## Facts

- In 1923, Olive H. Prouty created three inter vivos trusts and repeatedly amended them through 1931 under reserved powers.
- After 1931 amendments, Prouty retained power to revoke or amend each trust only with the written consent of her husband, Lewis I. Prouty, during his lifetime, and alone thereafter.
- The instruments also required, as a condition precedent to revocation or amendment in any calendar year, that Prouty give the trustee formal notice of intent in the preceding year.
- Lewis was entitled to an annuity of $2,500 from each trust; the trusts varied in additional benefits and control rights.
- In Trust 1, Prouty was trustee; Lewis was entitled to payments for his maintenance, support, and welfare, and if he survived Prouty he would become trustee with power to distribute corpus to himself and direct ultimate disposition by will.
- In Trusts 2 and 3, Prouty controlled payments to Lewis and a child; if Lewis survived Prouty, he would become trustee but could not make payments to himself, and the property would pass to the child at Lewis’s death.
- In 1935, Prouty relinquished her remaining power to revoke or amend.
- The Commissioner asserted a 1935 gift tax deficiency, treating the 1935 relinquishment as the taxable transfer under § 501(c) of the Revenue Act of 1932.

## Issues

1. Whether the trust transfers were completed gifts in 1931 (before the 1932 gift tax) or became complete only in 1935 upon Prouty’s relinquishment of her reserved power to revoke or amend.
2. Whether Lewis’s required consent meant Prouty’s retained power was held “in conjunction with” a person having a “substantial adverse interest” in the trusts’ property or income, taking the arrangement outside § 501(c)’s delayed-completion rule.
3. Whether Lewis’s present and contingent rights under Trust 1 were sufficient to constitute a substantial adverse interest.

## Decision

- The First Circuit affirmed the Board of Tax Appeals’ determination for Prouty.
- Lewis held a substantial adverse interest in the disposition of the trust property and income, including under Trust 1.
- Because Prouty could revoke or amend only with Lewis’s consent during his life, the gifts were completed when the trusts assumed their 1931 form.
- The 1935 relinquishment of the reserved power was not a taxable gift under § 501(c), and the asserted 1935 deficiency was improper.

## Legal Principles

- Under § 501(c) (Revenue Act of 1932), a transfer in trust is not treated as a taxable gift while the donor retains a power to revest title in herself, held alone or with a person who lacks a substantial adverse interest; relinquishment of such a power (other than by death) is treated as a taxable transfer.
- A co-holder’s interest is “adverse” when exercising the donor’s revocation/amendment power would reasonably threaten the co-holder’s own beneficial stake in trust income or corpus.
- The adverse interest must be “substantial,” meaning economically meaningful rather than nominal or merely formal; present benefits and contingent but valuable future rights may satisfy this requirement.
- When revocation or amendment requires consent of a substantially adversely interested person, the donor’s retained power does not prevent completion of the gift at the time the trust is placed in that constrained form; a later relinquishment of the power does not create a new taxable transfer under § 501(c).

## Conclusion

The court held that Prouty’s 1931 trust arrangements constituted completed gifts because her retained revocation/amendment power could be exercised only with her husband’s consent and he had substantial adverse interests in the trusts; therefore, her 1935 surrender of that power did not trigger gift tax liability.


Commissioner v. Prouty, 115 F.2d 331 (1st Cir. 1940)