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completed gift. Thus, respondent's reliance on the Golsen rule is misplaced.
Respondent does not really argue that the rental payments here involved do not qualify as rent under section 162(a)(3) because it was paid for property which the taxpayer has taken or is taking title to, or in which he has an equity. That argument is not applicable here because the corporation, rather than the grantor, is paying the rent and the corporation could not conceivably have any title or “equity” in the leased property. In any event, we held in Mathews v. Commissioner, 61 T.C. 12, 23 (1973), “that the property in which the taxpayer should have no equity does not include a reversionary interest, not derived from the lease or from the lessor, which is scheduled to become possessory after the expiration of a lessor's term of years."6
We conclude that the corporate petitioner is entitled to deduct the rent it paid for use of the medical equipment and furnishings.
The second issue is whether the rental paid by the corporation to the trust is taxable income to the beneficiaries of the trust or to the Lerners. The rationale for taxing the income to the Lerners set forth in the notice of deficiency and in respondent's opening statement assumes that the gift and lease are invalid for Federal income tax purposes.
This is not a typical sale-leaseback situation because the gifted property was leased to the corporation, a separate taxpayer, rather than the grantor. In the notices of deficiency, respondent's approach seems to be that the gift to the trust will not be recognized and that the equipment and furnishings were owned by Dr. Lerner and leased to the corporation. The rent paid by the corporation to the trust was determined to be "taxable income" to the Lerners. On brief respondent argues that
Since there was no business purpose for the transactions * * * (the creation of the trust, the transfer of property to it, and the lease of the property by the trust to the corporation), the transfers must be disregarded for tax purposes. Therefore, the monthly rental payments are nondeductible and may be included in Dr. Lerner's income. (Respondent's brief, p. 19.] Respondent allowed the Lerners depreciation on the medical
Neither party suggests that there might be a distinction between the rent for the property originally transferred to the trust and the rent for the property subsequently acquired by the trust and leased to the corporation, so we will not consider the possibility.
equipment leased to the corporation since Dr. Lerner was determined to be the owner of the equipment.
It is rather difficult to follow respondent's reasoning. Respondent recognizes the corporation as the entity that is taxable on the income from the practice of ophthalmology and claims that Dr. Lerner was the owner of the equipment used therein. But he advances no valid argument why the corporation should be entitled to use the equipment rent free. The rent was reasonable and, as we stated above, was an ordinary and necessary business expense of the corporation, whether it was paid to the trust or to Dr. Lerner. Respondent's reasoning must assume that there was no sale or gift of the medical equipment to anyone and the trust should be ignored. For reasons hereinafter stated, we disagree.
By enacting section 671 of the 1954 Code, Congress certainly recognized that usually a grantor of a family trust will not be treated as the owner of the trust for tax purposes solely on the grounds of his dominion and control of the trust unless he is treated as owner for one of the reasons specified in sections 673– 677.? Respondent does not point to any of those reasons for treating Dr. Lerner as owner of the trust and seems to recognize the trust as a “Clifford Trust.” However, it is clear from S. Rept. 1622, 83d Cong., 2d Sess. 365 (1954), that the provision of section 671 relative to dominion and control does not affect the principles governing the taxability of income to a grantor of a trust other than by reason of his dominion and control over the trust, i.e., a transfer of future earnings of the grantor, etc. It is also clear that subpart E (secs. 671-679) has no application in determining the right of a grantor to deductions for payments to a' trust under a transfer and leaseback arrangement. See also sec. 1.671-1(c), Income Tax Regs. Thus, while this is not a typical sale and leaseback arrangement, and we are more concerned at this point with the taxability of the income produced by, rather than the deductibility of, the rent, we believe we should examine the arrangement in the light of case law to determine whether there is any reason, other than dominion and control, to tax the
"Generally speaking, secs. 673-677 treat the grantor as owner if he has a reversionary interest that will take effect within 10 years (sec. 673), if the beneficial enjoyment of the corpus or income of the trust is subject to a power of disposition by the grantor alone (sec. 674), if the grantor has the power to deal with the trust property other than at arm's length (sec. 675), if the grantor has power to revest the corpus in himself (sec. 676), and if the grantor may distribute or accumulate income of the trust for himself or his spouse or use it to pay premiums on life insurance on his life (sec. 677).
income of the trust to the Lerners rather than the beneficiaries of the trust.
In determining the tax consequence of a gift-leaseback, two lines of thought have developed over the years. Respondent argues that the overall business-purpose test developed by the Court of Appeals for the Fifth Circuit and set forth in Mathews v. Commissioner, 520 F.2d 323 (5th Cir. 1975), revg. 61 T.C. 12 (1973), cert. denied 424 U.S. 967 (1976), should apply. On the other hand, petitioners argue that the criteria approach set forth in the decisions of this Court in Mathews v. Commissioner, 61 T.C. 12 (1973), and Serbousek v. Commissioner, T.C. Memo. 1977– 105, should be applied. We agree with petitioners that the approach used in our Mathews and other more recent opinions is the appropriate approach in this case rather than the overall business-purpose test utilized by the Fifth Circuit in Mathews.
In Van Zandt v. Commissioner, 40 T.C. 824 (1963), affd. 341 F.2d 440, 443 (5th Cir. 1965), cert. denied 382 U.S. 814 (1965), this Court held that a physician who transferred a building and equipment he used in his medical practice to trusts created for the benefit of his children, naming himself as trustee, and immediately leased the building and equipment back from the trust for use in his medical practice could not deduct the rent paid by the physician to the trusts because it would not have been necessary for him to pay the rent had he not transferred the property to the trusts. There the taxpayer, as trustee, retained complete control of the property and continued to use it in his business. The Court of Appeals for the Fifth Circuit affirmed our decision emphasizing, however, that while taxpayers have every right to avail themselves of all provisions of the law to minimize their taxes, the obligation of the taxpayer to pay rent arose not out of business necessity nor for any business purpose but solely for the purpose of permitting a division of taxpayer's income tax. The appellate court recognized “that from the standpoint of taxability of income of the trust, not deductions which a payor of that ‘income' may take, this was a perfectly valid trust. It met not only the minimum but all the statutory tests so that its income will be taxed to it, not the settlors.”
*See also Quinlivan v. Commissioner, T.C. Memo. 1978–70, in which the criteria approach of our case, Mathews v. Commissioner, 61 T.C. 12 (1973), was found to be the appropriate test for deductibility of rental payments by the grantor in a gift and leaseback arrangement.
In Mathews v. Commissioner, supra, under somewhat similar circumstances, we held the rents paid were deductible by the settlors. We distinguished Van Zandt for the reasons that there the grantor was himself the trustee and thus failed to relinquish effective control of the property while in Mathews, as here, there was an independent trustee. In our opinion, we also listed certain requirements that have to be met to permit the grantor to deduct rent paid to the trustee in the typical two-party giftleaseback transaction. Those requirements were:
(1) The grantor must not retain substantially the same control over the property that he had before he made the gift.
(2) The leaseback should normally be in writing and must require payment of a reasonable rental.
(3) The leaseback (as distinguished from the gift) must have a bona fide business purpose.
(4) The grantor must not possess a disqualifying “equity” in the property within the meaning of section 162(a)(3). In reversing us in Mathews, the Fifth Circuit looked to the substance and concluded that, because of the grantor's effective control of the property after the gift and leaseback, there was no business purpose for the arrangement and the trust was treated as an economic nullity.
Although we followed the Fifth Circuit approach in Butler v. Commissioner, 65 T.C. 327 (1975), this was because it was mandated by Golsen v. Commissioner, supra. In subsequent cases, see Serbousek v. Commissioner, supra, and Quinlivan v. Commissioner, T.C. Memo. 1978–70, we have followed the approach we took in Mathews requiring a business purpose for the lease but not for the gift.
We do not believe that an arrangement that is bona fide and arm's length in all respects but which results in splitting family income must be disregarded for tax purposes for the latter reason alone. The so-called Clifford provisions in the Code recognize that valid trusts can be created which result in splitting the family income and minimizing taxes if the grantor does not retain control of the property for his own benefit. The Fifth Circuit recognized this in its opinion in Van Zandt v. Commissioner, supra. There need be no business purpose for a father to transfer income-producing property to a trust for his children and have them taxed on the income produced. There is a difference, of course, if the father attempts to assign to the trust his future earnings and have the trust pay tax thereon. But in the case before us Dr. Lerner, having decided to incorporate his medical practice, could either have transferred his medical furnishings and equipment to the corporation, he could have retained ownership of it and rented it to the corporation himself, or he could do as he did-transfer the furnishings and equipment to a trust created for the benefit of his children and have the trust lease it to the corporation. The fact that the latter course of action would result in less taxes does not justify taxing the income of the trust to Dr. Lerner as long as he does not use that income for his own purposes or violate any of the restrictions contained in sections 673-677 of the Code. We believe respondent erred in not recognizing the trust as the true recipient and owner of the rental income and attempting to tax that income to the Lerners.
We have already concluded for other reasons that the corporation is entitled to deduct the rentals paid. For the sake of completeness, however, we will briefly examine this transaction in the light of the requirements set forth in our Mathews opinion, to determine whether the rental would have been deductible by the Lerners had they, instead of the corporation, leased the property back from the trust.
We are readily convinced that requirements 2, 3, and 4 as set out above were met. The lease was in writing and the rent was reasonable. The leaseback had a bona fide business purpose—the equipment was required to conduct the business. And the grantor did not possess a disqualifying "equity” in the property within the meaning of section 162(a)(3). We have more trouble in deciding whether the trustee in fact acted independently of Dr. Lerner-the first requirement in Mathews. However, this is a question of fact and, on balance, we conclude that he did.
Under the terms of the trust, the trustee was given full and sole power to deal with the trust corpus and he was expected to use it in such a way as to produce income for the beneficiaries. The evidence indicates that he had several appraisals made to determine the fair rental for the property. The lease was executed by the trustee and the corporation, and the rental was paid to the trustee when due. Under the terms of the lease it was anticipated that additional equipment would be purchased by the trust and added to the leased property. When this was done, the terms of the lease were reviewed and the rent was increased