.2d 251, (5th Cir. 1970).
Audano held for the Government in a similar situation but
carefully considered traditional tests, including the reason-
ableness of the rental payments. 428 F.2d at 256-57. Audano
was decided after Van Zandt but before Mathews, and has
not been overruled. Thus the real conflict may be among
cases in the Fifth Circuit.

18a

view as applied by the Tax Court below. This is a
second basis for affirmance.

III

Even if we were not convinced that section 162
(a) (3) expressly authorizes the taxpayers’ position
and that the majority view adopted by other courts
is correct, we would still affirm the Tax Court. There
is an interplay between section 162 and sections 671-
678 of the Internal Revenue Code of 1954. The latter
sections provide detailed rules governing the taxation
of income to the beneficiary of donative trusts; typi-
cally this means less tax is paid than would be other-
wise. If these rules are carefully followed, the
grantor of a trust will not be taxed on the income
generated by the gift; instead the beneficiaries will
bear that burden.

As we noted above, the trusts in this case were
valid and resulted in the income of the trusts being
taxed to the beneficiaries. The interplay with section
162 occurs because a deduction for rental payments
is essential if the grantor-taxpayers are to gain any
tax benefit from the arrangement. It is the Govern-
ment’s essential position that the law firm’s payments
to the trust amounted to gifts but that it was taxable
income to the beneficiaries.

Following the Government’s approach, sections 671-
678 would produce a benefit only in cases where in-
vestment property—not used in the grantor’s trade
or business—is placed in trust. Persons whose as-
sets consist largely of business property would be

19a

excluded from a tax benefit clearly provided by
Congress.°®

The Government defends this result by relying on
a single sentence contained in a Senate committee
report dealing with the 1954 Code. Referring to
sections 671-678, the report stated: “This subpart
also has no application in determining the right of a
grantor to deductions for payments to a trust under
a transfer and leaseback arrangement.” S. Rep. No.
1623, 83rd Cong., 2d Sess., pp. 364-72, reprinted in
[1954] U.S. CopE Conc. & Ap. News 4621, 5006.
Obviously, this statement, contained in a lengthy com-
mittee report and not paralleled in the House report,
aids the Government’s case but is of questionable
weight.

If we accept this strand of legislative history as
conclusive, we implicitly assume that in enacting the
1954 Code, Congress considered the propriety of de-
ductions similar to those involved in this case. Mak-
ing that assumption, we are immediately faced with
the fact that the two leading cases deciding this
issue before 1954 were Brown v. Commissioner, 180
F.2d 926 (3d Cir.), cert. denied, 340 U.S. 814 (1950),
and Skemp v. Commissioner, 168 F.2d 598 (7th Cir.
1948). Both of those cases favored the taxpayers.

* Presumably, the Government’s position would permit an
office building to be placed in trust under these sections so
long as the grantor didn’t occupy any of the premises. Thus
an elaborate pian of a gift of vacated office space followed
by rent of other office space would satisfy the Government,
although the substance of the transaction would be identical
with that involved here.

20a

Since Congress was rewriting the entire Code and
made no pertinent change in the section dealing with
business deductions, we can only conclude that it ap-
proved the result in Brown and Skemp.

We are left with a firm conviction that if section
162(a)(8) and sections 671-678 are considered in
pari materia, the taxpayers are entitled to the rent
reduction. On the other hand, if the sections are not
considered together due to legislative history, we can
only conclude that Congress wished to continue the
law existing in 1954. In either event, the judgment
of the Tax Court must be affirmed.

As noted by the Supreme Court: “The legal right -

of a taxpayer to decrease the amount of what other-
wise would be his taxes, or altogether avoid them, by
means which the law permits, cannot be doubted
* * *” Gregory v. Helvering, 293 U.S. 465, 469
(1935). See also Knetsch v. United States, 364 U.S.
361 (1960). The law permits the method of tax
minimization chosen by the Quinlivans.

Judgment affirmed.
A true copy.
Attest:

Clerk, U.S. Court of Appeals, Eighth Circuit.

21a

APPENDIX C

UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT

No. 78-1653
September Term, 1978
[Filed May 24, 1979]

RICHARD R. QUINLIVAN; ANN M. QUINLIVAN,
ROGER P. QUINLIVAN; JOYCE E. QUINLIVAN,
APPELLEES

vs.
COMMISSIONER OF INTERNAL REVENUE, APPELLANT

Appeal from the United States Tax Court
JUDGMENT

This Cause came on to be heard on the record of
the United States Tax Court, appendix and briefs of

the respective parties and was argued by counsel.

On Consideration Whereof, it is now here ordered
and adjudged by this Court that the judgment of the
Tax Court be and is hereby affirmed in accordance
with opinion of this Court.

Costs taxed in favor of Appellees: May 24, 1979
Costs of printing 10 copies
of brief: $64.00
Total costs of Appellees for

recovery from Appellant: $64.00

22a
APPENDIX D

Internal Revenue Code of 1954 (:26 U.S.C.) :

SEC. 162. TRADE OR BUSINESS
EXPENSES.

(a) In General.—There shall be allowed as a
deduction all the ordinary and necessary expenses
paid or incurred during the taxable year in
carrying on any trade or business, including—

* * * *

(3) rentals or other payments required
to be made as a condition to the continued
use or possession, for. purposes of the trade
or business, of property to which the tax-
payer has not taken or is not taking title or
in which he has no equity.

* * * *

SEC. 671. TRUST INCOME, DEDUCTIONS,
AND CREDITS ATTRIBUTABLE
TO GRANTORS AND OTHERS AS
SUBSTANTIAL OWNERS.

Where it is specified in this subpart that the
grantor or another person shall be treated as the
owner of any portion of a trust, there shall then
be included in computing the taxable income and
credits of the grantor or the other person those
items of income, deductions, and credits against
tax of the trust which are attributable to that
portion of the trust to the extent that such items
would be taken into account under this chapter in
computing taxable income or credits against the
tax of an individual. Any remaining portion of

EE ee ae ee ee

23a

the trust shall be subject to subparts A through
D. No items of a trust shall be included in com-
puting the taxable income and credits of the
grantor or of any other person solely on the
grounds of his dominion and control over the
trust under section 61 (relating to definition of
gross income) or any other provision of this title,
except as specified in this subpart.

SEC. 672. DEFINITIONS AND RULES.

(a) Adverse Party.—For purposes of this sub-
part, the term “adverse party” means any person
having a substantial beneficial interest in the
trust which would be adversely affected by the
exercise or nonexercise of the power which he
possesses respecting the trust. A person having
a general power of appointment over the trust
property shall be deemed to have a beneficial in-
terest in the trust.

(b) Nonadverse Party.—For purposes of this
subpart, the term “nonadverse party” means any
person who is not an adverse party.

(c) Related or Subordinate Party.—For pur-
poses of this subpart, the term “related or sub-
ordinate party” means any nonadverse party who
is

(1) the grantor’s spouse if living with the
grantor;

(2) any one of the following: The
grantor’s father, mother, issue, brother or
sister; an employee of the grantor; a cor-
poration or any employee of a corporation
in which the stock holdings of the grantor
and the trust are significant from the view-
point of voting control; a subordinate em-

os

24a

ployee of a corporation in which the grantor
is an executive.

For purposes of section 674 and 675, a related
or subordinate party shall be presumed to be
subservient to the grantor in respect of the exer-
cise or nonexercise of the powers conferred on
him unless such party is shown not to be sub-
servient by a preponderance of the evidence.

(d) Rule Where Power Is Subject To Condi-
tion Precedent.—A person shall be considered to
have a power described in this subpart even
though the exercise of the power is subject to a
precedent giving of notice or takes effect only on
the expiration of a certain period after the exer-
cise of the power.

SEC. 673. REVERSIONARY INTERESTS.

(a) General Rule——The grantor shall be
treated as the owner of any portion of a trust
in which he has a reversionary interest in either
the corpus or the income therefrom if, as of the
inception of that portion of the trust, the interest
will or may reasonably be expected to take effect
in possession or enjoyment within 10 years com-
mencing with the date of the transfer of that
portion of the trust.

(b) [Repealed].

(c) Reversionary Interest Taking Effect at
Death of Income Beneficiary.—The grantor shall
not be treated under subsection (a) as the owner
of any portion of a trust where his reversionary
interest in such portion is not to take effect in
possession or enjoyment until the death of the

25a

person or persons to whom the income therefrom
is payable.

(d) Postponement of Date Specified for Re-
acquisition.—Any postponement of the date speci-
fied for the reacquisition of possession or enjoy-
ment of the reversionary interest shall be treated
as a new transfer in trust commencing with the
date on which the postponement is effected and
terminating with the date prescribed by the post-
ponement. However, income for any period shall
not be included in the income of the grantor by
reason of the preceding sentence if such income
would not be so includible in the absence of such
postponement.

SEC. 674. POWER TO CONTROL BENE-
FICIAL ENJOYMENT.

(a) General Rule—The grantor shall be
treated as the owner of any portion of a trust in
respect of which the beneficial enjoyment of the
corpus or the income therefrom is subject to a
power of disposition, exercisable by the grantor
or a nonadverse party, or both, without the ap-
proval or consent of any adverse party.

(b) Exceptions for Certain Powers.—Subsec-
tion (a) shall not apply to the following powers
regardless of by whom held.

(1) Power to apply income to support a
dependent.—A power described in section
677(b) to the extent that the grantor would
not be subject to tax under that section.

(2) Power affecting beneficial enjoyment
only after expiration of 10-year period.—

26a

A power, the exercise of which can only af-
fect the beneficial enjoyment of the income
for a period commencing after the expira-
tion of a period such that a grantor would
not be treated as the owner under section
673 if the power were a reversionary inter-
est; but the grantor may be treated as the
owner after the expiration of the period un-
less the power is relinquished.

(3) Power exercisable only by will.—A
power exercisable only by will, other than
a power in the grantor to appoint by will the
income of the trust where the income is
accumulated for such disposition by the
grantor or may be so accumulated in the
discretion of a grantor or a nonadverse
party, or both, without the approval or con-
sent of any adverse party.

(4) Power to allocate among charitable
beneficiaries—A power to determine the
beneficial enjoyment of the corpus or the
income therefrom if the corpus or income is
irrevocably payable for a purpose specified
in section 170(c) (relating to definition of
charitable contributions).

(5) Power to distribute corpus.—A power
to distribute corpus either—

(A) to or for a beneficiary or bene-
ficiaries or to or for a class of bene-
ficiaries (whether or not income bene-
ficiaries) provided that the power is
limited by a reasonably definite stand-
ard which is set forth in the trust in-
strument; or

eR eT Ee ee ee ee ee Te eae

27a

(B) to or for any current income
beneficiary, provided that the distribu-
tion of corpus must be chargeable
against the proportionate share of cor-
pus held in trust for the payment of
income to the beneficiary as if the cor-
pus constituted a separate trust.

A. power does not fall within the powers
described in this paragraph if any person
has a power to add to the beneficiary or
beneficiaries or to a class of beneficiaries
designated to receive the income or corpus,
except where such action is to provide for
after-born or after-adopted children.

(6) Power to withhold income tempo-
rarily.—A power to distribute or apply in-
come to or for any current income bene-
ficiary or to accumulate the income for him,
provided that any accumulated income must
ultimately be payable—

(A) to the beneficiary from whom
distribution or application is withheld,
to his estate, or to his appointees (or
persons named as alternate takers in
default of appointment) provided that
such beneficiary possesses a power of
appointment which does not exclude
from the class of possible appointees
any person other than the beneficiary,
his estate, his creditors, or the creditors
of his estate, or

(B) on termination of the trust, or
in conjunction with a distribution of
corpus which is augmented by such ac-

28a

cumulated income, to the current in-
come beneficiaries in shares which have
been irrevocably specified in the trust
instrument.

Accumulated income shall be considered so
payable although it is provided that if any
beneficiary does not survive a date of dis-
tribution which could reasonably have been
expected to occur within the beneficiary’s
lifetime, the share of the deceased benefi-
ciary is to be paid to his appointees or to
one or more designated alternate takers
(other than the grantor or the grantor’s
estate) whose shares have been irrevocably
specified. A power does not fall within the
powers described in this paragraph if any
person has a power to add to the beneficiary
or beneficiaries or to a class of beneficiaries
designated to receive the income or corpus
except where such action is to provide for
after-born or after-adopted children.

(7) Power to withhold income during dis-
ability of a beneficiary.—A power exercis-
able only during—

(A) the existence of a legal disabil-
ity of any current income beneficiary,
or

(B) the period during which any in-
come beneficiary shall be under the age
of 21 years,

to distribute or apply income to or for such
beneficiary or to accumulate and add the
income to corpus. A power does not fall
within the powers described in this para-

29a

graph if any person has a power to add to
the beneficiary or beneficiaries or to a class
of beneficiaries designated to receive the in-
come or corpus, except where such action
is to provide for after-born or after-adopted
children.

(8) Power to allocate between corpus and
income.—A power to allocate receipts and
disbursements as between corpus and in-
come, even though expressed in broad lan-
guage.

(c) Exception for Certain Powers of Indepen-
dent Trustees.—Subsection (a) shall not apply
to a power solely exercisable (without the ap-
proval or consent of any other person) by a
trustee or trustees, none of whom is the grantor,
and no more than half of whom are related or
subordinate parties who are subservient to the
wishes of the grantor—

(1) to distribute, apportion, or accumu-
late income to or for a beneficiary or bene-
ficiaries, or to, for, or within a class of
beneficiaries ; or

(2) to pay out corpus to or for a bene-
ficiary or beneficiaries or to or for a class
of beneficiaries (whether or not income
beneficiaries).

A power does not fall within the powers described
in this subsection if any person has a power to
add to the beneficiary or beneficiaries or to a
class of beneficiaries designated to receive the
income or corpus, except where such action is to
provide for after-born or after-adopted children.

(d) Power to Allocate Income if Limited by a
Standard.—Subsection (a) shall not apply to a

30a

power solely exercisable (without the approval
or consent of any other person) by a trustee or
trustees, none of whom is the grantor or spouse
living with the grantor, to distribute, apportion,
or accumulate income to or for a beneficiary or
beneficiaries, or to, for, or within a class of
beneficiaries, whether or not the conditions of
paragraph (6) or (7) of subsection (b) are
satisfied, if such power is limited by a reasonably
definite external standard which is set forth in
the trust instrument. A power does not fall with-
in the powers described in this subsection if any
person has a power to add to the beneficiary or
beneficiaries or to a class of beneficiaries desig-
nated to receive the income or corpus except
where such action is to provide for after-born or
after-adopted children.

SEC. 675. ADMINISTRATIVE POWERS.

The grantor shall be treated as the owner of
any portion of a trust in respect of which—

(1) Power to deal for less than adequate and
full consideration—A power exercisable by the
grantor or a nonadverse party, or both, without
the approval or consent of any adverse party
enables the grantor or any person to pur-
chase, exchange, or otherwise deal with or dis-
pose of the corpus or the income therefrom for
less than as adequate consideration in money or
money’s worth.

(2) Power to borrow without adequate inter-
est or security.—A power exercisable by the
grantor or a nonadverse party, or both, enables

3la

the grantor to borrow the corpus or income di-
rectly or indirectly, without adequate interest or
without adequate security except where a trustee
(other than the grantor) is authorized under a
general lending power to make loans to any per-
son without regard to interest or security.

(8) Borrowing of the trust funds.—The
grantor has directly or indirectly borrowed the
corpus or income and has not completely repaid
the loan, including any interest before the be-
ginning of the taxable year. The preceding sen-
tence shall not apply to a loan which provides for
adequate interest and adequate security, if such
loan is made by a trustee other than the grantor
and other than a related or subordinate trustee
subservient to the grantor.

(4) General powers of administration.—A
power of administration is exercisable in a non-
fiduciary capacity by any person without the ap-
proval or consent of any person in a fiduciary
capacity. For purposes of this paragraph, the
term “power of administration” means any one
or more of the following powers: (A) a power
to vote or direct the voting of stock or other
securities of a corporation in which the holdings
of the grantor and the trust are significant from
the viewpoint of voting control; (B) a power to
control the investment of the trust funds either
by directing investment or reinvestment, or by
vetoing proposed investments or reinvestments,
to the extent that the trust funds consist of
stocks or securities of corporations ix which the
holdings of the grantor and the trust are signifi-
eant from the viewpoint of voting control; or

»

32a

(C) a power to reacquire the trust corpus by
substituting other property of an equivalent
value.

SEC. 676. POWER TO REVOKE.

(a) General Rule—The grantor shall be
treated as the owner of any portion of a trust,
whether or not he is treated as such owner under
any other provision of this part, where at any
time the power to revest in the grantor title to
such portion is exercisable by the grantor or a
non-adverse party, or both.

(b) Power Affecting Beneficial Enjoyment
Only After Expiration of 10-Year Period.—Sub-
section (a) shall not apply to a power the exer-
cise of which can only affect the beneficial en-
joyment of the income for a period commencing
after the expiration of a period such that a
grantor would not be treated as the owner under
section 673 if the power were a reversionary in-
terest. But the grantor may be treated as the
owner after the expiration of such period unless
the power is relinquished.

SEC. 677. INCOME FOR BENEFIT OF
GRANTOR.

(a) General Rule——The grantor shall be
treated as the owner of any portion of a trust,
whether or not he is treated as such owner
under section 674, whose income without the
approval or consent of any adverse party is, or,
in the discretion of the grantor or a nonadverse
party, or both, may be—

(1) distributed to the grantor or the
grantor’s spouse;

33a

(2) held or accumulated for future dis-
tribution to the grantor or the grantor’s
spouse; or

(3) applied to the payment of premiums
on policies of insurance on the life of the
grantor or the grantor’s spouse (except
policies of insurance irrevocably payable for
a purpose specified in section 170(c) (relat-
ing to definition of charitable contribu-
tions) ).

This subsection shall not apply to a power the
exercise of which can only affect the beneficial
enjoyment of the income for a period commenc-
ing after the expiration of a period such that the
grantor would not be treated as the owner under
section 673 if the power were a reversionary 1n-
terest; but the grantor may be treated as the
owner after the expiration of the period unless
the power is relinquished.

(b) Obligations of Support.—Income of a
trust shall not be considered taxable to the
grantor under subsection (a) or any other pro-
vision of this chapter merely because such in-
come in the discretion of another person, the
trustee, or the grantor acting as trustee or Co-
trustee, may be applied or distributed for the
support or maintenance of a beneficiary (other
than grantor’s spouse) whom the grantor is
legally obligated to support or maintain, except
to the extent that such income is so applied or
distributed. In cases where the amounts so ap-
plied or distributed are paid out of corpus or out
of other than income for the taxable year, such
amounts shall be considered to be an amount

34a

paid or credited within the meaning of para-
graph (2) of section 661(a) and shall be taxed
to the grantor under section 662.

SEC. 678. PERSON OTHER THAN
GRANTOR TREATED AS
SUBSTANTIAL OWNER.

(a) General Rule—A person other than the
grantor shall be treated as the owner of any por-
tion of a trust with respect to which:

(1) such person has a power exercisable
solely by himself to vest the corpus or the
income therefrom in himself, or

(2) such person has previously partially
released or otherwise modified such a power
and after the release or modification retains
such control as would, within the principles
of sections 671 to 677, inclusive, subject a
grantor of a trust to treatment as the owner
thereof.

(b) Exception Where Grantor Is Taxable.—
Subsection (a) shall not apply with respect to a
power over income, as originally granted or
thereafter modified, if the grantor of the trust
or a transferor (to whom section 679 applies) is
otherwise treated as the owner under the pro-
visions of this subpart other than this section.

(ce) Obligations of Support.—Subsection (a)
shall not apply to a power which enables such
person, in the capacity of trustee or co-trustee,
merely to apply the income of the trust to the
support of maintenance of a person whom the
holder of the power is obligated to support or

85a

maintain except to the extent that such income
is so applied. In cases where the amounts so
applied or distributed are paid out of corpus or
out of other than income of the taxable year,
such amounts shall be considered to be an amount
paid or credited within the meaning of para-
graph (2) of section 661(a) and shall be taxed
to the holder of the power under section 662.

(d) Effect of Renunciation or Disclaimer.—
Subsection (a) shall not apply with respect to
a power which has been renounced or disclaimed
within a reasonable time after the holder of the
power first became aware of its existence.

* * * *

Treasury Regulations on Income Tax (1954 Code),
Section 1.671-.1.

Likewise, these sections have no application in
determining the right of a grantor to deductions
for payments to a trust under a transfer and
leaseback arrangement.

~ * + *

ow. 8. covmanment printine orrics; 1979 302660 100

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385006_1121%3A1. Public record. Not legal advice.