Reinecke v. Smith

Background

In 1922 Douglas Smith created five trusts for his wife and four children. The named trustees were Smith himself, a son who benefited from one trust and was a contingent beneficiary of the others, and a bank. Each trust said it could be changed or revoked by a written instrument signed by Smith and either one of the other trustees. On October 22, 1924, the clause allowing that revocation was removed and Smith resigned as trustee. He did not report income that accrued earlier in 1924, and the tax commissioner assessed additional tax under the Revenue Act of 1924, §219(g). Smith’s personal representatives sued to recover the tax, and lower courts held the tax unconstitutional as applied to trusts created before the statute.

Reasoning

The Court examined the statute’s language and earlier decisions and concluded a trustee is not the same as a beneficiary. The Court found the tax targets income that accrued after January 1, 1924, not the earlier act of creating the trust, so it is not the sort of forbidden retroactive tax challenged in prior cases. The key question was who had practical control. Because Smith retained a joint power to revoke with someone who was not a beneficiary, the Court treated him as having sufficient control over the corpus and income. That practical control, the Court said, justified taxing the trust income to Smith and did not violate the Fifth Amendment.

Real world impact

The decision allows taxation of trust income to a settlor who keeps a revocation power jointly with a non-beneficiary, prevents easy tax avoidance by naming a friend as co-revoker, and applies to income accruing after January 1, 1924.