Opinion
Docket No. 9439.
1948-04-8
ROBERT L. GRAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Theodore Siskind, Esq., and Hyman Meyerson, C.P.A., for the petitioner. John E. Mahoney, Esq., for the respondent.
1. Petitioner, holding a one-third interest in a partnership, assigned to his wife two-thirds of such interest upon her advancing to the partnership at his request liquid assets of the value of about $23,000 to enable it to show a substantial financial statement, prerequisite to its procuring a contract from the War Department and a performance bond for the construction and operation of a shell-loading plant. Petitioner's wife delivered the assets, consisting of securities and cash, to petitioner with the understanding that they were to be returned to her in king if not needed. Upon receipt of these assets and other contributions the required financial showing of the partnership was deemed sufficient basis by the bonding company for issuance of the bond. Thereupon the War Department advised that the bond would not be required. Later the proposed contract with the partnership was rejected because it lacked experience in large scale operations. Instead, the contract was let to a construction company having such experience, under a participating and profit-sharing arrangement between the contractor and the partnership. Since the assets advanced by petitioner's wife were not then needed by the partnership, they were returned in kind to her. The wife did not participate in a substantial say in the management and control of the partnership and performed no vital services for it. A share of the net profits of the partnership was distributed to her as a partner. Held, the share of such profits so distributed to the wife is taxable le to petitioner.
2. Held, that reimbursement to petitioner for certain expenses incurred and paid by him in his efforts to negotiate the proposed contract between the War Department and the partnership did not constitute taxable income to him. Theodore Siskind, Esq., and Hyman Meyerson, C.P.A., for the petitioner. John E. Mahoney, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax for the calendar year 1941 in the amount of $10,149.16. There are two issues presented:
(1) Should petitioner include in his gross income for 1941 the amount attributed to his wife as her distributive share of the net income of the partnership of Martin H. Ray & Associates?
(2) Did the receipt of $8,000 by petitioner to reimburse him for expenses incurred and paid in an effort to procure a Government contract for the partnership constitute taxable income?
Petitioner's return for the taxable year was filed with the collector of internal revenue for the fifth district of New Jersey, at Newark.
FINDINGS OF FACT.
Petitioner resides in South Brooksville, Maine. He filed his income tax return for the year 1941 on the cash basis.
Partnership issue.— Sometime during the spring of 1940 petitioner and his associate, Martin H. Ray, became interested in obtaining a Government contract for the construction, outfitting, and operation of a shell-loading plant. Prior to that they had been in business together under the firm name of Martin H. Ray & Associates as business consultants, industrial operators, advisory engineers, and agents for manufacturing concerns.
On June 15, 1940, petitioner, Martin H. Ray, Arthur W. Copp, and Thomas H. Ray executed a partnership agreement for the purpose of continuing and carrying on the business formerly done by Martin H. Ray and persons previously associated with him. By this agreement petitioner had a 33 3/4 per cent interest in the partnership net profits.
During September 1940 the partnership began negotiations with the War Department for the purpose of obtaining a contract to construct the proposed shell-loading plant. Officials of the War Department informed the partnership that before the contract could be approved the partnership would be required to post a surety bond in the amount of $500,000 and show a substantial financial statement.
At this time the partnership did not have sufficient capital to qualify for the required bond. It then had assets totaling $10,000, which consisted of a bank account of Martin H. Ray and certain accounts receivable. On or about September 26, 1940, petitioner requested his wife, Bertha S. Gray, to make an assignment of her liquid assets to the partnership. In a telegram dated September 27, 1940, Mrs. Gray stated, ‘Assignment Ray and Associates $23,873.50 executed this date.‘ Mrs. Gray then completed an undated written assignment as follows:
FOR VALUABLE CONSIDERATION, I hereby sell, assign, transfer and convey to the firm Martin H. Ray & Associates, all of my right, title and interest in and to the following property:
+-----------------------------------------+ ¦125 Shares Chrysler Corp. stock¦$9,937.50¦ +-------------------------------+---------¦ ¦5 Shares Col. Gas. & Elec ¦402.50 ¦ +-------------------------------+---------¦ ¦50 Shares Gen. Motors ¦2,462.50 ¦ +-------------------------------+---------¦ ¦114 Shares Lockheed Aircraft ¦3,334.50 ¦ +-------------------------------+---------¦ ¦100 Shares Motor Wheel ¦1,700.00 ¦ +-------------------------------+---------¦ ¦25 Shares Vega Aircraft ¦287.50 ¦ +-------------------------------+---------¦ ¦ ¦18,124.50¦ +-------------------------------+---------¦ ¦$5,000.00 Cash ¦5,000.00 ¦ +-------------------------------+---------¦ ¦Total ¦23,124.50¦ +-----------------------------------------+
This assignment is made for the purpose of contributing the above total sum to the capital account of Martin H. Ray & Associates for the sole use of said firm under its Articles of Partnership dated June 15, 1940, and upon dissolution or liquidation of said firm may be returned in kind at the value above stated.
(Signed) BERTHA S. GRAY.
The discrepancy between the figure on the telegram and that shown in the assignment was caused by determining the market value of the securities from quotations on different days.
The assigned assets were turned over to petitioner and placed in the safe of the partnership's attorney with the Martin H. Ray papers.
Mrs. Gray expected that if the securities and cash were not needed for any purpose they would be returned to her. The assets set forth in the above assignment were returned to Mrs. Gray on or about November 23, 1940.
After this assignment by Mrs. Gray and a contribution by Thomas H. Ray of $21,000, the partnership had assets totaling $68,774.49. These assets were included in a balance sheet submitted to a surety company and to the War Department. The surety company on the basis of such financial statement issued to the partnership a letter of its intent to write a bond in the amount of $500,000. However, the War Department was satisfied with the financial statement and then informed Martin H. Ray & Associates that it would award the contract without any bond being posted.
Another partnership agreement was executed by petitioner, Martin H. Ray, Arthur W. Copp, and Thomas H. Ray on September 27, 1940. Paragraph 1 of that agreement contained the following:
1. In determining net profits derived from the contract in connection with the U.S. Government loading plant, the book profit is to be increased by the amount of any salary received by any partner from sources other than the firm in connection with that project, and also by the amounts of any salaries or drawing accounts paid by the firm to the partners. The total thus arrived at shall be considered to be the partnership net profit and shall be distributed to the partners according to the percentage specified, except that from each partner's share shall be deducted the amounts already received by him as salary or drawing account either from the firm or otherwise.
The Quartermaster General and the Chief of Ordnance recommended for approval a proposed contract between the partnership and the United States on October 4 and 5, 1940, respectively. By letter dated October 23, 1940, however, the War Department informed the partnership that it would not sign the agreement, due to the partnership's lack of experience in large scale operations. It was estimated that the operation of the plant, which was to be located near Union Center, Indiana, would cost $26,000,000 and that it would require employment of between 20,000 and 30,000 people.
In the meantime the partnership had been negotiating with the engineering firm of Todd & Brown, Inc., which had a substantial record of past performance in large constructions, for the purpose of obtaining its cooperation in complying with the terms of the proposed contract. When the proposed contract was rejected by the War Department, it was suggested that the Government enter into a similar contract with Todd & Brown, Inc., with the understanding that the latter execute a cooperating agreement with the partnership. On November 7, 1940, Todd & Brown, Inc., entered into an agreement with the United States similar to the proposed agreement between the partnership and the Government. The Government, in entering into this contract, expected to obtain and relied on obtaining the services of Martin H. Ray & Associates.
As of November 9, 1940, the partnership entered into an agreement with Todd & Brown, Inc., under which the corporation agreed to pay the partnership 50 per cent of the net profits realized from the performance of the Government contract in exchange for the partnership's aid in constructing and maintaining the shell-loading plant.
The War Department having awarded the contract for the shell-loading plant to Todd & Brown, Inc., instead of to the partnership, the latter did not need the assets assigned to it by petitioner's wife and they were returned to her as hereinabove stated.
On December 31, 1940, another partnership agreement was executed for the purpose of supplementing the agreements of June 15 and September 27, 1940. This agreement showed that the following were partners and that the net profits were to be distributed monthly in the following proportions:
+------------------------------+ ¦ ¦Per cent ¦ +-------------------+----------¦ ¦Martin H. Ray ¦10 ¦ +-------------------+----------¦ ¦Jeanne L. Ray ¦11 ¦ +-------------------+----------¦ ¦Neal Ormond ¦10 ¦ +-------------------+----------¦ ¦Robert L. Gray ¦10 ¦ +-------------------+----------¦ ¦Bertha S. Gray ¦21 ¦ +-------------------+----------¦ ¦Arthur W. Copp ¦20 3/4 ¦ +-------------------+----------¦ ¦Thomas H. Ray ¦9 1/4 ¦ +-------------------+----------¦ ¦Walter F. O'Malley ¦8 ¦ +------------------------------+
On January 11, 1941, Martin H. Ray & Associated informed Todd & Brown, Inc., by letter, that the firm of Martin H. Ray & Associates was a partnership consisting of the persons above named. Subsequent to the assignment of property made by Mrs. Gray to the partnership, she attended partnership meetings. Prior to that time she performed secretarial work.
The partnership earned net income of $48,982.74 for its fiscal year ended October 31, 1941. Such amount was reported as ordinary net income in its partnership return of income, which showed that 10 per cent of that amount, or $4,898.27, was the distributive share of petitioner and that 21 per cent of such amount, or $10,286.38, was the distributive share of Bertha S. Gray. These amounts were paid to them, respectively, by check. During the year 1941 petitioner also received $20,000 salary from Todd & Brown, Inc., for his services in connection with the Government contract. In his deficiency notice respondent stated as follows:
(a) It is determined that your distributive share of the net income of Martin H. Ray & Associates for the taxable year 1941 was $15,184,65, in lieu of the $4,898.27 reported by you from such source, and your gross income has, accordingly, been increased in the amount of $10,286.38.
Mrs. Gray's services were not vital either before or after she assigned her property to the partnership, she did not contribute substantially to the control and management of the business, and her assignment of securities to Martin H. Ray & Associates was a loan and not an investment.
Expense issue.— From the spring of 1940 until November 7, 1940, when the War Department agreed to let Todd & Brown, Inc., accept full responsibility for the construction of the shell-loading plant, petitioner did considerable work in connection with preliminary negotiations for obtaining the Government contract. During this time petitioner traveled extensively to interview people whose services might be used by the partnership and to select a suitable location for the plant. His travels included trips to Washington, D.C., a number of times; to Chicago, Illinois, twice; and to Cleveland, Ohio, and Decatur, Illinois. In addition, he visited the Government arsenals at Watervliet, New York, and Aberdeen Proving Grounds, Maryland. In such travels and preliminary negotiations petitioner incurred and paid expenses in the amount of $8,000.
At the time of these preliminary negotiations, petitioner was employed by the Reynolds Spring Co., which had plants at Jackson, Michigan, Cambridge, Ohio, and Passaic, New Jersey; the Crown Cork & Seal Co. of Baltimore, Maryland; and the Heyer Products Co. of Bellville, New Jersey. The work done for these concerns, however, was subordinated to his labors connected with negotiating for the contract with the War Department.
With respect to the expenses incurred by petitioner and Martin H. Ray relative to negotiating for the contract, the agreement between Todd & Brown, Inc., and Martin H. Ray & Associates contains the following:
SIXTH * * * In addition to the foregoing payment, the Corporation will pay to the Partnership and/or Martin H. Ray and Robert L. Gray individually, at the option of the Partnership, the sum of Sixteen thousand Dollars ($16,000.), which amount the partnership represents it has expended in connection with special studies and investigations made by it in connection with the designing, planning and operation of shell loading plants. Such last named sum shall be paid by the Corporation to the Partnership when the net earnings of the Corporation realized and collected under the Government Contract exceed that amount and when paid shall be deemed to be an expense of the Corporation growing out of its performance of the Government Contract in determining the amount of the net profits realized and collected therefrom.
In his individual income tax return for 1941 petitioner stated: ‘Refund of $8,000.00 for expenses incurred as provided in contract dated Nov. 9, 1940 between Todd & Brown and Martin H. Ray & Assoc. not included herein.‘
In his deficiency notice respondent stated:
(b) It is further determined that the $8,000.00 received by you during the taxable year 1941 from Todd & Brown, Inc., is includible in your gross income for said year.
The payment of $8,000 above mentioned was made to and received by petitioner in 1941 to reimburse him for the expenses incurred and paid by him in negotiating the Government contract in question.
OPINION.
HILL, Judge:
The first question is whether Mrs. Gray was, for Federal tax purposes, a partner in the firm of Martin H. Ray & Associates. We believe the record in this case supports respondent's position that she was not.
The Tower and Lusthaus cases
determined that for Federal tax purposes a wife may become a partner if she either invests capital originating with her, substantially contributes to the control and management of the business, or otherwise performs vital additional services. The partnership interest claimed for Mrs. Gray was in substance based on an arrangement solely between her and petitioner, since she shared only his partnership interest and the interest of no other partner was affected thereby.
Commissioner v. Tower, 327 U.S. 280; Lusthaus v. Commissioner, 327 U.S. 293.
Petitioner does not contend that Mrs. Gray either contributed vital services to or shared substantially in the management of partnership affairs.
It is argued, however, that Mrs. Gray's assignment of securities to the partnership constituted an investment of capital originating with her. Mrs. Gray testified that ‘if they (the partnership) didn't need the money for any purpose‘ she expected the securities to be returned to her. It is stated in the assignment that upon dissolution or liquidation of Martin H. Ray & Associates the securities were to be returned to her ‘in kind‘ at the values recited in the assignment. During cross-examination, she said the term ‘in kind‘ means ‘the same thing.‘ In fact, in accordance with her wishes the securities and cash were returned to Mrs. Gray on or about November 23, 1940. We are of opinion, therefore, that Mrs. Gray's assignment of securities and cash to the partnership was a loan or temporary arrangement rather than an investment of capital in the partnership venture. Certainly, the assets in question contributed nothing toward producing the partnership income in question.
Moreover, only petitioner's partnership interest was affected by Mrs. Gray's purported contribution of capital and her conclusion as a member of the partnership. His partnership interest was split between petitioner and his wife. Before the assignment petitioner's interest was 33 3/4 per cent; after the assignment it was only 10 per cent. Mrs. Gray was given a 21 per cent
interest despite the fact that neither her services nor her assignment of assets was in any way responsible for the production of partnership income. As between petitioner and Mrs. Gray, it was petitioner's personal services and professional qualifications that were responsible for the partnership income.
The discrepancy of 2 3/4 per cent could not be explained by petitioner. He testified, however, that only his partnership was affected by the transaction involving the assignment of securities.
Petitioner contends that if Mrs. Gray's assignment had not been made to the partnership the War Department would have terminated all negotiations with the partnership and that it would not then have been possible for Martin H. Ray & Associates to benefit from the contract subsequently awarded to Todd & Brown, Inc. Mrs. Gray made the assignment of assets at the request of her husband, so that the partnership could show a financial statement to the bonding company and the War Department. O'Malley, one of the partners, testified that, after he was successful in getting the ‘letter‘ of intent‘ from the bonding company, the War Department decided the bond was not necessary for awarding the contract to the partnership. However, the proposed contract with the partnership was rejected by the War Department for a reason entirely apart from the consideration of a bond to secure performance or the financial status of the partnership. The reason for such rejection of the proposed contract with the partnership was that it was without experience in large scale operations. The contract in question was awarded to Todd & Brown, Inc., instead of to the partnership. Obviously, the condition of the partnership's financial status was not even considered in the consummation of the contract between the War Department and Todd & Brown, Inc., or the profit-sharing arrangement between the partnership and Todd & Brown, Inc.
In view of the above, we hold that for Federal tax purposes Mrs. Gray was not a bona fide partner in the firm of Martin H. Ray & Associates and that the amount of the partnership income distributed to her is taxable to petitioner.
The second question is whether the $8,000 paid to petitioner in 1941 by Todd & Brown as reimbursement for expenses incurred and paid in connection with his negotiations to secure the Government contract in question represents taxable income to him.
The evidence is clear that petitioner did expend considerable money performing preliminary work with respect to that contract. Respondent contends no expense should be allowed because petitioner has submitted unsatisfactory evidence to support his argument. We disagree. The record shows that during the summer of 1940 petitioner did considerable traveling and spent a great deal of his own funds in performing preliminary work connected with procuring the proposed contract with the War Department. He visited various cities throughout the country, interviewing experts in the ammunition field; he looked over several sites proposed for the construction of the plant, which required considerable traveling; and he spent a great deal of time in Washington, D.C., negotiating with the War Department personnel. True, at the same time he was doing work for three other companies, but the evidence shows his principal efforts at this time were directed to tasks connected with procuring the Government contract.
To say that petitioner expended nothing would be inconsistent with the facts of this case. See Cohan v. Commissioner, 39 Fed.(2d) 540, 542. The fact that Todd & Brown, Inc., allowed petitioner $8,000 as expenses for his preliminary work with respect to the Government contract supports our belief that that figure is a fair estimate of his expenses for that work. We hold, therefore, that such reimbursement did not constitute income to petitioner.
Decision will be entered under Rule 50.