Opinion
Docket No. 17039.
1949-05-13
SIDNEY HESS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Sidney J. Hess, Jr., Esq., for the petitioner. A. H. Moorman, Esq., for the respondent.
Petitioner was a member of a partnership doing business as manufacturers' representatives. The partnership agreement provided that upon the death of one partner the other partner was obliged to make specified monthly payments contemplated to be made out of income of the business to the widow of the deceased partner so long as she lived and the same type of business was conducted by the surviving partner. Upon death of the other partner, petitioner acquired the former's interest by payment of a lump sum to his estate, pursuant to terms of agreement. As he continued to conduct the same type of business, petitioner made the monthly payments to the widow, as required by contract. Held, such payments are excludable from petitioner's income. Sidney J. Hess, Jr., Esq., for the petitioner. A. H. Moorman, Esq., for the respondent.
Respondent determined deficiencies in petitioner's income tax for the calendar years 1943 and 1944 in the respective amounts of $3,174.73 and $2,224.26. The year 1942 is involved by reason of the provisions of the Current Tax Payment Act of 1943. All issues but one have been resolved by the stipulation of the parties.
The sole issue that remains is whether payments made by petitioner to the widow of his former partner after the latter's death, pursuant to an agreement between petitioner and the former partner, are excludable or deductible from petitioner's gross income. More specifically, it is respondent's contention that the payments made by petitioner to the widow of the deceased partner were part of the consideration payable by petitioner for the acquisition of complete ownership of the deceased partner's interest in the partnership business. Petitioner, on the other hand, asserts as his primary purpose that the payments to the widow represented her share of the income from the business, under the terms of the agreement, which constituted income taxable to her and which are excludable from his income. He argues, in the alternative, that, if the payments are not excludable from income, they are deductible as a business expense.
Some of the facts have been stipulated.
FINDINGS OF FACT
The stipulated facts are hereby found accordingly.
During the years involved petitioner was a resident of Chicago, Illinois, and filed his tax returns, prepared on a calendar year, accrual basis, with the collector of internal revenue for the first district of Illinois.
Prior to 1927 petitioner and Robert Mayer worked together for many years as employees of Charles Rubens & Co., which engaged in the business of selling buttons, tapes, and other small wares to clothing manufacturers. In 1927 petitioner and Mayer left Rubens and formed their own company, known as the Mayer & Hess Button Co., to engage in the same business activities.
On or about December 30, 1936, they entered into a written agreement of copartnership to conduct as partners the business they were then carrying on. The business was thereafter conducted as a partnership until February 14, 1942, the date of Mayer's death. From that time until 1946, when the business was incorporated, it was conducted by petitioner as a sole proprietorship.
Pursuant to the terms of the partnership agreement of 1936, petitioner and Mayer were equal partners. In paragraph 16 of the agreement, provision was made to cover the contingency of the death of one of the partners. In general, it was provided that the business would be continued by the surviving partner for a period of sixty days after the death of one of them, and at the end of that period the share or interest of the deceased partner was to cease and determine, and that inventory and accounting of the business as of that day was to be made by independent auditors for the purpose of establishing the value of the share of the deceased partner, but, in determining such value, the good will, if any, of the partnership was not to be considered. The value so determined was then to be paid by the surviving partner to the personal representative of the deceased partner in payment of the decedent's complete interest in the business.
On or about August 1, 1941, petitioner, Mayer, their personal attorneys, and the attorney for the partnership conferred regarding the advisability of modifying the partnership agreement. The meeting was arranged at the request of Mayer, who desired some modification of the provisions of the 1936 agreement relative to the disposition of the interest of a deceased partner. It was his desire that some amendment in the form of additional provisions be made to paragraph 16 of the original agreement to insure a source of income to the widow of a deceased partner. It was his suggestion that the widow of the deceased partner continue as a partner in the business, and thereby participate in the future profits thereof. Petitioner objected to such an arrangement because he did not wish to have an inexperienced woman interfere in the operation of the business, but he was amenable to a profit-sharing arrangement in which the widow of the deceased partner would not, however, become a partner.
As a result of this meeting, on or about August 18, 1941, petitioner and Mayer entered into an agreement amending the 1936 partnership agreement. It was therein provided in part:
There shall be and hereby is inserted after Paragraph 16 of the (1936) Agreement the following:
The Partnership assets and property to be acquired by the Surviving Co-partner in the event of the death or mental incapacity of either of the Co-partners pursuant to the Agreement and this Amendment shall include the business, customer's lists, good will, and all intangible property of the Partnership and the name ‘Mayer & Hess Button Co.‘ The Surviving Co-partner shall have the unrestricted right and privilege to use or to refrain from using the said name ‘Mayer & Hess Button Co.‘, or any modification thereof, in his sole and uncontrolled judgment and discretion.
In the event of the death or mental incapacity of either of the Co-partners then in addition to the payments provided to be made pursuant to paragraph 16 of the Agreement by the Surviving Co-partner, the Surviving Co-partner shall pay to the widow (or wife) of the Deceased Co-partner, so long as she shall live and so long as the Surviving Co-partner shall continue to operate the business of the Co-partnership under the name and style of ‘Mayer & Hess Button Co.‘ or shall continue to operate said business in substantially the manner in which it shall be operated at the date of dissolution of the Partnership, for the use or privilege of use of the name ‘Mayer & Hess Button Co.‘, regardless of whether the said name actually shall be used, the sum of $250.00 on or before the first day of each month commencing on the first day of the second month after the month in which the death of the Deceased Co-partner shall occur, provided, however, that if in the uncontrolled judgment and discretion of the Surviving Co-partner it shall not be practicable or feasible because of the financial condition or cash position of the business to pay the widow (or wife) of the Deceased Co-partner the said sum of $250.00 per month, the Surviving Co-partner may pay to her such smaller sum as he shall deem practicable or feasible in full satisfaction of her claim hereunder, but in no event shall the Surviving Co-partner pay less than the sum of $100.00 per month. * * *
Nothing contained in this Amendment shall constitute the widow (or wife) of the Deceased Co-partner as a Co-partner in the operation of the business, nor vest in her the right to demand an accounting of the business, to examine its books or records, or to exercise any rights which normally would accrue to a Co-partner, * * *
Notwithstanding anything contained in this Amendment, the Surviving Co-partner may operate the business in such manner as he shall deem proper, and may sell or otherwise dispose of or deal with the assets and property theretofore comprising the assets and property of the Partnership, including the name ‘Mayer & Hess Button Co.‘, as his sole and absolute property in the same manner and to the same extent as if this Amendment had not been incorporated in the Agreement. * * *
The provision with reference to payments for the use of the name was inserted at the insistence of Mayer, who was of the opinion that some such recitation was necessary in order to make the agreement legally enforceable. He suggested that the stipulated payments should cease upon nonuse of the name. Petitioner, however, desired that the payments be continued irrespective of the use of the name, so long as a similar type of business was conducted. By the agreement it was sought to satisfy Mayer's apprehension as to failure of consideration and petitioner's desire for continuation of payments without regard to use of the name, although the parties to the agreement did not actually intend that the payments be for the use of the trade name or for the acquisition of any part of the deceased partner's interest, the acquisition of all of which was provided for elsewhere in the agreement.
In adopting the amendment to the partnership agreement, petitioner and Mayer intended to obligate themselves to make provision for a deceased partner's widow by some form of monthly payments out of the income of the business.
Mayer died on February 14, 1942. His widow, May Mayer, survived him. His estate was administered in the Probate Court of Cook County, Illinois.
On June 19, 1942, an order was entered in the probate court authorizing decedent's executors to accept and receive from petitioner as the surviving partner the sum of $24,318.16 in full settlement of all claims against the assets, property, and business of the partnership. The amount had been determined pursuant to the audit and accounting of the partnership, which had been made in accordance with the provisions of the partnership agreement. Pursuant to this order, the executors shortly thereafter executed an instrument of transfer in consideration of the payment of the sum of $24,318.16, receipt of which was acknowledged, transferring to petitioner all assets of the partnership, including good will and other intangible property, and specifically including the name ‘Mayer Hess Button Co.‘
On the same date, the probate court entered another order, in which it found and determined.
That the payments provided to be made under the provisions of the Supplemental partnership agreement between Robert Mayer and Sidney Hess, as partners, doing business under the name of Mayer & Hess Button Company, dated August 18, 1941, are payments intended for the sole and exclusive benefit of May Mayer as widow of the above named decedent, and that the executors under the Will of Robert Mayer, deceased, have no right, title or interest therein of any kind or nature whatsoever, and the entry of this order shall be deemed a disclaimer by the said Executors and the said estate of all right, title and interest therein.
That Sidney Hess, as sole surviving partner, be and he is hereby directed to make such payments as may be required under the provisions of said Supplemental Agreement dated August 18, 1941, directly to May Mayer, and that the payment of said sums to May Mayer shall constitute full and complete payment and satisfaction of the obligation of the said surviving partner under the provisions of the Supplemental Agreement.
From the time of the commencement of the Mayer & Hess business in 1927, it was the exclusive representative of the Rochester Button Co. in the general middle west territory. It also represented other manufacturers of tapes and buttons used by the clothing industry. Petitioner and Mayer developed a substantial business, and since 1936 it has never been conducted at a loss. Its principal business was the sale of Rochester buttons, its sales of the other items being incidental thereto.
Merchandise sold by Mayer & Hess was usually billed so that the customers paid for it about the 10th of each month, and at the end of the month Mayer & Hess would pay its bills for the merchandise that it sold. Mayer and petitioner personally sold 80 per cent to 85 per cent of all the goods handled by their company; and, following Mayer's death, petitioner sold between 75 per cent and 90 per cent of all the merchandise handled by the company. Prior to Mayer's death, two salesmen were employed. In 1943, a third salesman was employed.
Only nominal good will attached to the name ‘Mayer & Hess Button Co.‘ or to its business, as the success of the enterprise was dependent principally upon the skill and experience of petitioner and Mayer until the latter's death, and, after his death, upon the personality, skill, and reputation of petitioner. Capital was not a material income-producing factor.
Pursuant to the provisions of the partnership agreement, as amended, petitioner paid to May Mayer the sum of $2,125 during 1942, $3,000 during 1943, and $2,400 during 1944. These amounts were deducted on petitioner's tax returns under the caption ‘Other Business Deductions‘ as ‘cost of the use of the name Mayer & Hess Button Co.‘
In the notice of deficiency, respondent disallowed these deductions as not constituting proper deductions under section 23(a) of the Internal Revenue Code.
OPINION.
KERN, Judge:
Whether the payments made by petitioner to the widow of his deceased partner are excludable or deductible from his gross income depends primarily upon the terms of the partnership agreement, as amended. In determining the scope and effect of that agreement, respondent recognizes that we are ‘entitled to know of all the circumstances surrounding and motivating the parties to enter into an agreement.‘ In our attempt to ascertain the intention of the parties, as embodied in the agreement, which is in many vital respects ambiguous, we are also permitted to consider the parol testimony offered on behalf of petitioner. 20 Am.Jur., Evidence, par. 1155; Charles F. Mitchell, 45 B.T.A. 300; and Combs Lumber Co., 41 B.T.A. 339. See also Macon, Dublin & Savannah R.R. Co., 40 B.T.A. 1266, and Haverty Realty & Investment Co., 3 T.C. 161. Respondent's motion to strike such testimony is accordingly denied.
As we conceive what the partners intended and what they sought to embody in their agreement, there was to be a profit-sharing arrangement whereby the widow of the partner who died first would be entitled, as a third party beneficiary under the contract, to certain stipulated monthly amounts out of the income of the business continued by the survivor. These payments were to continue for as long as the widow lived, or as long as the same type of business was conducted by the survivor. These payments were not intended as gratuities, and neither petitioner nor respondent so urges. Nor were they intended to be part payment for the purchase of the interest of the deceased partner. And that they were not in fact such payments can be garnered from the agreement itself, as well as from the surrounding circumstances and the events subsequent to the death of Mayer.
Respondent's position, we believe, would not have been taken if it were not for the confusing language of the agreement that the payments were for the use of the trade name, whether it was used or not. However, no substantial meaning can be attributed to this provision in light of the agreement as a whole, the purposes sought to be accomplished, and the explanation of the ambiguity by petitioner. Under the agreement the surviving partner was to acquire the complete interest of the deceased partner
upon the payment of a sum determined by an independent audit. This was done here and the probate court so recognized. Nothing remained of the interest of the deceased partner which petitioner could or did purchase by the payments to Mayer's widow. As the probate court further found, and we believe that it properly construed the agreement, the deceased's estate had no interest in these payments, and they were intended for the sole and exclusive benefit of his widow and were an obligation of petitioner to the widow arising under the amended partnership agreement. By the modifications of the agreement, the partners intended something ‘ * * * in the nature of a mutual insurance plan, the disadvantage of which each partner was willing to accept in consideration of a similar commitment for his benefit on the part of all other partners, * * * . ‘ Charles F. Coates, 7 T.C. 125, 134.
Only nominal good will, as we have found, attached to the name and the business. D. K. MacDonald, 3 T.C. 720.
Under this view of the facts, we are of the opinion that the one litigated issue must be resolved in favor of petitioner upon the authority of such cases as Bull v. United States, 295 U.S. 247; Gussie K. Barth, 35 B.T.A. 546; Richard P. Hallowell, II, 39 B.T.A. 50; Charles F. Cates, supra; and Estate of Thomas F. Remington, 9 T.C. 99.
Because we believe that the payments are excludable from petitioner's gross income, we need not consider the alternative contention that they are deductible therefrom.
Reviewed by the Court.
Decision will be entered under Rule 50. DISNEY, J., dissenting: The original paragraph 16 of the partnership agreement provided for acquisition of a deceased partner's interest by the survivor. That paragraph was amended about August 18, 1941, the new paragraph referring to the partnership assets to be acquired by the survivor pursuant to the agreement and the amendment. Then provision was made for payments by the survivor to the wife of a deceased or mentally incapacitated partner, and for acquisition by the survivor of the right to use the partnership name. This appears to me to be a capital transaction, the payments to the wife being an integral part of the consideration for passage of title to the partnership assets to the survivor. I would not exclude such payments from petitioner's income. I therefore respectfully dissent.