8 T.C. 1269 (1947)

Whether a trust instrument creates a single trust or multiple trusts is determined by the grantor’s intent as expressed in the trust documents, and a state court’s non-adversarial determination is not binding on the Tax Court.

Summary

The Kelly Trust No. 2 case involves deficiencies in income tax payments. The central issue is whether trust deeds created by W.C. Kelly and G.E. Kelly established single trusts or multiple trusts for tax purposes. The Tax Court held that the trust deeds created single trusts, based on the language of the instruments and the lack of genuinely adverse proceedings in a related state court decision. The court reasoned that the grantor’s intent, as gleaned from the trust documents, was to establish single trusts, and the state court’s ruling was not binding due to its non-adversarial nature.

Facts

W.C. Kelly created two trusts in 1927 (Garrard E. Kelly Trust #2 and #4), and G.E. Kelly created one in 1926 (Lucy Gayle Kelly Trust #3). The trusts were substantially similar, benefiting Garrard E. Kelly during his life, then his children W.C. Kelly II and Lucy Gayle Kelly II. The trust agreements stipulated that when any child of Garrard E. Kelly reached 30, the trust “as to such child shall be terminated.” The trustees kept investments of each beneficiary separate for accounting but could make joint investments. After Garrard E. Kelly’s death, income was distributed to the beneficiaries, and a portion was reinvested into separate accounts for each beneficiary.

Procedural History

The Commissioner of Internal Revenue determined deficiencies, treating each trust deed as creating a single trust. The trustees filed fiduciary returns, treating the trusts as multiple trusts, one for each beneficiary. A New York Supreme Court action was initiated by the trustees to settle their accounts and determine questions relating to the trusts. The Supreme Court initially ruled there were four trusts under each trust deed. The Appellate Division affirmed the lower court’s ruling without an opinion, with one judge dissenting. The Tax Court then reviewed the Commissioner’s deficiency assessment.

Issue(s)

Whether the Supreme Court of the State of New York’s decision construing the trust deeds as creating multiple trusts is binding on the Tax Court.

Whether the trust deeds created single trusts or multiple trusts for federal income tax purposes.

Holding

No, because the New York Supreme Court proceeding was not genuinely adversarial, and the decision was akin to a consent judgment.

Single trusts, because the language of the trust documents indicates an intent to create a single trust, and the beneficial interests could be served by a single trust.

Court’s Reasoning

The Tax Court reasoned that it was not bound by the New York court’s decision because the state court proceedings were not truly adversarial. The question of the number of trusts was raised in a supplemental complaint, and none of the defendants opposed the prayers of the complaint. The court emphasized that the state court’s decision was “in the nature of a consent judgment.” The Tax Court examined the trust documents, noting the grantor consistently referred to “the Trust” in the singular. The court highlighted that the trust deeds did not contain provisions necessitating multiple trusts, and a single trust could adequately serve the beneficial interests. The court quoted section 12(a) indicating that when any child of Garrard E. Kelly reached the age of 30, after the death of Garrard E. Kelly, “the Trust as to such child shall be terminated, and his or her then share of the Trust property and funds shall be conveyed, delivered and paid over to him or her.” The court concluded that trustees cannot unilaterally establish multiple trusts for convenience or tax savings when the grantor’s intent was not to create them.

Practical Implications

This case clarifies that the Tax Court is not automatically bound by state court decisions regarding trust interpretation, particularly when those decisions arise from non-adversarial proceedings. Attorneys should ensure that state court actions intended to impact federal tax liabilities are genuinely contested to increase their persuasiveness. When drafting trust instruments, grantors should use clear and unambiguous language regarding the number of trusts intended to be created. This case emphasizes that consistent use of singular or plural terms (e.g., “the trust” vs. “the trusts”) can be a key indicator of the grantor’s intent. The case underscores the importance of evaluating the grantor’s intent based on the entirety of the trust document. Furthermore, trustees should not unilaterally establish multiple trusts without explicit authorization or a clear indication of the grantor’s intent, even if it seems beneficial for tax purposes. Later cases distinguish Kelly Trust by emphasizing the presence of adversarial proceedings or clear language indicating an intent to create multiple trusts.