Crisp v. United States

Don W. Crisp (plaintiff) was the trustee of the Caroline Hunt Trust Estate. In 1935, H. L. and Lyda Hunt, the parents of 12-year-old Caroline Hunt, established the trust, which allowed the trustee to make periodic payments to Caroline for life and then to her heirs for 21 years after her death. The trust agreement provided that the trustee could never diminish the trust corpus through distribution to a beneficiary but could pay net profits or net earnings to the beneficiary. For the tax year ending June 30, 1987, the trust distributed $4.5 million to Caroline, and for the shortened tax period ending December 31, 1987, the trust distributed another $1.6 million to Caroline. Accordingly, the trust deducted those amounts from its income, as the trust’s distributable net income (DNI) for each period exceeded the amount paid to Caroline. The trust had included within its DNI all capital gains credited to the trust’s capital account by ZH Associates, a limited partnership in which the trust was a limited partner. ZH Associates existed primarily to buy and sell securities, which was profitable under the volatile merger-and-acquisition-heavy market of the 1980s. The government (defendant) audited the trust’s returns and found that the trustee should not have included the ZH capital gains within DNI, and with those amounts removed from DNI, the estate would be liable for all income tax on the distributions to Caroline by the extent that they exceeded the recalculated DNI, which resulted in nearly $3 million in taxes, penalties, and interest. The trust paid those taxes and filed suit to obtain a refund. The governing law was clear that gains from the sale or exchange of capital assets classified as income and paid to the beneficiary were included in the computation of DNI, while gains classified within the trust corpus were not included in the DNI calculation. The government argued that the capital gains were trust corpus, while the trust argued that they were properly distributed as income to the trust beneficiary.