Whittemore v. United States

Henry Whittemore’s inter vivos trust and testamentary trust each paid net annual income to Henry’s wife and daughters for their lives. The final surviving daughter died in 1958, and in 1959 and 1960, the trust assets and the daughter’s estate were distributed to her children and grandchildren. At the termination of the inter vivos trust, it contained assets worth $2,307,493, of which 30.5 percent ($705,400) was invested in municipal bonds, which had tax-free interest. The testamentary trust contained assets worth $4,269,239, of which 39.5 percent ($1,688,870) was invested in municipal bonds. Finally, Henry’s estate included assets worth $1,365,345, of which 2.985 percent ($29,213) was invested in municipal bonds. On termination of the trusts, one of Henry’s grandsons, Clinton Whittemore (plaintiff), was co-trustee and, until his own death, was co-executor of his mother’s estate. Clinton received one-half of the corporate trustee’s fees for the thirteen months he served as co-trustee. Total fiduciary fees of $585,730 were paid. Interest income flowing from the municipal bonds was included to determine the trustee’s compensation but was not included in the calculation of gross income for income-tax purposes. The fraction of the annual fees allocated to interest on the municipal bonds was not deducted in figuring the annual income tax. The full termination fees were deducted from gross income for the years when each trust terminated. The government (defendant) refused to allow the taxpayer to deduct any portion of the trustee’s fees for administering the parts of the corpus that were invested in municipal bonds. A deficiency was assessed, and the taxpayer filed a refund claim. When it was disallowed, he filed suit. The district court ruled for the government that no portion of the termination fee for services related to the municipal bonds was deductible. That court also did not allow the trustee to deduct termination fees related to preservation of the corpus because the trustee had failed to establish how the work earning fees was related to corpus preservation. The taxpayer ultimately argued that the termination fees were solely for managing, conserving, or maintaining property held to produce income and should be deducted in full. The taxpayer argued in the alternative that the fees should be partially deductible based on the ratio of tax-exempt income to total income instead of ratio of municipal bonds to total asset value.