United States v. O'MALLEY
16 L. Ed. 2d 145, 383 U.S. 627, 1966 U.S. LEXIS 2012 (1966)
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Rule of Law:
When a grantor creates an irrevocable trust and retains, as a trustee, the discretionary power to distribute or accumulate trust income, any accumulated income added to the trust's principal is considered a 'transfer' by the grantor and must be included in their gross estate for estate tax purposes under § 811(c)(1)(B)(ii) of the Internal Revenue Code of 1939.
Facts:
- Edward H. Fabrice died in 1949.
- In 1936 and 1937, Fabrice created five irrevocable trusts for the benefit of his two daughters and his wife.
- Fabrice was one of three trustees for each of these trusts.
- Each trust instrument provided that the trustees, in their sole discretion, could pay trust income to the beneficiary or accumulate the income, in which event it became part of the principal of the trust.
Procedural Posture:
- The Commissioner of Internal Revenue included both the original principal of the trusts and the accumulated income added thereto in Fabrice’s gross estate, assessing a deficiency.
- The executors of Fabrice’s estate (respondents) paid the deficiency and initiated a refund action in the District Court.
- The District Court found the original corpus of the trusts includable in the estate but, citing Commissioner v. McDermott’s Estate, excluded the portion of trust principal representing accumulated income and ordered an appropriate refund.
- The Court of Appeals affirmed the District Court's decision, adhering to its own prior decision in McDermott’s Estate and noting its disagreement with Round v. Commissioner from another circuit.
- The Supreme Court granted certiorari due to these conflicting decisions among circuit courts.
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Issue:
Does Internal Revenue Code of 1939, § 811(c)(1)(B)(ii), require the inclusion of accumulated trust income (added to principal) in a decedent's gross estate, when the decedent, as a trustee, retained the power to distribute or accumulate that income during their lifetime?
Opinions:
Majority - Mr. Justice White
Yes, § 811(c)(1)(B)(ii) requires the inclusion of accumulated trust income (added to principal) in a decedent's gross estate when the decedent, as a trustee, retained the power to distribute or accumulate that income during their lifetime. The Court reasoned that Fabrice retained a significant power to "designate the persons who shall possess or enjoy the property or the income therefrom" by having the discretion to distribute income or accumulate it and add it to the principal. This power allowed him to deny immediate enjoyment to beneficiaries and condition their eventual enjoyment upon surviving the trust's termination. The Court determined that all income increments to trust principal are traceable to Fabrice himself, by virtue of his original transfer of the property and his subsequent exercise of the power to accumulate. Before creating the trusts, Fabrice owned all rights to the property and its income. By choosing to accumulate income and add it to the principal, he effectively made a "transfer" with respect to each addition, over which he retained the same power to deal with its income until his death. The Court distinguished prior cases like Gidwitz’ Estate and Burns v. Commissioner, where the transfers were deemed complete because the grantors retained no interest or power over the income, noting that here Fabrice's death was a significant step in completing a transfer that began inter vivos but remained incomplete due to his retained powers.
Dissenting - Mr. Justice Stewart
No, § 811(c)(1)(B)(ii) does not require the inclusion of accumulated trust income in the decedent's gross estate. Justice Stewart argued that the statutory provision applies only to property "of which the decedent has at any time made a transfer." Fabrice, the decedent, only "made a transfer" of the original trust corpus (the initial property put into the trust). He never "made a transfer" of the income that the corpus subsequently produced, whether that income was distributed or accumulated. Citing Commissioner v. McDermott’s Estate, the dissent emphasized that while the accumulated income represented the "fruit derived from the property which was transferred," Congress did not make provision for including the "fruit," only for the "property transferred." Therefore, absent explicit language from Congress, the statute should not be extended to include accumulated income.
Analysis:
This decision significantly broadens the scope of what constitutes a 'transfer' under § 811(c)(1)(B)(ii) for estate tax purposes, particularly in the context of discretionary trusts. It clarifies that a grantor's retained power to control the timing of enjoyment of trust income, even if only as a co-trustee, can render the underlying property, including accumulated income, includable in their gross estate. By resolving a circuit split, the Supreme Court established a uniform rule, making it more difficult for grantors to avoid estate tax on property where they retain substantial control over the beneficial enjoyment, thereby reinforcing the policy against incomplete inter vivos transfers.
