Opinion
Docket No. 21510.
1950-02-28
RUTH W. COLLINS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Samuel J. Gottesfeld, Esq., for the petitioner. Edwin P. Friedberg, Esq., for the respondent.
Partnership interest acquired in consideration of agreement to make fixed periodic cash payments and also to pay annually an amount equal to 5 per cent of the business profits for the preceding year, held, not to include beneficial interest in 5 per cent of the partnership income, which, being retained by retiring partner, is not taxable to petitioner. Samuel J. Gottesfeld, Esq., for the petitioner. Edwin P. Friedberg, Esq., for the respondent.
Petitioner seeks a redetermination of deficiencies in income tax of $780.40 for 1944 and $3,103.39 for 1945. Certain adjustments are not contested and one issue has been abandoned by petitioner. The issue in dispute is whether 20 per cent rather than 25 per cent of the partnership income of Collins Department Store is taxable to petitioner.
FINDINGS OF FACT.
Petitioner, a resident of Charleroi, Pennsylvania, filed returns for the periods involved with the collector for the twenty-third district of Pennsylvania.
On January 28, 1941, and for some years prior thereto, petitioner's husband, Leonard Collins, and his mother, Fanny Collins, were associated as co-partners conducting a general department store under the name of Collins Department sTore. Leonard owned a 75 per cent interest and Fanny owned a 25 per cent interest in the business, and they shared profits and losses in those proportions. Fanny worked regularly in the business. On January 28, 1941, Fanny had a capital interest of $32,037.37. Differences of opinion arose between the partners concerning the operation of the business. To settle the conflict, Leonard and Fanny executed a written agreement on January 28, 1941. In brief, the agreement provided that:
Fanny transferred to Leonard ‘all her right, title and interest in and to all the good will, rights, and assets‘ of the business. Leonard agreed to make the following payments to Fanny: $4,500 a year for 10 years, beginning January 1, 1941; $2,500 a year for Fanny's life, beginning January 1, 1951; and, in addition, commencing April 1, 1941, annually for Fanny's life, a ‘sum of money equivalent to five (5%) per cent of the annual profits of the business‘ for the preceding calendar year; the last named payments were subject to the substitution of certain cash payments in the event that Leonard should discontinue the business, and were to be eliminated entirely if contingencies occurred making it impossible for Leonard to continue in business; all payments were to terminate if Leonard predeceased Fanny, except that if he died within 10 years of January 1, 1941, then the annual payments of $4,500 were to continue for the balance of the stated 10-year period.
It was agreed that Fanny should have the rights of a ‘nominal partner,‘ that is, the right to term and style herself a partner, to enter upon, remain, and move about the premises of the business, and to be accorded by Leonard the courtesy due to a partner; Fanny agreed not to commit willfully any act which would create a disturbance with customers or friction among employees.
Leonard assumed all the obligations of the business. He agreed that the books of the business were to be open to Fanny and annual financial statements were to be delivered to her regularly. The term ‘profits‘ was defined in the agreement as meaning the net profit after deducting business expenses according to accepted accounting practices. Leonard agreed to permit Fanny to apply for a $25,000 insurance policy on himself in her favor. Fanny agreed to execute and deliver a quitclaim deed covering the real estate which the business occupied. Fanny agreed not to engage at any time in any other merchandising business in the Borough of Charleroi.
Leonard agreed to procure a $100,000 single premium paid=up life insurance policy on his life, having a cash surrender value of $38,000 at the end of the first year, and to assign the policy to the Pennsylvania Co. for Insurances on Lives and Granting Annuities, as trustee, to be held as security for the performance of the agreement. Fanny agreed that all payments required by the agreement could be made to this trustee for remittance to her.
On January 28, 1941, Leonard and Fanny signed a trust agreement which was also executed, on February 18, 1941, by the Pennsylvania Co. for Insurances on Lives and Granting Annuities, as trustee, under which Leonard assigned to the trustee, and the trustee accepted, a fully paid single premium life insurance policy on Leonard's life in the face amount of $100,000, to be held as security for the fixed cash payments required by the aforesaid agreement. In the event of default in payments, the trustee was authorized to borrow equivalent amounts from the insurance company against the policy and to pay such sums to Fanny. Petitioner, Leonard's wife, and the beneficiary in the policy, executed a supplement or ‘joinder‘ to the trust agreement on February 18, 1941, under which she assigned to the trustee all her rights in the policy.
On January 28, 1941, Fanny filed a statement of withdrawal from business in the office of the secretary of the Commonwealth, pursuant to the provisions of the Pennsylvania Fictitious Names Act, stating that she was no longer connected with or interested in Collins Department Store.
On January 29, 1941, petitioner and Leonard, her husband, executed an agreement by which Leonard transferred to petitioner all rights assigned to him under his agreement with Fanny. Petitioner assumed all the money obligations imposed upon Leonard under that agreement. Leonard accepted petitioner as a partner in the business upon the same terms and conditions as previously prevailed between him and Fanny, calling for a division of profits of 75 per cent to Leonard and 25 per cent to petitioner. On the same date Leonard and petitioner filed a certificate of fictitious name registration, pursuant to the provisions of the Pennsylvania Fictitious Names Act, stating that Leonard and petitioner were the only persons owning or interested in Collins Department Store.
The books of account of the business contain entries, dated January 1, 1941, recording a sale of Fanny's entire capital interest to petitioner.
Since January 28, 1941, Fanny has continued her activities in the business to the same extent and in the same manner as formerly, and petitioner has made payments to Fanny under the agreements through the medium of the aforesaid trustee.
In each of the years between 1941 and 1946, inclusive, Fanny received $4,500, paid in semiannual installments. Fanny received the following amounts as sums equivalent to 5 per cent of the profits of the preceding year, in each of the respective years between 1941 and 1946, inclusive: $2,941.82; $3,106.21; $1,893.73; $2,300.53; $2,676.33; and $3,503.05.
Fanny's tax return for the years 1941 to 1943, inclusive, did not report income from Collins Department Store. Each of those returns contains an appended statement setting forth a sale by Fanny of her partnership interest to Leonard, stating that the contingencies surrounding the annual payments make it impossible to evaluate the consideration for the sale, and taking the position that Fanny is entitled to recover the cost basis of her partnership interest before the annual payments become taxable income. In 1944 Internal Revenue agents asserted that money thus received constituted annuity payments. Fanny's tax returns for 1944 and 1945 reported as income in each year the sum of $1,982.24, represented as being 3 per cent of the price of two annuities costing $33,037.37.
In a statutory notice of deficiency to Fanny for the year 1944, dated May 27, 1949, respondent determined that 5 per cent of the partnership profits for 1944 should be included in Fanny's gross income.
The partnership returns for the years 1941 to 1944, inclusive, report Leonard and petitioner to be the sole partners, sharing in the income in proportions of 75 per cent and 25 per cent, respectively. The partnership return for the year 1945 reports Leonard, petitioner, and Fanny to be partners, sharing in the income in proportions of 75 per cent, 20 per cent and 5 per cent, respectively.
Petitioner's tax returns for the years 1941 to 1943, inclusive, reported 25 per cent of the partnership profits as taxable income. Petitioner's return for the year 1944 reported as taxable income from the partnership the sum of $11,399.41, which was 25 per cent of the profits less $1,982.24. Petitioner's return for the year 1945 reported 20 per cent of the partnership profits as taxable income.
In a statutory notice of deficiency mailed to petitioner, dated October 17, 1948, respondent determined that 25 per cent of the net income of Collins Department Store for the years 1944 and 1945 was taxable to petitioner.
OPINION.
OPPER, Judge:
Although the central issue is not without difficulty, what the parties here arranged seems to us more nearly the equivalent of a trust than any other ascertainable relationship. Petitioner's mother-in-law, it is true, purported to assign her entire partnership interest. But by the same instrument and as part of the same transaction she was to receive a 5 per cent interest in the profits for her life. As we said in Everett D. Graff, 40 B.T.A. 920, 923, 924; affd. (C.C.A., 7th Cir.), 117 Fed.(2d) 247:
* * * Prior to the transfer the grantor's legal and beneficial right to receive income from the property was absolute. By the trust he parted with that interest to some extent. * * *
In other words * * * (the transferor) failed to dispose of the beneficial interest * * * which he possessed prior to the declaration of trust, ‘the remainder being retained by the grantor‘ * * *
Even more comparable to the present situation is Frank R. Malloy, 5 T.C. 1112, 1116, where we said:
* * * If the testator chose to give his son something less than all his interest in the business and to give his wife a part of it, that was his privilege. In effect, that is what he did. * * * In substance, the bequest was a portion of the net income from that particular property, which, in equity, would ordinarily be treated as giving her an interest— a sort of life estate— in the property itself * * *.
If anything, the present case seems a stronger one, since the interest of petitioner's mother-in-law was retained by her out of a larger share which it is undisputed she had previously possessed.
While the mother-in-law did not in so many words appoint her son as trustee, she created an arrangement which we are not able to distinguish from that in Sallie Cosby Wright, 38 B.T.A. 746, 753, where we regarded the ‘Van Aken case (Annie Louise Van Aken, 35 B.T.A. 151) as deciding that in such a case as this the relationship between the parties is to be viewed as a whole and, since there that relationship appeared to be essentially of a fiduciary nature, income received by the beneficiary was taxable to her.‘ See also Flarsheim v. United States (C.C.A., 8th Cir.), 156 Fed.(2d) 105; Shellabarger v. Commissioner (C.C.A., 7th Cir.), 38 Fed.(2d) 566; Bettendorf v. Commissioner (C.C.A., 8th Cir.), 49 Fed.(2d) 173. The only case on the question cited by respondent, Robert Hoe Estate, 32 B.T.A. 903; affd. (C.C.A., 2d Cir.), 85 Fed.(2d) 4, is distinguishable here for the same reasons as those set forth in the Wright case.
Our determination that the mother-in-law in effect retained her beneficial interest in the 5 per cent of the business profits, and did not transfer that when she sold her remaining rights in the firm, stems not only from the provisions appearing throughout the agreement that the son was to be accountable to her, but also from the form of the consideration. Certain of the payments which are not in controversy were clearly of a capital nature, payable in consideration for the 20 per cent interest which was assigned outright. As to them, the conclusion of nondeductibility on the theory that they represented the payment for a capital asset is reasonable, Newark Milk & Cream Co. v. Commissioner (C.C.A., 3d Cir.), 34 Fed.(2d) 854; see James M. Straub, 13 T.C. 288, 290, and apparently accepted by both parties. The fact that they were payable at all events and irrespective of profits serves both as confirmation of their character as capital payments for the 20 per cent interest transferred and as a distinction from the treatment of the 5 per cent interest which in our view the mother sought to and did retain.
Charles F. Coates, 7 T.C. 125, is apt in this respect. We said (pp. 134, 135):
* * * These payments arose out of and depended upon the contract and their character must be determined by its terms. The estate acquired, upon the death of the partner, a vested contractual right to the share of the earnings, as earnings, and this right was fortified by a power lodged in the trustee to require a liquidation of the business if its rights were not fully respected by the surviving partners. When and as the income was earned, it became immediately subject to the preexisting rights of the estates to their share of it. The amounts so distributable to the estates were not distributable to any surviving partner, with the result that here, as in Richard P. Hallowell, 2d, supra (39 B.T.A. 50) the disputed amount attributed by the respondent to each surviving partner may not be regarded as ‘his distributive share, whether distributed or not, of the net income of the partnership.‘
The contention of the mother that she disposed of her entire interest in the profit of the business is understandable as an effort to diminish her own taxes, but to the extent, if any, that her escape from taxation would account for respondent's position here we regard it as without weight.
Her liability to tax would seem sufficiently clear under the doctrine of the Wright and Van Aken decisions, supra, so that, although we are not here required to, and do not, decide the question, it furnishes no support for the theory that the income would escape taxation altogether if respondent's effort fails here.
The evidence shows that respondent has in fact determined a deficiency against the mother for 1944.
Regarding the situation as a whole, and treating it, in accordance with respondent's suggestion, as a controversy arising ‘out of the interpretation of an agreement‘ which ‘is vital to this case,‘ we conclude that the agreement of the parties was such as to provide for a continuing beneficial interest in the mother to the extent of the disputed share in the profits and to eliminate from the taxable income of petitioner a corresponding amount. On this disposition of the proceeding it is unnecessary to consider whether in the alternative, as petitioner also contends, the mother remained in essence a limited partner whose share of the profits was not taxable to the other members of the partnership. Cf. Theodore F. Wilson, 13 T.C. 409. To dispose of uncontested items,
Decision will be entered under Rule 50.
Reviewed by the Court.