Fabens v. Commissioner

Augustus Fabens (plaintiff) kept a trust account from 1953 to 1969 that included both municipal bonds, which produced tax-exempt income, and securities, which produced taxable income. His trust also realized capital gains, and when the trust was terminated, the assets included a large amount of unrealized capital appreciation, which is an increase in the value of a held asset. This figured into the fiduciary fees, as they were calculated based on a percentage of the current market value of all trust assets. Fabens then deducted the full amount of his fiduciary fees as expenses for the production of income. The Commissioner of Internal Revenue (the commissioner) (defendant) disallowed a portion of the deduction in the ratio of tax-exempt income over the life of the trust to total income, including net capital gains during the life of the trust. To be more specific, the income applicable to tax-exempt bonds was $211,443, while the total income was $715,084 plus a $25,009 net realized capital-gain income, for a total product of 28.57 percent applied to $50,695 in fiduciary fees, resulting in $14,484 allocable to tax-exempt income. Fabens filed suit and argued that the formula should not apply in light of the appreciation of trust assets. Evidence showed that the unrealized appreciation had a roughly 60 to 1 ratio to the net realized capital gains, with nonmunicipal bonds having $1,476,023 in unrealized appreciation. The tax court ruled for the government, and Fabens then appealed. On appeal, the commissioner argued that no evidence established that Fabens was managing trust assets for capital appreciation and that the ratio used was appropriate. Fabens again argued that the formula was not reasonable.