Opinion
Docket No. 2359.
1946-04-23
S. KENNETH ALEXANDER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Byron M. Gray, Esq., for the petitioner. Loyal E. Keir, Esq., for the respondent.
1. The petitioner, the owner of a three-fourths interest in a partnership engaged in the baking business, declared himself trustee for his wife for a one-fourth interest. The wife could not assign, pledge, or anticipate either income or corpus of the trust. Petitioner retained management of the trust and the business, as with property absolutely owned by him, and the trust income was payable to the wife only as petitioner might deem for her best interest. In case of her death, the trust estate was to revert to the petitioner. She contributed no services to the partnership. Held, that the petitioner is taxable on the income of the one-fourth interest placed in trust.
2. Petitioner's wife, with $5,000 paid to her from profits of the one-fourth interest in trust, and $30,000 borrowed (petitioner endorsing her note and furnishing collateral), purchased and received title to an additional one-fourth interest from petitioner's uncle. She borrowed, and repaid, $12,000 from petitioner. Another $2,000 was paid by him on the $30,000, and has not been repaid. She borrowed and repaid $9,000 from her husband's parents. The net earnings of the purchased quarter interest for the taxable years more than equaled the $21,000 borrowed from petitioner and his parents. The wife received the withdrawals of profits from the purchased quarter interest and deposited them in her own bank account. Petitioner had no authority to draw on her bank account. Held, the respondent's plea for an increased deficiency, on the theory that the income of the purchased quarter interest was that of petitioner, is denied. Byron M. Gray, Esq., for the petitioner. Loyal E. Keir, Esq., for the respondent.
The Commissioner determined deficiencies in petitioner's income taxes of $2,355.08, $5,842.98, and $6,098.19 for 1939, 1940, and 1941. The deficiencies are the result principally of the inclusion of petitioner's taxable income of income attributable to a one-fourth interest in a business transferred by petitioner to himself as trustee for the benefit of his wife. The Commissioner makes claim for increased deficiencies for 1940 and 1941 of $12,022.10 and $12,694.08, based upon his error in failing to include the income attributable to another one-fourth interest in such business allegedly purchased in 1940 by petitioner's wife. The questions involved are whether the income for 1939, 1940, and 1941 of the interest held in trust is includible in petitioner's taxable income under section 22(a), or sections 166 and 167, of the Internal Revenue Code and whether the income for 1940 and 1941 from the interest allegedly purchased by the wife is taxable to petitioner under section 22(a) of the Internal Revenue Code. Other issues raised were abandoned.
FINDINGS OF FACT.
Most of the facts of record were stipulated. We find them to be as stipulated. Such facts will, in so far as material, be set forth herein, with other facts found from evidence adduced.
The petitioner is a resident of Topeka, Kansas. He filed his Federal income tax returns for 1939, 1940, and 1941 in the district of Kansas.
The Alexander Brothers Baking Co. of Topeka, Kansas (hereinafter referred to as the company), has, since about 1906, been engaged in the manufacture, sale, and distribution of baking products. It employed an average number of 42 employees.
The company was established by Moses Alexander, father of petitioner, who operated the company as an individual until 1910. In that year Samuel Alexander, brother of petitioner's father, purchased a one-fourth interest in the business, and it then became a partnership business, in which petitioner's father had a three-fourths interest and his uncle a one-fourth interest. Such partnership continued until 1914 or 1915, at which time petitioner's father gave his wife, Ella F. Alexander, mother of petitioner, a one-fourth interest in the business. The business then continued to operate as a new partnership, in which petitioner's father had a one-half interest, his mother a one-fourth interest, and his uncle a one-fourth interest. In 1920 petitioner was given a one-fourth interest in the business by his father and the business then continued as a partnership, in which petitioner and his father, mother, and uncle each had a one-fourth interest. Such arrangement continued until January 1, 1935, at which time petitioner purchased the interests of his mother and father and the business then continued as a partnership, in which the petitioner had a three-fourths interest and his uncle a one-fourth interest. Such arrangement continued until January 1, 1938, at which time petitioner executed a ‘Trust Indenture‘ wherein he declared that he held in trust for his wife, Helen Alexander, an undivided one-fourth interest in the business and assets of the company, including the leasehold premises, machinery, fixed and movable, plant, fixtures, stock in trade, accounts, trade-marks, copyrights, and assets and property of every kind, nature and description, with the powers and for the uses and purposes, as follows:
1. For and in consideration of my love and affection for my wife, Helen Alexander, it is my desire to establish an independent competency for my wife to the end that she shall be protected against the contingency of future debts and embarrassments, and shall have ample property and income to meet the present liability of supporting herself in the circumstances to which she has been accustomed, and to give her, irrevocably, and free from any control for my benefit whatsoever, the above described property, as free as the law can make it from attachment by creditors or liability for my debts. My purpose is to provide her an assured living free from interference by any creditors for any debt or obligation contracted by me subsequent to the creation of this trust, and to conserve my estate as much as possible;
2. The Alexander Bros. Baking Company, of Topeka, Kansas, of which the trust estate herein created is a part, is a going business concern in which I still retain a substantial interest. To preserve the value of this trust estate and secure for its beneficiaries the largest possible return, I am to have full power to manage and control said property as deemed advisable by me and to exercise all power and right over and concerning said property insofar as directing its use; to sell any of the trust property or estate for such price and prices as I may determine; to rent or lease any and all real estate which may be included in such trust property for the terms of any duration whether the terms shall extend to a time beyond the duration of this trust or not; in my discretion to borrow money and to secure the sum so borrowed by pledge or mortgage of any and all portions of said trust estate, and out of such both corpus and income to repay the sum so borrowed; to invest or reinvest any sum so borrowed for the benefit of said estate; to collect and receive the rents, income, and profits arising from the trust estate herein created; and of any money coming into my hands as the proceeds of any such sale or otherwise, I shall reinvest as soon as practical and in making such investment shall have full power to purchase any property, real or personal, which I may thing (sic) desirable to acquire or hold as part of and for the benefit of said trust estate, and I am not to be restricted to the purchase of such property as is ordinarily deemed advisable for trust estates;
3. Out of the income and revenue accruing from said trust estate, I shall have power to pay all taxes, expenses necessary or properly incident to the care, preservation and management; and all other reasonable and necessary charges incident to the administration of the trust created hereby;
4. It is my intention to retain as Trustee, such rights, power, and authority in respect to the management, control, and disposition of said trust estate and the business of which it is a part, for the use and benefit of the beneficiary, as I have with respect to property absolutely owned by me and to my interest in said business;
5. All of the remaining income and revenue, I am to pay to the beneficiary of this trust from time to time whenever I may deem it to be for the best interest of said beneficiary and this trust estate;
6. Any income which is not distributed as hereinabove provided, shall be added to the principal of said estate;
7. Any receipt given by the beneficiary of this trust to me for any sum paid to her by me, shall be a full acquittance and discharge for the payment mentioned in such receipt;
8. The foregoing provisions for my said wife, Helen Alexander, shall be for her sole and separate use without power on my part to revoke, at my will, or to enjoy any beneficial interest therein, and beyond my reach and opportunity to use it for my own personal benefit, it being my purpose to transfer to the beneficiary the right to the property and the immediate present income therefrom, and also to continue to discharge my legal obligation to support my family;
9. She is to have the sole and separate use, free from all statutory and marital rights which I might have therein as her husband and free from her debts, and without the right on her part to assign, pledge, hypothecate, or anticipate or in any way create a lien upon any of the income or corpus of the trust estate hereby created before she shall receive the same, nor shall any of the said income or corpus be subject to any claims of any persons who may at any time be creditors of my said wife;
10. If the said beneficiary shall die before my death, then this trust estate shall thereupon revert to me and become mine immediately and absolutely. Or, if I should die before her death, then this property shall thereupon become hers immediately and absolutely and be turned over to her and in either case this trust shall cease;
11. This trust may be canceled and revoked by an agreement in writing signed by me and by the beneficiary.
The trust indenture was not recorded. No other deed or bill of sale of such one-fourth interest was executed by petitioner at that time.
At no time in the history of the company have the various parties operated under written articles of copartnership, and no written articles of copartnership are in existence at the present time.
Petitioner filed a Federal gift tax return for 1938 in which he reported a gift of the one-fourth interest in the company to the ‘Helen Alexander Trust‘ at a value of $43,142.46. No gift tax was paid, as the available specific exemption plus the annual exclusion exceeded the amount of the reported gift.
Under date of January 2, 1940, petitioner's uncle and his wife, Nancy Alexander, as first parties, petitioner's wife as second party, and petitioner as third party, executed an agreement, as follows:
WHEREAS, a co-partnership has heretofore existed between Samuel Alexander, Helen Alexander and Samuel Kenneth Alexander under the name and style of Alexander Brothers Baking Company of Topeka, Kansas, with its principal place of business and correct post office address at 107 West Tenth Street, in which Samuel Alexander is the owner of a one-fourth interest, Helen Alexander the owner of a one-fourth interest, and Samuel Kenneth Alexander, the owner of a one-half interest;
AND WHEREAS, Samuel Alexander now desires to withdraw and retire from said business and said co-partnership, and sell his said one-fourth interest therein to Helen Alexander, who has agreed to purchase the same as hereinafter set forth, to which the said Samuel Kenneth Alexander has agreed and does hereby agree thereto.
NOW THEREFORE, in consideration of the payment of the sum of $35,000.00, in cash or its equivalent to Samuel Alexander by Helen Alexander, the said Samuel Alexander, with the joint consent and approval of his wife, Nancy Alexander, hereto shown and exhibited by the affixing of her signature hereto, hereby transfers, sells, assigns and sets over unto the said Helen Alexander absolutely and forever all of the right, title, interest and benefit of every kind and nature whatsoever of the said Samuel Alexander in and to said co-partnership, and in the good will thereof, and including also the right to continue said business under the name of Alexander Brothers Baking Company, or under any modification thereof which may be selected by Helen Alexander and Samuel Kenneth Alexander, the remaining partners, and the right to the use of the name, ‘Butter-Krust‘.
The parties hereto further stipulate and agree that there are no obligations, either actual or contingent, of said co-partnership which are not now shown on its books and records, and the said Helen Alexander and Samuel Kenneth Alexander, as a part of the consideration for the above sale and conveyance, hereby covenant and agree with the said Samuel Alexander to pay all the indebtedness and obligations of said co-partnership, and to hold the said Samuel Alexander free from any liability therefor, except any liability for unjust enrichment taxes.
On the same date petitioner's uncle and his wife, Nancy Alexander, executed a bill of sale transferring to petitioner's wife all their undivided one-fourth interest in and to the company:
* * * including the personal property of every kind and nature whatsoever, and wherever situated, and specifically including the equipment, furniture and fixtures, machinery stock in trade, merchandise on hand, raw materials, trucks and other motor vehicles, cash on hand and in the bank, accounts receivable, and all other assets, however, evidenced; and also specifically including all the right, title and interest of the undersigned in and to the baking and manufacturing methods, processes, formulas and recipes, and the trade names including the name of ‘Butter-krust‘, and the right to the future use thereof.
The bill of sale was not recorded. As a part of the same transaction and in order to transfer to petitioner's wife his undivided one-fourth interest in the garage and real estate, located approximately one and one-half blocks south of the building wherein the baking business of the company is carried on and used in connection with storage, repair, and maintenance of the company's trucks and vehicles, petitioner's uncle and his wife, Nancy Alexander, executed and delivered to petitioner's wife their warranty deed dated January 2, 1940, and filed for record in the office of the Register of Deeds of Shawnee County, Kansas, on March 29, 1940, and recorded in book 790 of deeds at page 530.
Petitioner's wife issued a check dated January 2, 1940, payable to Samuel Alexander in the amount of $35,000 against her separate bank account. As of January 1, 1940, she had a balance in her bank account of approximately $5,000, having been built up by withdrawals from the company in 1939. In order to finance the payment to Samuel Alexander of the sum of $35,000, petitioner and his wife arranged a loan in the amount of $30,000 from the Central National Bank of Topeka, Kansas. Petitioner's wife executed a note dated January 3, 1940, payable to such bank in the amount of $30,000. Interest in the amount of $262.50 was collected by the bank in advance. Petitioner endorsed the note and assigned to the bank stocks owned by him (including Timken Roller Bearing, Sperry Corporation, Montgomery Ward, Kennecott Copper, and Republic Steel stocks) as collateral security for the payment of the note. Petitioner's wife made payments to the bank by checks drawn on her bank account in an aggregate amount of $28,000 through withdrawals from the company and loans from petitioner and petitioner's parents. The loans, aggregating $12,000 from petitioner and aggregating $9,000 from his parents, including the interest on the loans from petitioner's parents, were repaid by withdrawals from the company. No interest was paid on the loans from petitioner. Petitioner, on June 17, 1940, made a final payment of $2,000 on the bank loan, for which he has not been reimbursed by his wife.
The dates and amounts of the loans hereinabove referred to and the dates of repayment are itemized in the following schedule:
+---------------------------------------------------------+ ¦ ¦ ¦ ¦Date of ¦ ¦ +-------+---------------------+-------+------------+------¦ ¦Date ¦Borrowed from- ¦Amount ¦payment ¦Amount¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦(1-25-40 ¦$9,000¦ +-------+---------------------+-------+------------+------¦ ¦1-3-40 ¦Central National Bank¦$30,000¦(3-21-40 ¦9,000 ¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦(5-21-40 ¦10,000¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦1 (6-17-40¦2,000 ¦ +-------+---------------------+-------+------------+------¦ ¦1-4-40 ¦Petitioner ¦2,000 ¦ ¦ ¦ +-------+---------------------+-------+------------+------¦ ¦3-21-40¦Petitioner ¦5,000 ¦(12-10-40 ¦3,000 ¦ +-------+---------------------+-------+------------+------¦ ¦5-21-40¦Petitioner ¦5,000 ¦(9-41 ¦9,000 ¦ +-------+---------------------+-------+------------+------¦ ¦1-24-40¦Ella Alexander ¦4,000 ¦(9-24-40 ¦3,000 ¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦(12-10-40 ¦1,000 ¦ +-------+---------------------+-------+------------+------¦ ¦1-24-40¦Moses Alexander ¦5,000 ¦(8-14-40 ¦4,000 ¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦(9-24-40 ¦1,000 ¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------+---------------------+-------+------------+------¦ ¦ ¦ ¦51,000 ¦ ¦51,000¦ +---------------------------------------------------------+ FN1 By petitioner.
The company maintained only one capital account on its books, styled ‘Capital Investment Account.‘ The withdrawals and profits shown therein are as follows:
+-------------------------------------------------------------------------+ ¦1938 ¦ ¦1939 ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦Dec. 31, Withdrawals ¦$40,000.00¦Jan. 1, Balance ¦$73,748.35¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦Dec. 31, Profits for 1939¦41,185.56 ¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦ ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦1939 ¦ ¦ ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦Dec. 31, Withdrawals ¦30,000.00 ¦1940 ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦Jan. 1, Balance ¦84,933.91 ¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦Dec. 31, Profits for 1940¦48,407.16 ¦ +-------------------------+----------+-------------------------+----------¦ ¦1940 ¦ ¦ ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦Dec. 31, Withdrawals ¦50,000.00 ¦ ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦1941 ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦1941 ¦ ¦Jan. 1, Balance ¦83,341.07 ¦ +-------------------------+----------+-------------------------+----------¦ ¦Dec. 31, Withdrawals ¦30,000.00 ¦Dec. 31, Profits for 1941¦45,246.20 ¦ +-------------------------+----------+-------------------------+----------¦ ¦ ¦ ¦ ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦1938 ¦ ¦1942 ¦ ¦ +-------------------------+----------+-------------------------+----------¦ ¦Jan. 1, Balance ¦76,571.70 ¦Jan. 1, Balance ¦98,587.27 ¦ +-------------------------+----------+-------------------------+----------¦ ¦Dec. 31, Profits for 1938¦37,176.65 ¦ ¦ ¦ +-------------------------------------------------------------------------+
Withdrawals were charged to the respective personal accounts of petitioner and his wife. As petitioner drew funds from the business, a check for a like amount would be issued to his wife. No books of account were maintained for the Helen Alexander trust, and there were no distributions from the company to the trust and from the trust to Helen Alexander. The withdrawals so charged to the personal accounts were as follows:
+-------------------------------------+ ¦ ¦Petitioner's¦Helen Alexander¦ +--------+------------+---------------¦ ¦ ¦account ¦account ¦ +--------+------------+---------------¦ ¦1938 ¦ ¦ ¦ +--------+------------+---------------¦ ¦Apr. 19 ¦$5,000 ¦a $2,500 ¦ +--------+------------+---------------¦ ¦June 3 ¦5,000 ¦a 2,500 ¦ +--------+------------+---------------¦ ¦Aug. 5 ¦5,000 ¦b 2,500 ¦ +--------+------------+---------------¦ ¦Oct. 13 ¦5,000 ¦a 2,500 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦ ¦20,000 ¦10,000 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦1939 ¦ ¦ ¦ +--------+------------+---------------¦ ¦Jan. 5 ¦5,000 ¦a 2,500 ¦ +--------+------------+---------------¦ ¦Aug. 21 ¦5,000 ¦a 2,500 ¦ +--------+------------+---------------¦ ¦Dec. 20 ¦5,000 ¦c 2,500 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦ ¦15,000 ¦7,500 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦1940 ¦ ¦ ¦ +--------+------------+---------------¦ ¦Mar. 20 ¦5,000 ¦a 5,000 ¦ +--------+------------+---------------¦ ¦May 20 ¦5,000 ¦a 5,000 ¦ +--------+------------+---------------¦ ¦Aug. 14 ¦5,000 ¦c 5,000 ¦ +--------+------------+---------------¦ ¦Sept. 23¦5,000 ¦c 5,000 ¦ +--------+------------+---------------¦ ¦Dec. 10 ¦5,000 ¦c 5,000 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦ ¦25,000 ¦25,000 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦1941 ¦ ¦ ¦ +--------+------------+---------------¦ ¦Mar. 12 ¦5,000 ¦c 5,000 ¦ +--------+------------+---------------¦ ¦Sept. 22¦10,000 ¦c 10,000 ¦ +--------+------------+---------------¦ ¦ ¦ ¦ ¦ +--------+------------+---------------¦ ¦ ¦15,000 ¦15,000 ¦ +-------------------------------------+ FNa Canceled checks endorsed by petitioner in the name of his wife.FNb Canceled check endorsed by petitioner. The check was made out to Helen Alexander, but her name does not appear on the back of the check.FNc Canceled checks endorsed by petitioner's wife.
The above amounts withdrawn by petitioner's wife were deposited in her bank account. Petitioner at no time had authority to draw checks on his wife's bank account. She has maintained a bank account since 1931. During the taxable years petitioner's wife expended her withdrawals from the company in the payment of Federal and state income taxes, the repayment of the loans above referred to, and the payment of personal and household expenses averaging approximately $3,000 per year, of which approximately $2,500 per year was allocable to her clothing and other personal expenses and approximately $500 per year was devoted to household expenses. Other investments made by petitioner's wife during 1938 to 1941 were as follows:
+--------------------------------------------------+ ¦100 shares, St. Joseph Lead Co ¦$4,292.00¦ +----------------------------------------+---------¦ ¦100 shares, American Radiator & Standard¦1,614.00 ¦ +----------------------------------------+---------¦ ¦100 shares, Radio Corporation of America¦913.00 ¦ +----------------------------------------+---------¦ ¦ ¦ ¦ +----------------------------------------+---------¦ ¦ ¦6,819.00 ¦ +--------------------------------------------------+
Petitioner's wife at no time rendered any personal services to, and received no salary from, the company.
The management of the affairs of the company is vested in petitioner. During the taxable years petitioner drew a salary of $40 per week, which was charged on the books of the company as an expense of operations.
Petitioner owned and maintained during the taxable years the residence in which he and his family resided. Except for the amounts expended by his wife above referred to, petitioner during the taxable years paid the expenses of maintaining the household and educating the two children.
Petitioner's net worth, exclusive of his interest in the company, ranged from $100,000 to $120,000 during the years 1938 to 1941, inclusive. His investments outside of his interest in the business consisted of miscellaneous securities and the land and building in which the company carried on its operations. Such land and building were rented to the company of a net rental of $1,800 per year and had a fair market value of approximately $30,000.
The company maintained a bank account at the Central National Bank of Topeka, Kansas. From April 27, 1927, to June 10, 1941, the company authorized the bank to accept checks signed by petitioner, his father, and his uncle. Commencing June 10, 1941, only petitioner and R. B. Knowles, an employee of the company, were authorized to sign checks. No further authorizations have been made.
The advertising of the company is carried out in the name of Alexander Brothers Baking Co. without the use of any individual names. On January 4, 1940, the company's license as a private motor carrier, filed with the State Corporation Commission, was changed from Samuel Alexander and S. K. Alexander d.b.a. Alexander Brothers Baking Co. to Samuel Kenneth Alexander and Helen Alexander d.b.a. Alexander Brothers Baking Co. On the same date a similar change was effected on the insurance policy issued to the company by the Automobile Insurance Co. Letterheads on which the names of M. Alexander (petitioner's father), S. Alexander (petitioner's uncle), and S. K. Alexander (petitioner), were printed above the name of the company, were used by the company as late as February 9, 1940. Sometime subsequent thereto the company had a new supply of letterheads printed on which no individual names appeared. The company had little need for stationery in its business. To get a good price it usually placed a large order, which was used up before new stationery was obtained.
The net sales and net profits of the company for 1935 to 1944, inclusive, were as follows:
+---------------------------------------------------------+ ¦Year¦Net sales ¦Net profits¦Year¦Net sales ¦Net profits¦ +----+-----------+-----------+----+-----------+-----------¦ ¦1935¦$277,490.93¦$44,373.26 ¦1940¦$274,476.32¦$48,407.16 ¦ +----+-----------+-----------+----+-----------+-----------¦ ¦1936¦305,126.69 ¦54,303.65 ¦1941¦278,542.42 ¦45,246.20 ¦ +----+-----------+-----------+----+-----------+-----------¦ ¦1937¦298,267.18 ¦55,644.37 ¦1942¦353,543.28 ¦65,683.73 ¦ +----+-----------+-----------+----+-----------+-----------¦ ¦1938¦268,258.62 ¦37,176.65 ¦1943¦429,975.96 ¦87,438.21 ¦ +----+-----------+-----------+----+-----------+-----------¦ ¦1939¦264,836.83 ¦41,185.56 ¦1944¦472,424.07 ¦90,935.41 ¦ +---------------------------------------------------------+
Condensed balance sheets of the company as of December 31, 1938, 1939, 1940, and 1941 are as follows:
+-----------------------------------------------------------------------------+ ¦Assets ¦Dec. 31, ¦Dec. 31, ¦Dec. 31, ¦Dec. 31, ¦ ¦ ¦1938 ¦1939 ¦1940 ¦1941 ¦ +---------------------------------+----------+----------+----------+----------¦ ¦Current assets, including cash ¦$18,467.08¦$12,996.49¦$16,186.71¦$33,549.33¦ ¦and inventories ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦Deferred charges, of supplies and¦4,344.29 ¦6,812.69 ¦5,272.03 ¦4,944.30 ¦ ¦prepaid insurance ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦Fixed assets, including furniture¦ ¦ ¦ ¦ ¦ ¦and fixtures, machin- ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦ery and equipment, auto, ovens, ¦ ¦ ¦ ¦ ¦ ¦moist air room, ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦garage (real estate and ¦ ¦ ¦ ¦ ¦ ¦building), garage equipment, ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦electric sign and display ¦50,936.98 ¦65,124.73 ¦62,366.35 ¦60,817.61 ¦ ¦equipment ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+----------¦ ¦ ¦73,748.35 ¦84,933.91 ¦83,825.09 ¦99,311.24 ¦ +-----------------------------------------------------------------------------+
Liabilities Current liabilities, including accrued pay roll and com- missions 484.02 723.97 Capital account 73,748.35 84,933.91 83,341.07 98,587.27 73,748.35 84,933.91 83,825.09 99,311.24
The company filed partnership income tax returns on Form 1065 for the taxable years showing the following division of interests:
+---------------------------------------+ ¦Year¦Partner ¦Interest ¦ +----+----------------------+-----------¦ ¦ ¦(S. Kenneth Alexander ¦One-half. ¦ +----+----------------------+-----------¦ ¦1939¦(Helen Alexander trust¦One-fourth.¦ +----+----------------------+-----------¦ ¦ ¦(Samuel Alexander ¦One-fourth.¦ +----+----------------------+-----------¦ ¦ ¦(S. Kenneth Alexander ¦One-half. ¦ +----+----------------------+-----------¦ ¦1940¦(Helen Alexander trust¦One-fourth.¦ +----+----------------------+-----------¦ ¦ ¦(Helen Alexander trust¦One-fourth.¦ +----+----------------------+-----------¦ ¦ ¦(S. Kenneth Alexander ¦One-half. ¦ +----+----------------------+-----------¦ ¦1941¦(Helen Alexander trust¦One-fourth.¦ +----+----------------------+-----------¦ ¦ ¦(Helen Alexander ¦One-fourth.¦ +---------------------------------------+
For the years 1939, 1940, and 1941 petitioner's wife filed Federal and state income tax returns wherein she reported one-fourth, one-half, and one-half, of the net income of the company for such years. Except for nominal amounts received as dividends she reported no other income.
For the years 1939, 1940, and 1941, petitioner filed nontaxable fiduciary income tax returns in the name of Helen Alexander trust.
OPINION.
DISNEY, Judge:
1. The Commissioner in the deficiency notice increased petitioner's reported taxable income for 1939, 1940, and 1941, (so far as herein concerned) by adding thereto $10,385.14, $12,220.54, and $11,413.42, respectively. It is stated in the notice of deficiency that these amounts represent one-fourth of the net income disclosed on the partnership return of Alexander Brothers Baking Co. and shown thereon as distributable income to Helen Alexander or Helen Alexander trust. The Commissioner held that such income was taxable to petitioner under section 22(a), or under sections 166 and 167, of the Internal Revenue Code.
Is such income taxable to petitioner under section 22(a)? The Commissioner contends that it is, under the doctrine of Helvering v. Clifford, 309 U.S. 331, and cases stemming therefrom.
The petitioner argues that under the constitution and laws of Kansas a wife may have her sole and separate property and may enforce her rights in and to such property even against her husband; that under the laws of Kansas petitioner was required to execute the trust in the interest of the beneficiary, and under no circumstances would he be permitted to act in his own interest; that the gift to the wife was a proper and lawful means of perpetuating the traditional character of the business as a family partnership; and that the gift in trust divested petitioner of all economic interest or benefit in the trust estate or in the income therefrom and he was in no sense the owner of the trust estate, and hence the income of the trust was not taxable to him.
That the arrangement was valid under the constitution and laws of Kansas is not determinative of the issue involved. Commissioner v. Tower, 327 U.S. 280. See also Doll v. Commissioner, 149 Fed.(2d) 239; certiorari denied, 326 U.S. 725.
Whether or not petitioner remained the owner of the partnership interest and income for purposes of section 22(a) is a question of fact. Helvering v. Clifford, supra.
On January 1, 1939, petitioner owned a three-fourths interest in the partnership business of Alexander Brothers Baking Co. His uncle owned the remaining one-fourth interest. The management of the business was vested in petitioner. On January 1, 1938, petitioner executed an instrument in which he declared that he held in trust for his wife Helen an undivided one-fourth interest in such business. Although the instrument provided that the provisions made for the wife:
* * * shall be for her sole and separate use without power on my part to revoke, at my will, or to enjoy any beneficial interest therein, and beyond my reach and opportunity to use it for my own personal benefit, it being my purpose to transfer to the beneficiary the right to the property and the immediate present income therefrom, and also to continue to discharge my legal obligation to support my family;
9. She is to have the sole and separate use, free from all statutory and marital rights which I might have therein as her husband * * *
it also provided that the wife was to be without right to assign, pledge, or anticipate in any way whatever the income or corpus of the trust, nor was the income or corpus subject to the claims of her creditors. The purpose of petitioner, as stated in the indenture, was not only to provide for his wife ‘an assured living free from interference by any creditors for any debt or obligation contracted by me subsequent to the creation of this trust, ‘ but also ‘to conserve my (petitioner's) estate as much as possible.‘ The intention of petitioner, as expressed in the indenture, was to retain as trustee such rights, power, and authority in respect to the management, control, and disposition of the ‘trust estate and the business of which it is a part‘ as he had with respect to property absolutely owned by him and to his interest in the business. The income of one-fourth interest, after payment of expenses, was payable to the beneficiary as petitioner might deem it to be for the ‘best interest of said beneficiary and this trust estate,‘ and the income not distributed was to be added to the principal of the trust. If the beneficiary died, the trust estate immediately reverted to petitioner absolutely. The wife at no time rendered any personal services to the business.
Clearly the trust indenture effected no change in the investment, in the management and control, or in the operation of the business. It is true that petitioner's wife received cash withdrawals from the business which she deposited in her bank account. Whenever petitioner drew funds from the business, a check for a like amount was issued to the wife, and not to petitioner as trustee for distribution to the beneficiary. As stated in the Clifford case, supra:
* * * Since the income remains in the family and since the husband retains control over the investment, he has rather complete assurance that the trust will not effect any substantial change in his economic position. It is hard to imagine that respondent (petitioner) felt himself the poorer after this trust had been executed or, if he did, that it had any rational foundation in fact. For as a result of the terms of the trust and the intimacy of the familial relationship respondent retained the substance of full enjoyment of all the rights which previously he had in the property. * * *
The bundle of rights which he retained was so substantial that respondent cannot be ,heard to complain that he is the ‘victim of despotic power when for the purpose of taxation he is treated as owner altogether.‘ * * *
The facts that the powers and control over the trust principal and income were reserved to petitioner as trustee and that the courts upon appeal to it by the beneficiary would review and correct any abuse of the trustee's powers and discretion are not determinative of the question here. When consideration is given to the broad powers and discretion vested in the donor and to the relationship existing between the donor and the beneficiary, ‘it is wholly improbable that a beneficiary would exercise his right to resort to a court of equity to restrain the discretion of the donor.‘ Cox v. Commissioner, 110 Fed.(2d) 934 (C.C.A., 10th Cir.); certiorari denied, 311 U.S. 667. As stated in Rollins v. Helvering, 92 Fed.(2d) 390 (C.C.A., 8th Cir.); certiorari denied, 302 U.S. 763:
* * * A court of equity has power to control the administration of a trust so that it will accord with the purposes of the grantor. This power exists solely for the protection of rights of the grantor who created the trust and of the rights of the beneficiaries of the trust— there is no public interest in the matter where the parties to the instrument are purely private parties.
See also, Harold F. Jones, 6 T.C. 412, and Gordon M. Mather, 5 T.C. 1001, where we said:
* * * Equity courts will go no farther than to protect the beneficiaries in the enjoyment of the rights actually granted to them by the terms of the trust agreement.
Those terms have above been seen to reserve very broad powers to the petitioner.
The case of Armstrong v. Commissioner, 143 Fed.(2d) 700 (C.C.A., 10th Cir.), cited by petitioner, is distinguishable. In that case taxpayer owned a 50 percent interest in a partnership. Upon the death of his father in 1937 he acquired an additional 5 percent interest which interest he determined to keep separate from his own. Taxpayer's mother acquired a 30 percent interest, and his sister and two brothers each acquired a 5 percent interest. A new partnership agreement was entered into by the parties in 1938 upon the closing of the father's estate, in which each of them was to have a voice in the management and control of the partnership business, petitioner being given the general management, supervision, and control of the partnership business. The affairs of the partnership were discussed at length in partnership meetings held at least once a year and all matters of policy concerning its operations were approved by all the partners. In 1938 petitioner executed a declaration of trust purporting to transfer to himself as of June 1, 1938, the 5 percent interest in the partnership in trust for the benefit of his 2 minor children. The trust was to terminate when the youngest child, then aged 13, became 25 years of age, at which time the corpus and accumulated income was to vest equally in the two beneficiaries or the survivor of them, and in the event of the death of both of them, in their mother. The Circuit Court of Appeals for the Tenth Circuit in its opinion, in distinguishing the situation in the Armstrong case from that in the Clifford case, pointed out that the property did not revert to the donor, that there was no way by which he could be reinvested of any interest in the corpus by operation of the trust declaration, and that, although taxpayer was the manager of the partnership business, every member of it had an equal voice in the management thereof, irrespective of the amount of interest. Herein, upon the death of the beneficiary, the property did revert to petitioner and the petitioner had complete control of her interest and the distribution of the income.
In our opinion, the broad and extensive powers over the trust estate and income reserved to petitioner as trustee and his actual and complete control of the partnership business of which the trust res and accumulated income was a part gave him a dominion over the trust corpus substantially equivalent to full ownership. It is therefore our conclusion that the respondent did not err in taxing one-fourth of the net income of the partnership attributable to the Helen Alexander trust in 1939, 1940, and 1941 to the petitioner under the provisions of section 22(a).
In view of this conclusion it is not necessary to determine whether sections 166 and 167 are applicable.
2. In his amended answer the respondent alleged that he had erred in failing to increase the taxable income of petitioner for the years 1940 and 1941 in the amounts of $12,220.54 and $11,413.42, respectively, representing the net income from the one-fourth interest in the baking business purchased on January 2, 1940, from Samuel Alexander, petitioner's uncle. The burden of proof as to such increase in deficiency is on the respondent. It is argued by him that in the purchase of his uncle's interest, petitioner, and not his wife, was the real party in interest, that the transaction constituted nothing more than an attempt by petitioner to give his wife a one-fourth interest in the business so as to make her a partner therein, that petitioner's control over the interest was not less than that exercised by him over the share held in trust for his wife, and that, as in the situation involving the setting up of the trust, there was no execution of a partnership agreement and no carrying on of a business in partnership with his wife, that petitioner's attempt to change the form of the business to a partnership of himself and wife was not real and substantial and he did not thereby form ‘an essentially new and different economic unit.‘ Earp v. Jones, 131 Fed.(2d) 292 (C.C.A., 10th Cir.).
The evidence shows that under date of January 2, 1940, petitioner and his wife entered into an agreement with his uncle and wife for the purchase of the uncle's one-fourth interest in the business by petitioner's wife for the sum of $35,000. Petitioner's wife paid the amount of $35,000 with her own check. However, as of January 1, 1940, she had only about $5,000 in her bank account and this $5,000 represented moneys which had been withdrawn from the business in 1939. In order to meet the check issued by the wife, petitioner and his wife arranged a bank loan of $30,000 and petitioner's wife executed a note in that amount. Petitioner endorsed the note and assigned to the bank certain stocks owned by him as collateral security for the payment of the note. The bank loan to the extent of $28,000 was paid by petitioner's wife by checks drawn on her bank account to which had been deposited withdrawals from the business, loans without interest from petitioner totaling $12,000, and loans from petitioner's parents aggregating $9,000. Such loans, together with interest on the loans from petitioner's parents, were repaid by withdrawals from the business. The final payment of $2,000 was paid by petitioner, for which he has not been reimbursed by his wife. The loans, except for $2,000 from petitioner, for which he was not reimbursed by his wife, were repaid by her during 1940, except $9,000 repaid in September 1941.
Upon the facts of this case, we must now answer, as to the purchased quarter interest, the question posed in these husband and wife partnership cases: ‘Did the husband, despite the claimed partnership, actually create the right to receive and enjoy the benefit of the income, so as to make it taxable to him? ‘ (Commissioner v. Tower, supra.) This one-fourth did not originate with or come to the wife from the petitioner, as is the situation in the cases cited by the respondent, and many others involving this general question. It was purchased from the uncle, and the gist of the question is, in a large sense, who purchased it, petitioner or his wife? In our view, she did so. He signed the agreement with the uncle, but on the face of the instrument it is apparent that he did so merely to agree to the sale of the partnership interest, a prerequisite to any properly conducted sale of such interest, and to agree, together with his wife, that all partnership debts should be paid, relieving the uncle from that liability. Nothing in the instrument indicates that petitioner was purchaser. He was not a grantee in or signatory to the bill of sale from the uncle and wife to Helen Alexander, whereby the one-fourth partnership was conveyed.
On the question of contribution of capital to the partnership, we have here in large part no mere transfer from husband to wife, as in Commissioner v. Tower, supra, and Lusthaus v. Commissioner, 327 U.S. 293, and many other cases. The $30,000 note was repaid. To the extent of $9,000 it was repaid by loans from petitioner's father and mother, and there is no showing that petitioner had any connection with such loans. The quarter interest purchased from the uncle itself produced $12,101.79 in 1940 (and the wife received title on January 2, 1940), and $11,311.55 in 1941, which is more than sufficient to repay the $21,000 borrowed from petitioner and his parents, and which was repaid to them. Thus, it appears that the petitioner contributed only $2,000, for which he was not reimbursed, and the fact that $12,000 was a loan, repaid to him, is some indication that the other $2,000 was also a loan. The mere fact that it had not been repaid at time of trial does not prove otherwise. Considering the earnings of the quarter interest, it is apparent that only $5,000 of the $35,000 purchase price is shown to have originated with the other quarter interest held in trust, the income of which we have held belonged to petitioner, and thus to have originated with him, making $7,000 not originating with the wife. (The earnings and withdrawals from the trust quarter interest are, in the absence of explanation, sufficient to cover her other expenditures.) We think that such fact is not sufficient, under all the circumstances here, to place this case in the same category with those where the entire capital contribution arose from the earnings in the partnership of the party held taxable. The uncle from whom this quarter interest came is not the petitioner here. We held, in effect, in Carlton B. Overton, 6 T.C. 304, and in Abe Schreiber, 6 T.C. 707, that, though income was taxable to a husband, a gift thereof to the wife was effected by her receipt of the income with the husband's consent, and property purchased by her therewith was her own. Under all the facts, we think that principle is applicable here, where the amount is only one-fifth of the purchase price, from one not the husband or petitioner, where it is not shown that tax avoidance was the motive, but where one partner wished to sell and it was desired to keep the business in the family, in accordance with many years custom. Mere desire to reallocate family income is not demonstrated by the respondent, with the burden of proof. We may not here regard a gift of $2,000 by husband to wife (if in fact it is not loan, like the other $2,000, and still to be repaid) as determinative proof that the husband was the real purchaser. The loan of his name as endorser, which cost him nothing, likewise fails to indicate sham or unreality in the uncle's sale to petitioner's wife. We see nothing here that a husband might not reasonably do in assisting his wife, and not himself, to acquire another's partnership interest. That the wife contributed no services to the partnership is one one element to consider. Commissioner v. Tower, supra. The petitioner is not shown to have received, or to have had the right to receive, the profits from the purchased partnership interest. On the contrary, it is stipulated that the wife maintained her own bank account, that petitioner had no authority to draw checks on it, and that her withdrawals, which amounted in 1940 to $25,000 and in 1941 to $15,000, were deposited to her bank account. Upon the facts before us, as to the purchased quarter interest, we are of the opinion that this is one of those instances recited in Commissioner v. Tower, supra, where a wife becomes a real partner, and that the petitioner did not create the right to receive and enjoy the benefit of the income from that interest. It has not been shown otherwise. We deny the increases in deficiency sought by the respondent.
Decisions will be entered under Rule 50.