SSR 67-7: SECTION 211(a). -- NET EARNINGS FROM SELF-EMPLOYMENT -- VALID TRUST CREATED BY FARM OPERATOR -- GRANTOR (SETTLOR) SOLE TRUSTEE AND LIFE BENEFICIARY
20 CFR 404.1050 and 404.1051
- A farm owner and operator conveyed his assets and property to a trust of which he was both life-beneficiary and sole trustee. Held, the income derived from operation of the farm constituted his net earnings from self-employment and not trust income, so long as he remained in possession of the farm land, conducted the farm enterprise on it, and continued to enjoy the fruits of ownership to the same extent as before creation of the trust.
T, who filed application for retirement insurance benefits, at age 66, owns a potato-growing farm. Some months prior to making application for benefits, he set up a living trust, placing his assets and property in the trust. Under its terms, T is grantor and trustee and is sole beneficiary for life with the right of revocation of the trust, remainder to his daughter if she survives him (otherwise to other named relatives). The daughter may become T's successor trustee on his death, resignation, or incapacity. The trust agreement also provides that the trustee is to collect, hold, and manage the trust estate and collect and invest the income and profits. After paying the necessary expenses, the net income and principal is to be turned over by the trustee to the settlor during his lifetime.
Both before and since establishment of the Trust, T has been actively operating the potato farm business. However, while T had been reporting his income from the farm business as net earnings from self-employment before he set up the trust, he states that he considers that the trust is now operating the farm and the income derived from such operation is trust income payable to him only as a beneficiary of the trust. This income has, therefore, been reported in the fiduciary tax returns filed by the trust. On his individual income tax return, T has reported this as income from a trust rather than as net earnings from a trade or business carried on by him.
The question to be resolved is whether the income derived from operation of the farm enterprise after establishment of the trust still constitutes T's "net earnings from self-employment" within the meaning of section 211(a) of the Social Security Act, or whether it represents a distribution of trust income to him as a beneficiary of the trust and thus specifically excluded from net earnings from self-employment. If, as T alleges, the latter is true, then his benefits would not be subject to deductions under section 203 of the Act on the basis of this income. If, on the other hand, such income constitutes "net earnings from self-employment," then deductions could be imposed against part or all of his benefits. Section 203 of the Social Security Act provides in pertinent part that deductions may be imposed against the benefits otherwise payable to persons entitled thereto if, while under age 72, they engage in self-employment or work for wages after becoming entitled to benefits.
Section 211(a) of the Social Security Act provides that the term "net earnings from self-employment" means the gross income, as computed under subtitle A of the Internal Revenue Code of 1954 derived by an individual from any trade or business carried on by him, less the deductions allowed under that subtitle which are attributable to such trade or business, with exceptions not here pertinent.
In describing income includible in computing net earnings from self-employment as defined by section 211(a) of the Act, section 404.1051(b) of Social Security Administration Regulations No. 4 (20 CFR 404.1051(b)) provides:
- The trade or business must be carried on by the individual, either personally or through agents or employees. Accordingly, income derived from a trade or business carried on by an estate or trust is not included in determining the net earnings from self-employment of the individual beneficiaries of such estate or trust.
The trust created by T enables him as trustee to retain the legal title to the farm, while reserving to himself the beneficial interest in the proceeds from the property for his life and the power to revoke the trust in whole or in part at any time. It is well settled that in order to create a valid trust, the legal estate must be separate from the beneficial enjoyment or the equitable estate. This means that a valid trust cannot exist where the same person possesses both sole legal title as trustee and sole equitable title as beneficiary or cestui que trust, because the two titles then merge in law and there is not that severance of the legal and equitable title necessary to create a valid trust. However, in the present case, the grant of the right of remainder to T's daughter after his death, even though subject to divestment by T during his lifetime, is sufficient to divide T's legal title and beneficial interest so as to sustain the validity of the trust. Thus the validity of the trust is not disputed.
We look now to the tax effects of the trust created by T. In Helvering v. Clifford, 309 U.S. 31 (1940), it was held that where the settlor retained full control over the corpus of the trust, where the trust itself was of short duration, and where the settlor's wife was the beneficiary, the settler continued to be the owner of such property for income tax purposes and the income derived therefrom was taxable as his income. Comparably, in Kent v. United States, 60 F. Supp. 203 (Ct. Cl., 1945) to the effect that income from a series of trusts which might be paid eventually to the settlor if specified conditions were met as taxable to him as his income, the Court said:
* * * As the plaintiff set up his trusts, he was * * * to get the income
by surviving the two year period of retention. If, by failing to survive,
he did not get it, it was, by the terms of the trust, to go to his wife,
or to other natural objects of his bounty, in substantially the manner,
which the several concurrently created trusts are considered, that other
property which he owned outright would normally go, upon his death. He
had, then, as to the income of the property which he had owned completely
before he put it in trust, the substance of continued ownership of the
income, which substance consisted of * * * the primary right and the
probability that the income would actually come into his possession and
the * * * arrangement whereby, upon his death, which would keep the income
from coming into his possession, it would go largely if not entirely to
persons who would, normally, take by inheritance or devise what he owned
when he died.
* * * * * * *
- * * * The different treatment given by the statutes to the grantor as beneficiary of his own trust, and other persons as beneficiaries, is natural. The status quo, when the grantor sets out to create a trust, is that he owns the property, is entitled to its income, and is liable for taxes on that income. The trust device has been used for centuries not only for proper purposes, but on occasion to create appearances which do not correspond with the substance of ownership, in order to defeat some policy of the state. When, therefore, the grantor makes himself a beneficiary of a trust of his own creation, the law must be astute to see whether not only the appearance of things, but their substance, has been changed by the creation of the trust. It takes note of the status quo ante the trust, i.e., that the now beneficiary was then the complete owner. If, as in our case, it finds that after the creation of the trust he is still the one who has the primary right to enjoy the fruits of ownership, it may think it necessary to disregard the change in legal title in order to prevent some policy of the law from being nullified by a legal device. * * *
This rationale would apply a fortiori to this case in which the settlor was not only full beneficiary of the trust for his lifetime, but always retained legal title to the trust property. Therefore, in the light of the foregoing, the income T derived from operation of the farm is creditable to him; the fact that it was reported in the fiduciary tax returns of the trust does not establish either that receipt of such income represented a distribution of income by the trust to its beneficiaries or that it was trust income. It was earned by T through his own efforts and not through his activities as a representative of the trust. Accordingly, so long as he remains in possession of the land and conducts a farming enterprise on it, enjoying the fruits of ownership after execution of the trust agreement to the same extent as before the trust had been established, he is in fact engaged in the trade or business of farming. Therefore, it is held that the income derived by T from the farm business since establishment of the trust, is includible in computing his net earnings from self-employment.