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November 16, 1977


Suffolk. Trustees' accounts filed in the Probate Court for the county of Suffolk under the will of Abby Shaw Proctor on September 18, 1970, November 5, 1971, and December 14, 1972, and under the will of Mary Ida Converse on July 8, 1971, December 22, 1971, December 28, 1972, March 6, 1973, November 8, 1973, and January 24, 1974. The cases were reserved and reported by Warner, J. The Supreme Judicial Court granted requests for direct review.

Hennessey, C.j., Quirico, Braucher, Kaplan, & Wilkins, JJ.


Trust, Taxation, Income beneficiary, Capital and income, Federal capital expenses deduction.

The opinion of the court was delivered by: Braucher

Trustees of trusts which were established under wills probated prior to the enactment of § 643 of the Internal Revenue Code of 1954, and which provided that the net income of each trust was to be paid currently and gave the trustees no discretionary authority to apportion charges and expenses as between principal and income, were not required to make an adjustment between principal and income reimbursing principal for the difference between the Federal capital gains taxes paid out of principal and the lesser capital gains taxes which would have been paid if deductions for certain expenses paid out of principal were given to the trust rather than to the income beneficiaries. [640-644]

Guardians ad litem are here objecting to trustees' accounts because no adjustment was made between income and principal to reimburse principal for a portion of Federal capital gains taxes paid out of principal. Pursuant to Federal law certain capital expenses were deducted in determining the net income taxable to the income beneficiaries; if those expenses had been available as deductions in determining the capital gains taxes, lesser taxes would have been paid out of principal. We hold that in the circumstances of these cases the trustees are not required to make the adjustment in question.

In each case testamentary trustees are seeking allowance of accounts, and a guardian ad litem is objecting. A Judge of the Probate Court for Suffolk County reserved and reported the cases without decision to the Appeals Court pursuant to G. L. c. 215, § 13, on statements of agreed facts. We allowed applications for direct appellate review. We summarize the agreed facts.

1. The agreed facts. The net income of each trust is to be distributed currently to beneficiaries, and the trustees have no discretion to allocate charges between income and principal. Under § 643 of the Internal Revenue Code of 1954 certain items are deducted in computing the "distributable net income" taxable to income beneficiaries under § 652. Those items, such as trustees' capital compensation, Massachusetts taxes on gains, and other administration expenses, are paid from principal under Massachusetts probate practice. When the trust realizes net capital gains, those items are not deductible under the Code in computing the tax to be paid by the trust out of principal, and the principal bears the tax accordingly. In the first of three cases principal paid extra taxes of $3,191.53, in the second $4,158.55, and in the third $17,298.61. The guardians ad litem, however, propose allocation of the tax on the basis of adjusted income and adjusted capital gains; this method would produce an adjustment of $2,584.32 for the first trust, $3,110.41 for the second, and $14,595.96 for the third.

It has not been the usual practice among Massachusetts fiduciaries to make such adjustments. None of the corporate fiduciaries makes the adjustment; a few of the individual fiduciaries do. The question whether the adjustment should be made arises when and only when the trust pays Federal capital gains taxes out of principal. Absent capital gain, the deductions for capital expenses would be wasted unless they are used by the income beneficiaries, as the Federal law provides. There is no evidence of a congressional intent to bind the States in the application of principles of equity as between income and principal.

Estimates of the administrative costs of making the adjustments have been made by six Boston corporate fiduciaries. The estimates range from $1,485 to $17,000 for one-time departmental start-up costs and from $18 to $100 annual cost per account. A Boston corporation which claims to have made such adjustments for more than twenty years asserts that the required clerical time for each trust would not exceed thirty minutes a year unless there were some very unusual circumstances; no special charge is made for the adjustment.

Corporate fiduciaries in Philadelphia make such adjustments. Because of circumstances not present in Massachusetts, *fn2 trusts valued at less than $1,000,000 are excluded on a "de minimis" principle. Corporate fiduciaries in Pittsburgh and New York City do not make such adjustments.

2. The equities. Before 1954, capital expenses like those in issue here were deductible in computing capital gains taxes payable by the trust. If there was insufficient income taxable to principal, the deductions could not be used by anyone, and there was dissatisfaction on account of such "wasted" deductions. S. Rep. No. 1622, 83d Cong., 2d Sess. 346 (1954). Under § 643 of the Internal Revenue Code of 1954 that waste was ended, since the benefit of the deductions was given to the income beneficiaries.

It was promptly objected that "it is unsound as a general principle to give one person the benefit of a deduction when the burden of the expenditure involved is borne by another." Fillman, Selections from Subchapter J, 10 Tax L. Rev. 453, 461 (1955). Later it was suggested, "The fiduciary and the court must be free in such cases to repair the damage by equitable adjustment." Browning, Problems of Fiduciary Accounting, 36 N.Y.U.L. Rev. 931, 953 (1961), quoted with approval, Matter of Holloway, 68 Misc. 2d 361, 364 (N.Y. Sur. Ct. 1972).

In Rice Estate, 8 Pa. D. & C.2d 379, 410-416 (Orphans' Ct. 1956), the court made an equitable adjustment like that for which the guardians ad litem here contend. In Matter of Dick, 29 Misc. 2d 648, 650 (N.Y. Sur. Ct. 1961), however, the court recognized the "inequities created by the tax statute," but held it did not have "the authority to alter the impact of the tax statute." Accord, Matter of Adler, N.Y.L.J., June 21, 1974, at 15 (N.Y. Sur. Ct. 1974). The New York cases distinguished situations where a fiduciary had made a choice permitted by the Federal tax statute and an equitable adjustment was made. Matter of Warms, 140 N.Y.S.2d 169 (Sur. Ct. ...

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