Opinion
Docket No. 4423.
1946-05-6
WILLIS B. ANDERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Edgar W. Pugh, Esq., and J. Emmett Tunney, Esq., for the petitioner. A. J. Friedman, Esq., for the respondent.
Held, husband and wife were equal partners in a business in 1941 and entitled to divide its income equally between them where both contributed capital to the business and both performed services in its operation. Edgar W. Pugh, Esq., and J. Emmett Tunney, Esq., for the petitioner. A. J. Friedman, Esq., for the respondent.
The respondent determined a deficiency in income tax against Willis B. Anderson for the year 1941 in the amount of $15,181.72.
The contested issues are (1) whether the income for the year 1941 of a business known as Standard Die Cast Die Co. is taxable in its entirety to the petitioner, and (2) determination of the amount allowable as a deduction for reasonable compensation for services paid in 1941 to Walter Anderson, an employee of the Standard Die Cast Die Co.
Certain of the respondent's adjustments were not contested. Other issues raised by the pleadings have been abandoned by the petitioner.
FINDINGS OF FACT.
The petitioner is an individual, residing at Detroit, Michigan. His return for the year in controversy was filed with the collector of internal revenue at Detroit.
In 1935 the petitioner was married to Emily Alice Thornton. At the time of her marriage the petitioner's wife was employed as a comptometer operator. She contributed $200 of her own as a down payment on their home, title to which was held in both their names jointly.
The petitioner has been in the machine tool and die business all his adult life. In 1938 he was employed as a machine tool and die hand for the Ternstedt Manufacturing Co. of Detroit. In that year, during his spare time and after working hours, he started purchasing secondhand machinery in various junk yards around Detroit. The machinery so purchased was set up and reconditioned for use in the basement of his home.
During the early part of 1939 the petitioner entered into a partnership agreement with one Nelson for the manufacture of molds and machinery for die casting and plastics. Under the agreement Nelson contributed $400 for a 20 percent interest in the business, the petitioner retaining 80 percent. This partnership was terminated after a short time. Later in the same year the petitioner formed another partnership with one Willmore, to engage in a similar line of endeavor. Under this agreement each partner was to have a 50 percent interest in the business. This partnership also proved unsatisfactory and was soon dissolved, the petitioner purchasing Willmore's interest for $846. In the fall of 1939 the petitioner, as an individual, filed with the proper official a certificate of doing business under the name of Standard Die Cast Die Co. (hereinafter for convenience sometimes called the company).
The business of the company was conducted in the basement of the petitioner's home until September 1939. Thereafter, until September 1941 it was located at 8530 Tireman Street. It was subsequently moved to another site.
In the summer of 1940 the company was in distressing financial condition. The machinery was mortgaged and no new orders were expected that year, due to the seasonal nature of the business. Petitioner had no more money to invest. About that time Mrs. Anderson made a trip to St. Louis, Missouri, to visit her mother. While she was there she discussed the financial difficulties she and the petitioner were having. Her mother offered to lend her $1,000 to be used in the business, which she accepted. She took the $1,000 with her to Detroit, in cash. She did not inform the petitioner immediately upon her return from St. Louis that she had obtained this money. After several weeks, she told him she had $1,000 which she would put into the company, providing the petitioner would abandon the die business and go into the machining business. At the same time she insisted that a written agreement be executed showing her to be an equal partner in the business. To this the petitioner agreed. About the first of September 1940 Mrs. Anderson advanced $400; the middle of September she advanced $300; and the remaining $300 about a month later.
The money which was advanced by the petitioner's wife was used to buy parts, repair, and put into condition used and run-down machinery. Some of the machines were sold and other productive machines were purchased with the proceeds.
During the last week of 1940 the petitioner and his wife executed an agreement drawn up by a lawyer at their request, the provisions of which, except for signatures, follow:
PARTNERSHIP AGREEMENT
This agreement made and entered into this 1st day of January, A.D., 1941 by and between Willis B. Anderson and Emily Alice Anderson, his wife, in which it is mutually agreed as follows:
Whereas the said Emily Alice Anderson has been an active participant in the organization, management and building up of the business of Standard Die Cast Die Company, which business is now registered in the name of Willis B. Anderson, and has contributed materially to the success of said business:
Wherefore, it is mutually agreed that Willis B. Anderson and Emily Alice Anderson shall share all the profits to be derived from the business known as Standard Die Cast Die Company and that each of the parties hereto shall share equally in the ownership of said business and each shall be entitled to any and all net profits from said business. It is further agreed that the said parties shall also share equally any and all debts and liabilities of said business. In case of the death of either of the parties hereto, the interest of said deceased partner shall go to the surviving partner and that said surviving partner shall be the sole owner of said business, known as Standard Die Cast Die Company.
The partnership was not disclosed to anyone during 1941, with the exception of a bookkeeper. No changes were made in the certificate of doing business under an assumed name, previously filed by the petitioner. Employer's tax returns filed in 1941 were signed by the petitioner as owner of the company. A chattel mortgage covering tools and equipment of the company, executed March 14, 1941, was signed only by the petitioner as owner of the company. The petitioner believed that such actions were necessary, since he was advised by a lawyer that the laws of Michigan in force at that time did not permit a wife to enter into a contract of general partnership with her husband.
Prior to 1941 Mrs. Anderson had regularly helped the petitioner in the conduct of the business. In the early days she helped to prepare for operation the second-hand machines the petitioner had purchased by cleaning, scraping, and painting them. When the company was making dies she also operated a shaper and drill press. She did most of the detail work on the books, although she did none of the actual bookkeeping. An accountant was hired periodically for that purpose.
During the taxable year in controversy Mrs. Anderson took care of the office end of the business, doing the letter writing, filing, matching the shippers' and receivers' invoices, telephone work, purchasing and general office work. She also figured the pay roll and, in addition, made deposits at the bank and performed similar errands.
During 1941 the company was engaged in machining war parts, tank parts, gun parts, motor parts, etc. At March 31, 1941, it had 41 employees; on June 30, 1941, the number of employees stood at 88.
Beginning in 1939 the company kept an informal set of books. In 1940 a bookkeeper was employed to supplement the records which were kept by Mrs. Anderson. A set of books was opened by the bookkeeper in the early part of 1941, which was kept throughout that year. In the fall of 1942, Alfred S. Dunnett, a certified public accountant, was called in to audit the books of the company. He conferred with the bookkeeper and took over the records from 1940, 1941, and 1942. When Dunnett received the books they contained salary accounts for the petitioner and his wife and a ‘withdrawal‘ account for Walter Anderson, an employee.
On March 16, 1942, the petitioner signed and filed a partnership return, Form 1065, for the Standard Die Cast Die Co. for 1941, disclosing gross receipts of $166,570.96, gross income of $97,832.56, and net income of $40,166.64. Included in ‘cost of goods sold‘ was the item ‘cost of labor, supplies, etc.‘ in the amount of $57,637.04. The return listed the sum of $20,771.82 as a deduction for salaries and wages. Included in this amount was $2,250 which had been received by Mrs. Anderson in that year and had been charged to her ‘salary‘ account by the bookkeeper. After the books had been audited by Dunnett an amended partnership return for 1941 was filed on December 7, 1942, in which the figure of $2,250 was eliminated from the deduction for salaries and wages. The amount of net income disclosed by the amended return was $48,146.29.
Of the total profits earned by the company from January 1, 1941, to July 31, 1945, one-half, or $237,042.92 was credited to the account of Mrs. Anderson. In addition, her investment account was credited with ‘original 1945 in the amount of $13,000, making total credits to her account in the sum of $255,501.39, exclusive of withdrawals. The total withdrawals charged to her account for the same period were $213,692.87. Of this amount $120,023.20 was withdrawn by checks payable to others than Mrs. Anderson and was used for the payment of income tax, the purchase of tax bonds, the purchase of farms and cattle, and miscellaneous items. In addition, the amount of $93,669.67 was paid by checks drawn to her order. These amounts were expended for personal items and for other purposes, including 50 percent of of the cost of a home, Federal income tax, mortgage payments on the house, repayment of the loan to her mother, purchase of stocks and real property, gifts to children, etc. At July 31, 1945, the balance in Mrs. Anderson's account on the books of the company stood at $41,808.52.
During 1941 the petitioner paid the living expenses of himself, his wife, and his family.
On January 1, 1941, the petitioner and his wife had two children of the approximate ages of 4 and 2. A third child was born within a month thereafter. Mrs. Anderson did her own housework, except for the occasions when her mother-in-law visited and helped around the house.
Walter Anderson is a brother of the petitioner. Before entering the employment of the company he was a tool and die maker, working in St. Louis for about $125 per week. He started to work for the petitioner in 1940 and after working a short time he left. He was reemployed at the end of 1940 and continued to work for the petitioner during the following year. In 1941 the petitioner and Walter Anderson agreed that the compensation of the latter should be computed upon the basis of 10 percent of the sales. The sales for that year amounted to $166,570.96 and Walter Anderson was paid approximately 10 percent of that figure as compensation for 1941.
During 1941 Walter Anderson was directly under the petitioner in the factory. He had the responsibility of all the men, the operation and the completion of the jobs.
The net income of the business for 1941, amounting to $48,146.29, was divided equally between the petitioner and his wife on their income tax returns for that year. On the partnership return there was deducted the sum of $16,293.11 representing salary paid to Walter Anderson. The respondent determined that the entire net income of the Standard Die Cast Die Co. for the year 1941 was taxable to the petitioner. He further disallowed the deduction claimed for salary paid to Walter Anderson in 1941 to the extent of $4,293.11. He allowed as a deduction the sum of $2,250 for compensation for services rendered by Mrs. Anderson in that year.
OPINION.
VAN FOSSAN, Judge:
The principal issue before us is whether the petitioner and his wife were equal partners in the conduct and operation of the Standard Die Cast Die Co. during 1941 and hence are entitled to divide its net profits for that year equally between them for income tax purposes. The respondent has determined that the petitioner was the sole owner of the company during 1941 and that, in consequence, its earnings for that year are taxable to him in their entirety.
The Supreme Court, in the recent case of Commissioner v. Tower, 327 U.S. 280, stated the rule to be applied as follows:
* * * When the existence of an alleged partnership arrangement is challenged by outsiders, the question arises whether the partners really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both. And their intention in this respect is a question of fact, to be determined from testimony disclosed by their agreement, considered as a whole, and by ‘their conduct in execution of its provisions.‘ Drennen v. London Assurance Company, 113 U.S. 51, 56; Cox v. Hickman, 8 H.l. cas. 268. We see no reason why this general rule should not apply in tax cases where the government challenges the existence of a partnership for tax purposes. * * *
The facts show that the petitioner, who has been in the machine tool and die business all his adult life, began in 1938 in a small way to buy junked machinery in Detroit. The machinery so purchased was originally set up in the basement of his home. Mrs. Anderson helped her husband to put the machines in working order by cleaning, scraping, and painting them. After the petitioner had started in the die business, she operated a shaper and drill press and performed various other duties.
In 1939 the petitioner entered successively into two short-lived partnerships for the manufacture of molds and machinery for die casting and plastics. After this dissolution he entered business under the name of Standard Die Cast Die Co., filing, as an individual, a certificate of doing business under an assumed name.
The company did not prosper, due in part to the seasonal nature of the business. By late summer of 1940 the work for the year was finished, the machinery was mortgaged, and the petitioner was without funds. At that time the petitioner's wife, on her own initiative, borrowed $1,000 from her mother, which she agreed to invest in the business, provided the petitioner would abandon his die=making activities and would enter the machining business. She insisted also that the interest in the business which she had considered to be hers since its inception should be evidenced by a written agreement. This was agreed to by the petitioner. The money so invested was used to buy parts, repair, and put into condition used and run-down machines. Some of these machines were sold and other productive machines were purchased with the proceeds.
In the last week of 1940 the petitioner and his wife executed an agreement of partnership effective January 1, 1941, under the terms of which they agreed to share equally in the ownership of the company and in its profits and debts and liabilities.
Under the facts here present, the partnership agreement was sufficient to evidence in Mrs. Anderson an equal interest in the business. The conduct of the parties in execution thereof showed a real intention that she should be a partner.
Although the existence of a partnership was not disclosed to the company's customers nor to others, this conduct was explained by the fact that petitioner had been advised by a lawyer that the laws of Michigan did not permit a contract of general partnership between husband and wife. Furthermore, it has been decided in numerous cases that a bona fide partnership between husband and wife will be recognized under the Federal revenue laws despite provisions of state law to the contrary. See Felix Zukaitis, 3 T.C. 814; L. F. Sunlin, 6 B.T.A. 1232; Earle L. Crossman, 10 B.T.A. 238; Albert Kahn, 14 B.T.A. 125; R. E. Wing, 17 B.T.A. 1028.
The evidence shows that the petitioner's wife contributed both capital and services to the business. We have observed that prior to 1941, when they were reconditioning junked machines, she aided in cleaning and painting the machines and preparing them for use and, later, operated a shaper and drill press. During the taxable year she took care of the office, doing the letter writing, filing, matching the shippers' and receivers' invoices, telephone work, purchasing, and general office work. She also figured the pay roll.
There is nothing in the record to suggest that the partnership was a mere device for tax avoidance because of high profits. In fact, in the summer of 1940 the business had reached a low ebb. The petitioner was without funds and had no orders for machine work, the work which later produced the large profits here involved. It is uncontradicted that the suggestion that a written partnership agreement be entered into originated with Mrs. Anderson, who insisted on it as a condition of her investing her money in the business. She also insisted on confining the operations to the work of machining parts.
It appears clearly also that the petitioner's wife exercised complete dominion and control over the share of profits credited to her. Between January 1, 1941, and July 31, 1945, out of a total of $255,501.39 credited to her account, she withdrew a total of $213,692.87. The amounts so withdrawn, other than those paid to the collector of internal revenue, were expended by her in part for personal items, such as antiques, in part for the purchase of property jointly with the petitioner or in her own name, and the rest for other purposes, including the repayment of the loan to her mother and gifts to the children. The household and family expenses were paid by the petitioner.
The respondent, in support of his contention that there was no partnership, points to the fact that no entry was made in the company's books until 1942 to show that Mrs. Anderson had a capital or partnership interest in the business. In this case the books are entitled to little or no weight in determining the issue before us. Prior to 1942 the books were kept very informally. The petitioner testified that he knew nothing about books and was unable to keep a set of books himself. The accountant, Dunnett, who audited and revised the books in the fall of 1942, testified that he found them ‘in a very deplorable condition.‘ The books had contained salary accounts for the petitioner and his wife and a ‘withdrawal‘ account for an employee.
The respondent further asserts that the net income of the business was earned primarily by the personal services of the petitioner. He states that the contribution of $1,000 by the petitioner's wife must have been a negligible factor in the production of the large profits of the company.
We do not agree. While the petitioner's services were doubtlessly an important factor in the earning of the income, it si clear that capital played an equally important role. The business of the company was the making of tools and parts for guns, tanks, etc., which required a substantial outlay for machinery and labor. On March 31, 1941, the company had 41 employees and on June 30 of the same year it had 88. On the partnership return for 1941 the sum of $57,637.04 was deducted for the cost of labor and supplies. The importance of Mrs. Anderson's contribution is emphasized when considered in the light of the circumstances surrounding it. At the time, the petitioner was in the die business and was ‘practically broke.‘ That the business was not prospering is shown by the fact that in the previous year Willmore had sold his 50 percent interest in the business to the petitioner for $846. It was Mrs. Anderson's suggestion that they go into the machining business and it was her contribution of $1,000 which provided the capital necessary to convert to that type of activity. The rapid expansion of the business thereafter may largely be attributed to the acceleration of the national war program. It appears from the books also that subsequent to 1941 Mrs. Anderson made an additional investment of $13,000 in the business, presumably from earned profits. The case in this respect is not unlike Humphreys v. Commissioner, 88 Fed.(2d) 430, where the court said:
* * * Though the present case is one where the services of Humphreys and Day contributed to the earnings of the firm, the capital furnished by their wives was what started the business, and this and the additional capital which they later contributed helped to furnish the moneys necessary to conduct it. * * *
See also Felix Zukaitis, supra.
Since we are of the opinion that the petitioner and his wife, in a very real sense, intended to, and did carry on the business as partners during 1941, it follows that the petitioner is taxable upon only one-half of the income of the company for that year.
The other issue involves the reasonableness of the salary paid to Walter Anderson in 1941. Of the amount of $16,293.11 which was claimed on the partnership return as a deduction, the respondent disallowed $4,293.11 and determined that $12,000 constitutes reasonable compensation for Walter Anderson for 1941.
The respondent must be sustained for lack of proof. The only evidence in the record to show the nature and value of the services is the petitioner's testimony that Walter Anderson was directly under him in the factory and had the responsibility of all the men, the operation and completion of the jobs. From such a sketchy and general description of the duties, it is impossible for us to determine that the services of Walter Anderson had a value greater than that placed upon them by the respondent. On the record his allowance appears reasonable and in the absence of further proof we must sustain his determination.
Reviewed by the Court.
Decision will be entered under Rule 50.
OPPER, J., dissenting: There is nothing new about the situation typified by this proceeding. In my opinion, petitioner and his wife under the circumstances which the evidence here discloses were not ‘carrying on business in partnership‘ (sec. 181, I.R.C.), and never intended to do so. Even before the decisions in Lusthaus v. Commissioner, 317 U.S. 293, and Commissioner v. Tower, 327 U.S. 280, the principles governing such situations had become adequately established. See, e.g., Lewis Hall Singletary, 5 T.C. 365; Clarence L. Fox, 5 T.C. 242; W. M. Mauldin, 5 T.C. 743.
Commissioner v. Tower, supra, is quoted in part in the present opinion to the effect that the intention of the parties ‘is a question of fact, to be determined from testimony disclosed by their agreement, considered as a whole, and by 'their conduct in execution of its provisions.’‘ The present petitioner's wife obtained a loan from her mother of $1,000. She received a half interest in a business treated by the parties as worth upwards of $10,000, and the firm's accounts show her capital account to have been opened with a credit of $5,458.47, the origin of which is unexplained. The earnings credited to her account were used to buy property in the joint names of petitioner and herself, to pay a premium on insurance on petitioner's life, for payment of the wife's income tax, and gifts to the children. There is no evidence that any considerable sum was disposed of in a manner different from what it would have been had the husband continued to be in name, as he was in fact, the sole proprietor of the business.
The wife rendered services which could hardly have been of the managerial or ‘vital‘ nature described in Commissioner v. Tower, supra, and Lusthaus v. Commissioner, supra. Part of them are designated as ‘similar errands.‘ She was a housewife with two children, and a third was born with a month of the execution of the ‘partnership agreement.‘ She had no household servants. The value of her contribution seems extravagantly measured by the salary which was actually set up on the books in her favor in the amount of $49.50 a week. Petitioner's brother, who performed highly responsible services, was paid only $16,000, and even the reasonableness of that amount is denied in the present opinion; yet the wife's share for one year is upwards of $20,000.
The partnership agreement, which is in the highest degree ambiguous and provides that petitioner and his wife ‘shall share all the profits,‘ without specifying the proportions, goes on to provide that ‘each shall be entitled to any and all net profits.‘ And to make clear the family nature of the transaction an arrangement based on survivorship is included. During all of the year in issue the existence of the partnership was undisclosed. Petitioner's certificate of doing business as a sole proprietorship was unchanged. Employer's tax returns and even a chattel mortgage on the business property were signed only by petitioner as owner. It seems to me difficult in the extreme to find evidence in the record which warrants the conclusion that, as evidenced by the conduct of the enterprise, there was any actual or intended carrying on of this business in partnership.
As in W. M. Mauldin, supra, ‘the agreement to divide the profits according to the supposed shares in the capital of the enterprise,‘ coupled with the devotion of petitioner's full time and effort to the business and the necessarily negligible participation by the wife, ‘leads inevitably to the result that some— undisclosed— part of the earnings from (his) labor was being enjoyed by the wife— a contrivance which has long been viewed as inadmissible in dealing with the proper allocation of income tax burdens. Lucas v. Earl, 281 U.S. 111.‘