Opinion
Docket No. 7008.
1945-11-27
ESTATE OF FRANK G. ENNIS, SR., DECEASED, CARRIE MAE ENNIS, EXECUTRIX, AND NATIONAL BANK OF COMMERCE OF NORFOLK, EXECUTOR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Vivian L. Page, Esq., and Leslie C. Garnett, Esq., for the petitioners. Elmer L. Corbin, Esq., for the respondent.
Held, that in the taxable years a bona fide partnership existed between decedent, his wife, and his adult son for the carrying on of a wholesale paper business, the decedent and the son having contributed both capital and services and the wife having contributed her entire time to the business, and that the shares of partnership income which were reported and on which income tax was paid by the wife and the son are not taxable to decedent; held, further, that the minor son of the decedent, neither of whom performed any services for the business or contributed any new capital of their own, were not bona fide partners and as to them the partnership is not required. Vivian L. Page, Esq., and Leslie C. Garnett, Esq., for the petitioners. Elmer L. Corbin, Esq., for the respondent.
This proceeding involves income tax deficiencies for the calendar years 1940 and 1941, and the taxable period from January 1, 1943, to December 16, 1943, in the respective amounts of $2,179.06, $14,954.19, and $49,861.38, a total of $66,994.63. The deficiencies arise from the inclusion in the gross income of Frank G. Ennis, Sr., of the entire profits of the business of the Frank G. Ennis partnership during each of the years in controversy. The issue is whether a bona fide partnership existed between decedent and various members of his family during the taxable periods involved.
FINDINGS OF FACT.
Frank G. Ennis, Sr., died December 16, 1943, a resident of Norfolk, Virginia, and Carrie Mae Ennis his widow, and the National Bank of Commerce of Norfolk were duly appointed and qualified executrix and executor of his estate. The income tax returns for the years in question were filed with the collector for the district of Virginia.
Frank, Sr., and Carrie Mae Ennis were married in 1911. For a number of years Ennis worked as a salesman. In about 1922 he borrowed $500 and started in business for himself, selling brooms. Mrs. Ennis assisted him by taking orders over the telephone at home and in making out statements for the goods sold. After about two years Ennis opened a small store, and Mrs. Ennis worked daily at the store while he was out making deliveries. Mrs. Ennis received about $500 from her father after her mother's death, and that money was used to pay off the original loan. Gradually the business grew and additional employees were hired. From some time in the early 1930's and continuing through the taxable periods involved, the business consisted of the buying and selling, at wholesale, of paper, paper products, and sanitary supplies.
Mrs. Ennis continued to work with her husband until 1929, when their youngest son, Robert L. Ennis was born. She was home from the office about sixteen months, after which she returned to work. From that time on she worked regular business hours at the office, doing general office work such as answering the telephone, selling and taking orders, making out statements, posting accounts receivable, collecting bills, etc. She received no salary prior to 1938.
Frank G. Ennis, Jr., while in school, worked at the business in the afternoons and during summer vacations. In 1930 or 1931, when he was 19, he began to work full time, for which he was paid a small salary. Usually at the end of each year prior to 1938 his father placed a bonus to his credit on the books. Art of the time Frank, Jr., worked as outside salesman, and later he became manager of the warehouse.
In 1933 or 1934 Ennis and Mrs. Ennis purchased a lot for about $1,500 and built thereon a house costing approximately $6,000, title to which was vested in Mrs. Ennis from the beginning.
As of December 31, 1937, the following is a condensed balance sheet of the business of Frank G. Ennis, Sr.:
+-------------------------------------------+ ¦ASSETS ¦ +-------------------------------------------¦ ¦Cash in bank and on hand ¦$4,644.96¦ +---------------------------------+---------¦ ¦Accounts receivable (good) ¦28,151.86¦ +---------------------------------+---------¦ ¦Merchandise inventory ¦28,931.81¦ +---------------------------------+---------¦ ¦Fixed assets and deferred charges¦2,418.77 ¦ +---------------------------------+---------¦ ¦Total ¦64,147.40¦ +-------------------------------------------+
LIABILITIES Notes payable 16,300.00 Accounts payable 16,172.85 Reserve for taxes 1,019.40 Frank G. Ennis capital invested 30,655.15 Total 64,147.40
At that time Frank G. Ennis, Sr., had some 10 or 15 employees, including salesmen who called on the trade.
On January 1, 1938, Frank G. Ennis, Sr., entered into the following agreement with his wife, Carrie Mae Ennis, his son, Frank G. Ennis, Jr., and his daughter, Mary Louise Ennis, who was then about 17 years old:
THIS AGREEMENT, made this 1st day of January, 1938 between Frank G. Ennis, Sr., Party of the first part, and Carrie Mae Ennis, Frank G. Ennis, Jr., and Mary Louise Ennis, parties of the second part, all of the City of Norfolk, and State of Virginia, WITNESSETH:
The parties hereto agree to form a partnership for the purpose of taking over and operating the business now being conducted by the party of the first part.
The party of the first part agrees to furnish the Capital and the parties of the second part agree to furnish their services.
The partnership to Trade under the name of FRANK G. ENNIS.
The party of the first part to continue in full charge and to have final decision in any and all matters pertaining to the operation of the business.
It is agreed that all parties hereto shall draw salaries as agreed on, and all parties hereto shall continue to perform all their present duties, and any other that may be necessary for the good of the business.
All Profits and Losses to be divided equally among all four parties hereto, and same credited or charged to their respective accounts.
The books to be balanced up and closed at the end of each year, same as heretofore.
It is further agreed that in the event of any disagreement or dissolution of the partnership any and all money standing to the credit of any partner shall remain in the business as Working Capital, until such time as it may be convenient and available and desirable for distribution.
The agreement was duly recorded in accordance with the laws of Virginia.
As of January 1, 1938, Frank G. Ennis, Sr., had to his credit on the books of the business the sum of $30,655.15, representing the then net worth of the business, which he contributed to the capital of the partnership. Frank G. Ennis, Jr., on that date, had to his credit on the books the sum of $5,637.83, which he likewise contributed to the capital of the partnership. Mrs. Ennis and Mary Louise Ennis made no contributions to capital at that time.
After the execution of the partnership agreement and at all times material here, both Mrs. Ennis and Frank, Jr., continued to devote their entire time to the business. Frank, Jr.'s, duties and responsibilities gradually increased. Mrs. Ennis commenced drawing a salary of $2,400 a year in 1938. Frank, Jr., continued to draw a salary, which increased in amount as his responsibilities grew. Mary Louise also drew a small salary. She performed no services for the partnership, but did operate a book store which her father owned.
After January 1, 1938, state and city privilege licenses were applied for and issued in the names of all the parties to the partnership agreement, and the leases for the office and warehouse were executed by them all. Commencing with the year 1938, partnership returns of income were filed for each subsequent year and individual returns were made for each of the parties to the partnership agreement.
Frank Ennis, Sr., drew no regular salary, but had an unlimited drawing account. Mrs. Ennis, Frank, Jr., and Mary Louise each had salary accounts, but no drawing accounts. At the end of the year the net profits of the business, after deduction of drawings and salaries, were credited equally to the capital accounts of the four parties. The first credits to the capital accounts of Mrs. Ennis and Mary Louise were made on December 31, 1938, at which time the four capital accounts were as follows:
+------------------------------+ ¦Frank G. Ennis, Sr ¦$31,628.56¦ +-------------------+----------¦ ¦Frank G. Ennis, Jr ¦7,026.21 ¦ +-------------------+----------¦ ¦Carrie Mae Ennis ¦2,224.62 ¦ +-------------------+----------¦ ¦Mary Louise Ennis ¦2,224.62 ¦ +------------------------------+
The amounts credited to the capital accounts were customarily left in the business, to be used as capital.
Frank Ennis, Sr., Mrs. Ennis, and Reynolds, the office manager and bookkeeper, were authorized to draw checks on the partnership funds in the bank, the signatures of any two of the three being required.
In accordance with the agreement, Frank Ennis, Sr., continued to manage the business after January 1, 1938.
At some time in 1938 or 1939 a house was purchased for Frank Ennis, Jr., at a cost of $4,556.68, and title was taken in the joint names of Frank Ennis, Sr., and Mrs. Ennis.
The following schedule shows the four capital accounts as they stood at the end of 1939, 1940, and 1941:
+--------------------------------------------------------+ ¦ ¦Dec. 31, 1939¦Dec. 31, 1940¦Dec. 31, 1941¦ +--------------+-------------+-------------+-------------¦ ¦F.G. Ennis, Sr¦$36,205.98 ¦$39,044.02 ¦$45,394.34 ¦ +--------------+-------------+-------------+-------------¦ ¦F.G. Ennis, Jr¦9,397.40 ¦12,073.34 ¦19,605.88 ¦ +--------------+-------------+-------------+-------------¦ ¦C.M. Ennis ¦4,595.81 ¦8,335.92 ¦16,348.59 ¦ +--------------+-------------+-------------+-------------¦ ¦M.L. Ennis ¦4,595.80 ¦8,335.90 ¦17,708.57 ¦ +--------------------------------------------------------+
On January 1, 1942, the following agreement was executed by the parties named therein:
THIS AGREEMENT, made this 1st day of January 1942 between Frank G. Ennis, Sr., Frank G. Ennis, Jr., Carrie M. Ennis, and Mary L. Ennis, parties of the first part, and Robert L. Ennis, party of the second part, all of the City of Norfolk, and State of Virginia, WITNESSETH:
The parties hereto agree to form a partnership to take over the existing partnership of the parties of the first part, and to continue to operate the business now being conducted by the parties of the first part.
The parties of the first part agree to furnish the new Partnership for Working Capital the amounts now standing to the credit of their respective accounts on the books of the Partnership, and the party of the second part agrees to furnish the amount of $2,000.00 cash as his part of the new Partnership Capital, and all parties hereto agree to furnish their services as may be necessary and desirable.
The Partnership to Trade under the name of FRANK G. ENNIS.
Frank G. Ennis, Sr., to continue in full charge and to have the final decision in any and all matters pertaining to the operation of the business.
It is agreed that all parties hereto shall draw salaries as agreed on, and all parties hereto shall continue to perform all their present duties, and any others that may be necessary for the good of the business.
All Profits and Losses to be divided equally among all five parties hereto, and same credited or charged to their respective accounts at the end of each year.
The books to be balanced up and closed at the end of each year, same as heretofore.
It is further agreed that in the event of any disagreement among the partners or dissolution of the Partnership, any and all monies standing to the credit of any partner shall remain in the business as Working Capital, until such time as it may be convenient and available and desirable for distribution.
Robert Ennis was then approximately twelve years old. Several months later the $2,000 which the agreement provided he was to contribute was paid in by check signed by Mrs. Ennis, ‘as trustee for Robert L. Ennis,‘ from funds she had saved for him. Robert performed no services for the business. He was not represented by a guardian.
As of the end of 1942 the five capital accounts on the books of the business were as follows:
+------------------------------+ ¦Frank G. Ennis, Sr ¦$51,594.57¦ +-------------------+----------¦ ¦Frank G. Ennis, Jr ¦26,378.94 ¦ +-------------------+----------¦ ¦Carrie Mae Ennis ¦23,321.65 ¦ +-------------------+----------¦ ¦Mary Louise Ennis ¦24,581.63 ¦ +-------------------+----------¦ ¦Robert L. Ennis ¦11,848.06 ¦ +------------------------------+
Mrs. Ennis and her husband had a joint savings account in the bank. She deposited the salary she drew from the business in that account, and from her savings she from time to time made loans to the company, aggregating about $7,000 or $7,500, which were carried on the books and were repaid to her with interest after her husband's death.
The Commissioner determined that the entire net income of the business should have been included in the income of Frank G. Ennis, Sr., and accordingly added $12,684.29 to his 1940 income, $31,067.63 to his 1941 income, $48,235.36 to his 1942 income, and $58,399.98 to his 1943 income, resulting in the asserted deficiencies of $2,179.06 for the calendar year 1940, $14,954.19 for the calendar year 1941, and $49,861.38 for the taxable period January 1 to December 16, 1943.
OPINION.
ARUNDELL, Judge:
Respondent has included in the gross income of decedent the entire net income of the Frank G. Ennis paper business during the taxable periods in controversy, and we are here called upon to determine whether he erred in so doing. Petitioners contend that in those periods valid partnerships existed between decedent and members of his family and that the distributive shares of income were properly reported and the tax due thereon paid by the several partners individually.
The first partnership agreement, covering the years 1938 to 1941, inclusive, included the decedent, his wife, his son, Frank G. Ennis, Jr., and his daughter, Mary Louise, then a minor; and the second agreement, covering the years 1942 and 1943, included the same four and in addition decedent's son, Robert L. Ennis, then a minor.
Valid partnerships may exist between members of a family under the same circumstances and conditions as between persons unrelated; but, as has been often said, family partnerships must be subjected to especially careful scrutiny, because of the close familial relationship, in order to determine whether they are in reality what they purport to be. In the present trend of decisions it is apparent that family partnerships will not be recognized for tax purposes unless they involve contributions either of capital or of services on the part of each member. Where no services are performed and reliance is placed solely on capital contributions, increased attention and significance have been given in recent cases to the source and nature of the alleged capital contributions.
In the light of these principles, we turn to an examination of the facts and circumstances relating to the claimed partnerships in this case.
From the time Ennis first went into business for himself in 1922, Mrs. Ennis worked with and assisted him— not in the sense that an ordinary housewife assists her husband, but as a real business associate. Both devoted practically all their time to the business, working long hours to build it up. Its success was undoubtedly due to their joint efforts, almost as much to hers as to his. What they earned they earned together. It was her money which was used to pay off the original loan of $500 borrowed to go into business. Throughout the years, except for a period of sixteen months when her youngest child was born, Mrs. Ennis worked at the office. After the execution of the first partnership agreement, she worked regular business hours every day. Her duties included selling, bookkeeping, making out statements, collecting bills, and receiving shipments of merchandise. She was authorized to sign checks on the partnership funds in the bank, and at the time of the partnership agreement she owned property of a value of at least $7,500, which was subjected to the risk of losses in the business. From time to time she made considerable advancements to the business from her savings. Indeed, since her husband's death she has been actively managing the business.
Mrs. Ennis' situation was not unlike that of the wife in Felix Zukaitis, 3 T.C. 814, who ‘had a stake in the business from the beginning‘ by furnishing $1,500 of the capital upon which the business was begun, and who had taken an active part in the business from its inception, working long hours at the office while her husband was out selling. We there sustained a partnership between husband and wife, even though such partnerships were not fully recognized under the laws of Michigan, the situs of the business, and held that the wife was entitled to report separately and pay the tax on her share of the profits. So here, Mrs. Ennis had a stake in the business almost from its inception, by paying off with her money the amount borrowed to go into business, and she devoted all her time to work in the office.
As for Frank, Jr., the facts are that he, too, devoted his entire efforts to the business from the time he finished school in about 1930. He was 26 or 27 years old when the first partnership agreement was entered into. For a while he worked as outside salesman and later became manager of the warehouse. During the years preceding 1938 he received a small salary. From time to time during those years his father placed additional sums to his credit on the books of the business in the way of bonuses. By 1938 such credits amounted to more than $5,000, and, though the partnership agreement did not require it, Frank, Jr., did in fact contribute that amount to capital. It appears, therefore, that not only did he make a contribution to capital, but he also rendered valuable services and took an active part in the business during all the periods in question.
Respondent stresses the fact that the partnership agreements make no conveyance by title of any interests in the several assets of the business to the wife or any of the children and of the fact that under the terms of the agreement Frank Ennis, Sr., alone was to furnish the capital. So far as Mrs. Ennis and Frank, Jr., are concerned, we think it immaterial that the capital was furnished largely by Ennis or that the contributions to capital were unequal, for both Mrs. Ennis and Frank, Jr., furnished valuable services. As the Supreme Court said in Meehan v. Valentine, 145 U.S. 611, 623, ‘those persons are partners, who contribute either property or services to carry on a joint business for their common benefit, and who own and share the profits thereof in certain proportions.‘ There may be a perfectly valid partnership between one partner who contributes all the capital and another who contributes nothing but services. Miller & Co. v. Simpson, 107 Va. 476; 59 S.E. 378. In such a partnership, in the absence of a contrary agreement, the partner contributing capital would, upon dissolution and liquidation, he entitled first to a return of his capital, and the two would share equally in the remaining proceeds. Virginia Code of 1936 Ann., Sections 4359(18), (40). See also W. H. Simmons, 22 B.T.A. 1106, in which we said that where two new members of a partnership had rendered services, it was of no importance that the other partners had given them no interest in the accumulated profits or in the property used in the business because there ‘may be a partnership in which one partner is the sole owner of the property and the firm capital may consist merely of the right to use property contributed by and belonging to one member.‘
The partnership agreement before us provided for the sharing of profits and losses, for the contribution of capital by Ennis, and for the performance of services by the others. Mrs. Ennis and Frank, Jr., did render services, as has been stated, and Frank, Jr., also made a contribution to capital at the time the agreement was executed.
In view of all the circumstances recited, we have little hesitancy in holding that during the taxable periods involved Mrs. Ennis and Frank, Jr., were bona fide partners in the business. A fundamental principle of income taxation, often referred to in family partnership and other similar cases, including Lucas v. Earl, 281 U.S. 111; Burnet v. Leininger, 285 U.S. 136, and others cited by respondent, is the taxation of income to him who earns it or to him whose property earns it. It may fairly be said in the instant case that the success and the earnings of the business were attributable in large part to the joint efforts of Ennis and Mrs. Ennis and Frank, Jr., and we are therefore but applying the stated principle in holding that Mrs. Ennis and Frank, Jr., were entitled to report separately and pay the tax due on their respective shares of the profits.
We have almost as little hesitancy in holding that the minors, Mary Louise, and Robert L. Ennis, were not bona fide partners. Petitioners must rest their case for sustaining the partnership or partnerships as to these two on contributions to capital, since admittedly neither performed any services for the business. During the years in controversy Mary Louise worked at a book shop, called the Atlantic Book Store, which was owned by her father individually and not by the partnership. The bookkeeper for the partnership testified that she did no work in his office, except for one day, but that she spent her time at the book store looking out for her father's interest. Petitioners point out that at the beginning of the first taxable year in controversy there had been credited to Mary Louise's capital account on the books her share of two years' earnings. They argue, therefore, that she had ‘capital‘ amounting to $4,595.80, which she contributed by leaving it in the business. All this money, however, consisted simply of shares of business income. It was not money which she earned or helped to earn, as in the case of the $5,000 odd contributed by Frank, Jr., at the outset, because admittedly she did no work for the business. As to Robert L. Ennis, petitioners point out that the second partnership agreement provided that he should contribute $2,000; that that sum was actually paid in; and that at the end of 1942, after the year's earnings had been credited, Robert had ‘capital‘ amounting to $11,848.06, which he contributed by leaving it at risk in the business. The $2,000 was apparently paid in by Mrs. Ennis from funds which she controlled, and no guardian was appointed to represent Robert's interest. As for the remainder of the $11,000, consisting of a year's share of business income, the same is true with respect to Robert as with respect to Mary Louise, since he likewise rendered no services. We conclude that neither made a capital contribution within the meaning of the rule requiring contribution of capital or of services, and that during the taxable periods involved these two were not carrying on business in partnership with the others.
In view of our conclusion with respect to Mrs. Ennis and Frank, Jr., a recomputation of the income tax liability of decedent will be required. The Commissioner has included in decedent's gross income the shares reported by all the members of his family. We hold only that he erred in including the shares which were reported and on which the tax was paid by Mrs. Ennis and Frank, Jr., and that those shares should be excluded in the recomputation.
Decision will be entered under Rule 50.