Victor W. Krause

[Editor’s Note: This case can also be found under the title “Estate of Krause v. Commissioner of Internal Revenue.”] Victor Krause set up three trusts in 1963 for his three children—Gordon, Elizabeth, and Ruth. Victor immediately transferred 12,000 shares of Wolverine Shoe & Tanning Corp. stock to the Gordon trust and 8,000 shares each to the Elizabeth and Ruth trusts. Each trust agreement provided that the trustees were to pay all federal gift taxes or other taxes attributable to the stock transfer and that the trustee could sell stock or borrow money to handle such payments. All trust income was to be applied first to pay taxes and second for trustee fees, attorney’s fees, or other administrative costs. In 1964, the trustees took loans from Old Kent Bank & Trust Co. for $134,500 to cover the gift-tax liabilities of Victor and his wife, Gertrude, because each consented to have the gifts treated for tax purposes as made one-half by each of them. The amount of taxes paid was $134,331.65. For the taxable year ending August 31, 1964, the trusts received dividend income of $7,650 for Gordon and $5,100 each for Elizabeth and Ruth. From September 1964 to August 1970, the trusts made payments to Old Kent Bank & Trust Co. on the loans for the gift-tax payments, with the payments made from dividend income received on the stock held by each trust. The government found a deficiency of $91,249.05 in Victor and Gertrude’s 1964 federal income-tax return. The Internal Revenue Code provided that gift tax was to be paid by the donor. The government argued that Victor transferred the stock to the trusts, reserving an income interest for the payment of his gift-tax liability. On that basis, the 1964 trust income was taxable to Victor in the amount of $14,091.62. The government argued that Victor’s income interest in the trusts ended with the payment of the gift-tax liability and that the payment was a purchase in liquidation of that interest, with Victor being responsible for another $120,240.03 in income. Victor’s estate argued that the gift taxes were paid by the proceeds of the loans obtained, not by trust income, and that in fact, the trust agreements did not expressly allow trust income to be used to pay gift taxes.