Opinion
Docket No. 20869.
1950-09-22
MORRIS COHEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Ronald Shankland, Esq., and James J. Waters, Esq., for the petitioner. William B. Springer, Esq., for the respondent.
On February 21, 1944, petitioner executed a trust instrument whereby he transferred to himself as trustee both his entire interest in an agreement between his employer and himself relating to certain patents developed by petitioner and assigned by him to his employer and his entire interest in an agreement between two others and himself concerning distribution of profits from the exploitation of a license. Respondent determined that the entire net income of the trust was taxable to petitioner in 1944, 1945, and 1946. Held:
1. The transfer by petitioner of his entire interest in an agreement between his employer and himself constituted an assignment of his right to compensation for past services and therefore payments received by the trust from his employer are taxable to petitioner.
2. The transfer by petitioner of his entire interest in an agreement concerning distributions of profits from the exploitation of a license constituted an assignment of income-producing property in the form of an equitable interest in the license so that profits paid to the trust are not taxable income to petitioner.
3. The net income of the trust is not taxable to petitioner as settlor-trustee under the rationale of Helvering v. Clifford, 309 U.S. 331. Ronald Shankland, Esq., and James J. Waters, Esq., for the petitioner. William B. Springer, Esq., for the respondent.
Respondent determined deficiencies in the income tax of petitioner for the calendar years 1944, 1945, and 1946 in the respective amounts of $2,179.86, $9,541.62, and $12,735.10. The principal question raised in this proceeding is whether respondent erred in taxing to petitioner the entire net income of the Morris Cohen Trust in 1944, 1945, and 1946. A subsidiary question involves a medical expense deduction taken by petitioner in 1946 which respondent disallowed.
FINDINGS OF FACT.
Part of the facts were stipulated and are so found.
Petitioner is an individual residing in Kansas City, Missouri. During the taxable years 1944, 1945, and 1946 he filed his income tax returns with the collector of internal revenue for the sixth district of Missouri. Petitioner has been employed as an industrial engineer by Interstate Bakeries Corporation, hereinafter referred to as Interstate, ever since 1927 and was paid a regular salary for these services. He was neither an officer nor director of the company during the years 1944, 1945, and 1946, but was a stockholder in this period.
An agreement existed between Interstate, as employer, and petitioner, as employee, pertinent parts of which state:
That for and in consideration of the mutual covenants and agreements herein contained, and for and in consideration of the furnishing by Employer to Employee of facilities, statistics, and the advice and counsel of the officers and other employees of the Employer, it is understood and agreed as follows:
1. All improvements, inventions, and discoveries, directly and indirectly connected with the baking business and made by the Employee while in the employment of the Employer, shall become the property of the Employer. Promptly upon his conception of any such invention or improvement, the Employee shall disclose the same to the Employer, and if the Employer shall decide that United States letters patent should be secured for such invention or improvement, the Employee agrees that he will make and assign the application for such letters patent to the Employer.
2. The Employer may, at its discretion, undertake the promotion or exploitation of any invention or improvement acquired by it hereunder, with such cooperation and assistance of the Employee as the Employer may reasonably desire, but without prejudice to Employee's duties as an employee of Employer.
3. The Employer will bear the cost and expense of such promotion or exploitation work as it shall undertake hereunder, it being further understood and agreed that unless otherwise hereafter agreed upon in writing between the parties, the Employer shall not be liable for any expenditures made or obligations assumed by the Employee in connection with the foregoing.
4. The Employer will pay to Employee a sum equal to one-half (1/2) of the net profits, if any, received by the Employer from persons or corporations, other than the Employer and its affiliated or subsidiary companies, in connection with the use, promotion, or exploitation of any of said inventions or improvements. All such payments to the Employee shall be made within twenty (20) days from and after the end of every six (6) months' period, beginning with the first six months' period after the Employer begins such exploitation or promotion work. Net profits shall be determined in accordance with good and recognized accounting and business principles, and in case of disagreement the net profits shall be determined by a certified public accountant acceptable to both parties, whose fee shall be borne equally by the Employee and Employer.
5. It is further understood and agreed that all improvements or inventions appertaining to the baking business which the Employee shall discover or invent within one year subsequent to the termination of his employment by the Employer shall also be the property of Employer and be disclosed and assigned to Employer in the same manner as above provided with respect to the period during which the Employee is employed by the Employer, and after the termination of said employment the rights of the Employee and of the Employer to any profits from said improvements or inventions shall be as hereinbefore set forth, the same as though Employee were still in the employ of Employer.
6. This agreement shall inure to the benefit of and be binding upon the heirs, executors, administrators, successors and assigns of the respective parties hereto, SAVE AND EXCEPT that the Employee agrees that he will not assign any of his rights or interests in, to, or arising out of this Agreement without the Employer's written consent thereto.
Pursuant to the above agreement and prior to February 21, 1944, petitioner assigned to Interstate all his right, title and interest in the following inventions which he had created while in its employ, and for which he had submitted patent applications in his own name:
(a) Design Patent No. 136,653, being a design for a Combined Fumes Removal Hood and Lighting Fixture.
(b) Patent Application, Serial No. 429,764, being Methods and Means for Treating Dough.
(c) Patent Application, Serial No. 441,580, being Methods and Means for Sheeting and Elongating Dough.
(d) Patent Application, Serial No. 514,040, on Means for Treating Dough.
At the close of 1943 Interstate had developed for use in the production of bread and cake the Nafziger Dough Process Machine which was based on Fonken Patent No. Reissue 22,399, Patent Application, Serial No. 429,764, Patent Application, Serial No. 514,040, and Patent Application, Serial No. 441,580. Interstate did not have the facilities to manufacture the machine and such an enterprise would have been outside the scope of the corporation's activities. Thus Merlin A. Sticelber, who was in the business of manufacturing baking machinery under the name of Quik-Seal, Inc., was approached by petitioner in December 1943 concerning the possibility of producing the Nafziger machine. In January 1944 the two men held a conference with Nafziger, the president of Interstate, where Sticelber stated his interest in the manufacture and sale of the machine if a license could be procured for him to do so. They reached an oral agreement that Nafziger and petitioner would obtain such a license in the name of Sticelber from Interstate and that thereafter each of the three would own a one-third interest therein and share equally in the profits from its exploitation.
On February 15, 1944, Interstate issued an exclusive license to Sticelber doing business at Quik-Seal, Inc., for the manufacture and sale of the Nafziger machine for use only in the manufacture of sweet rolls for a period of 5 years. The license agreement stated that Interstate was the owner of the entire right, title and interest in the patent and patent applications which were the subject matter of the license and in return for their use Sticelber agreed to pay Interstate a royalty of 8 per cent of its gross sales of all machines.
At a special meeting of the board of directors of Interstate on December 11 and 12, 1944, the acts of the company's officers in entering into the above license agreement with Sticelber were ratified and approved. At this meeting Nafziger informed the directors that the manufacture and marketing of the Nafziger Dough Process Machine was a joint undertaking in which he had a one-third interest with Sticelber.
On February 15, 1944, Nafziger, Sticelber and petitioner entered into a supplemental written agreement which provides in pertinent part:
THIS AGREEMENT made and entered into by and between RALPH L. NAFZIGER, MERLIN A. STICELBER and MORRIS COHEN, WITNESSETH:
WHEREAS, Merlin A. Sticelber, doing business as QUIK-SEAL, INC., has obtained from the Interstate Bakeries Corporation, a license for five years from February 15, 1944 to manufacture and sell a dough handling machine known as the ‘Nafziger Dough Process Machine‘, said license agreement providing among other things, that Interstate Bakeries Corporation shall receive a royalty of 8% of the gross sales price of all machines sold and manufactured by said Sticelber under said license, and,
WHEREAS, for a period covering fifteen years Ralph L. Nafziger, Merlin A. Sticelber and Morris Cohen have been working closely together on patents and inventions for the baking business and industry in general. During this period, R. L. Nafziger has furnished more than $200,000.00 in cash for the carrying out of some of these ideas. Morris Cohen has given many long hours of his valuable time and experience in engineering to working on these ideas. Merlin Sticelber has contributed both time and money continuously to these ideas and inventions, and,
WHEREAS, R. L. Nafziger and Morris Cohen were instrumental in the obtaining of the said license taken in the name of Merlin A. Sticelber, and,
WHEREAS, it was the agreement of the parties hereto that they should share equally in the profits realized from the manufacture and sale of said machine under said license,
NOW THEREFORE in consideration of the promises, IT IS AGREED AS FOLLOWS:
(1). During such time as said license agreement shall continue in force and effect, MERLIN A. STICELBER shall pay to RALPH L. NAFZIGER, one-third and to MORRIS COHEN, one-third of the net profits realized from the sale and manufacture of said machines under said license.
(2). Net profits shall be calculated on the basis of gross price of all machines sold and for which payment has been made, less costs of manufacturing, sales commissions, advertising and normal office overhead.
(3). Merlin A. Sticelber agrees to keep true and accurate books and records of the manufacture and sale of said dough handling machines, and the costs as provided in paragraph 2 hereof, which records shall be open to inspection by either or both of the other parties during reasonable business hours.
(4). Amounts due Ralph A.* Nafziger and Morris Cohen, under this agreement shall be paid by Merlin A. Sticelber not less often than once per calendar year, and at such other times as the parties may agree.
*(It is clear that the use of the initial ‘A‘ in the original of this agreement is a typographical error.)
The Nafziger machine was manufactured and sold under the license of February 15, 1944, throughout the remainder of 1944 and in 1945 and 1946. Petitioner performed no services in connection with these operations.
On February 21, 1944, petitioner executed a ‘Declaration of Trust‘ for the benefit of his wife, Rose Cohen, and his daughter, Carolyn Ruth Cohen, which reads in part as follows:
I.
WHEREAS, the undersigned, is desirous of establishing an irrevocable trust for the benefit of the beneficiaries herein named, and,
WHEREAS, the undersigned has heretofore assigned, transferred and conveyed, (and does by these presents assign, transfer and convey), unto himself as Trustee, in trust for the benefit of beneficiaries and upon the trust hereinafter declared, the following:
(1). The entire right, title and interest of Morris Cohen in the agreement dated February 15, 1944, between Ralph L. Nafziger, Merlin A. Sticelber and Morris Cohen, concerning ‘Nafziger Dough Process Machine‘, a copy of said agreement being hereto attached, and,
(2). The entire right, title and interest of Morris Cohen in and to the agreement now existing between Interstate Bakeries Corporation and Morris Cohen evidencing Royalty Agreement and other rights of the undersigned relative to the following patents:
(a). Design Patent No. 136,653, issued November 16, 1943, being a design for a COMBINED FUMES REMOVAL HOOD AND LIGHTING FIXTURE.
(b). Patent Application, Serial No. 429,764, filed February 6, 1942, being METHODS AND MEANS FOR TREATING DOUGH.
(c). Patent Application, Serial No. 441,580 filed May 4, 1942, being METHODS AND MEANS FOR SHEETING AND ELONGATING DOUGH.
II.
NOW THEREFORE, for and in consideration of the premises, (and of the sum of ONE DOLLAR), the undersigned hereby acknowledges and declares that he is possessed of the property above described, and that they are to be held by him as Trustee, or by his successors, in trust, for the purposes hereinafter set forth:
(1). The Trustee shall receive, hold, manage, improve, convert, sell, assign, lease, alter, reinvest and otherwise deal with the above described properties and additions thereto, as in the Trustee's discretion shall be deemed to be for the best interests of the beneficiaries hereunder.
(2). By way of illustration but not of limitation of the Trustee's powers, the Trustee is hereby authorized and empowered to:
(a.) To retain the original properties, above described for such time as to the Trustee shall seem best and to dispose of them by sale or exchange or otherwise, as and when the Trustee shall deem advisable.
(b.) To participate in the liquidation, reorganization, consolidation or other financial readjustment of any corporation or business in which the trust estate is or shall be financially interested.
(c.) To invent and reinvest, and keep the trust estate invested so far as the Trustee is able to do so to advantage, without being bound by any legal, statutory or customary rules relating to investments by Trustees;
(d.) To borrow money for the benefit of the trust estate, and if required to do so, secure the same by collateral or mortgage.
(e.) To compromise, arbitrate, or otherwise adjust claims in favor of, or against the trust estate.
(f.) To execute deeds, contracts, bills of sale, notes and other instruments in writing required for the businesslike administration of this Trust.
(g.) To receive all income of every nature due to the Trust estate.
IV.
For so long as ROSE COHEN and CAROLYN RUTH COHEN shall live, the Trustee shall, subject to his discretion, as hereinafter set forth, pay not less frequently than quarter-annually the net income of the Trust estate to ROSE COHEN, sixty percent of said net income, and to CAROLYN RUTH COHEN, forty percent of said net income.
Upon the death of either ROSE COHEN or CAROLYN RUTH COHEN the entire net income of the trust estate shall, subject to the Trustee's discretion as hereinafter set forth, be paid to the survivor, during her lifetime.
During the continuance of this Trust, the trustee may in his discretion, withhold from distribution to the beneficiaries such amounts as he may deem necessary for the protection of the trust property.
Upon the death of ROSE COHEN and CAROLYN RUTH COHEN, the trust herein created shall cease and terminate and the Trustee shall forthwith pay, distribute, convey, transfer, assign and deliver property of every kind, constituting the trust estate to the heirs-at-law in accordance with the present Statutes of Missouri covering the descent of property to and among those who at that time, by the terms of said Statute should have inherited said property, had deceased died intestate owning the same.
V.
The undersigned reserves no power to revoke the trust herein created, nor to change or annul any of the provisions herein contained, except that he may hereafter bring other properties within the operation of this trust.
On March 15, 1945, petitioner filed a 1944 Federal gift tax return and trustee's information return of gifts disclosing the trust of February 21, 1944, and paid the tax thereon. Attached to these returns was a statement which reads:
Donor has transferred to Morris Cohen, Trustee, all of donor's right, title and interest in and to Patent license granted by Interstate Bakeries to Merlin A. Sticelber, Scarritt Building, Kansas City, Missouri (donor's interest in said license being one-third thereof), for the manufacture and sale of the equipment under the following:
Patent Application, Serial No. 429,764, filed February 6, 1942, being METHODS AND MEANS FOR TREATING DOUGH.
Patent Applications, Serial No. 441,580, filed May 4, 1942, being METHODS AND MEANS FOR SHEETING AND ELONGATING DOUGH.
Donor has also transferred to Morris Cohen, Trustee, all of donor's right, title and interest in and to an agreement with Interstate Bakeries, evidencing donor's interest in the following:
(a.) Design Patent No. 136,653, issued November 16, 1943, being a design for a COMBINED FUMES REMOVAL HOOD AND LIGHTING FIXTURE.
(b.) Patent Application, Serial No. 429,764, filed February 6, 1942, being METHODS AND MEANS FOR TREATING DOUGH.
(c.) Patent Application. Serial No. 441,580, filed May 4, 1942, being METHODS AND MEANS FOR SHEETING AND ELONGATING DOUGH.
Under the Trust all income is currently distributable to donees:
The donees are: Carolyn Ruth Cohen and Rose Cohen, 1010 West 70th Street, Kansas City, Missouri.
On February 21, 1944, petitioner gave notice to Interstate and received its consent to the assignment to himself as trustee of his title and interest in the employer-employee agreement existing between Interstate and himself in so far as it comprehended any right or benefit to him as the result of his transfer of the inventions disclosed in Patent Applications, Serial Nos. 429,764 and 441,580 and Design Patent No. 136,653. Petitioner also notified Sticelber that the proceeds of his equity in the license were to be paid to him as trustee.
On December 20, 1944, petitioner opened a bank account in the name of ‘Morris Cohen, Trustee‘, for the trust created on February 21, 1944. All income from the trust was deposited in this account and all expenses paid by the trust and distribution made to the beneficiaries were withdrawn from it during the years under consideration.
Separate bank accounts were opened in the names of Rose Cohen and Carolyn Cohen on December 22, 1944, and January 13, 1945, respectively. No one other than the individual beneficiaries had the right to draw on such accounts. During the taxable years under consideration petitioner and his wife maintained a joint bank account wherein the personal income of petitioner was deposited and from which all living and educational expenses of the family were paid. None of the trust income was used to defray any expense for the support and care of the trust beneficiaries incumbent on petitioner as husband and father. None of the trust income distributed to the beneficiaries was returned to petitioner directly or indirectly.
Petitioner's share of the profits from the manufacture and sale of the Nafziger Machine in 1944, 1945, and 1946 was distributed by checks drawn by Sticelber payable to ‘Morris Cohen, Trustee‘, with one exception and in that instance remittance was made by check payable to ‘Morris Cohen‘ through a bookkeeping error. This check was deposited in the bank account of ‘Morris Cohen, Trustee.‘
The ledger book kept by Sticelber for the Nafziger Machine venture shows the amounts to which petitioner was entitled on sheets entitled ‘Commissions‘ for the year 1944 and ‘Commissioners paid-special‘ in 1945 and 1946. On the sheet for 1944 the entry for petitioner appears as ‘Morris Cohen, trustee‘, and for 1945 and 1946 the entries appear as ‘M. Cohen‘ or ‘M. C. Cohen‘. The journal records kept for the venture for 1944, 1945, and 1946 show amounts distributable to petitioner opposite entries reading ‘Commissions, M. C. Cohen‘ with the exception of one entry for 1944 which reads ‘Morris Cohen, trustee.‘ The terms ‘Commissions‘ and ‘Commissions paid-special‘ were actually misnomers and represented a distribution of one-third of the net profits of the venture.
The Morris Cohen Trust filed fiduciary income tax returns on the cash basis for the calendar years 1944, 1945, and 1946. The gross income reported and the amounts distributable to the beneficiaries were shown as follows:
+----------------------------------------------+ ¦Year¦Gross income¦Rose Cohen (60¦Carolyn Cohen¦ +----+------------+--------------+-------------¦ ¦ ¦ ¦per cent) ¦(40 per cent)¦ +----+------------+--------------+-------------¦ ¦1944¦$5,407.16 ¦$3,244.30 ¦$2,162.86 ¦ +----+------------+--------------+-------------¦ ¦1945¦17,347.50 ¦10,303.50 ¦6,869.00 ¦ +----+------------+--------------+-------------¦ ¦1946¦22,439.89 ¦13,463.94 ¦8,975.95 ¦ +----------------------------------------------+
The income reported in these years arose entirely from payments by Interstate and by Sticelber with the exception of $185 in 1946 which constituted cash dividends on stock purchased by the trust. Income received by the trust from Sticelber and Interstate during 1944, 1945, and 1946 was in the following amounts:
+------------------------------------------+ ¦ ¦1944 ¦1945 ¦1946 ¦ +----------+---------+----------+----------¦ ¦Sticelber ¦$5,024.66¦$15,000.00¦$20,564.89¦ +----------+---------+----------+----------¦ ¦Interstate¦382.50 ¦2,347.50 ¦1,690.00 ¦ +----------+---------+----------+----------¦ ¦Totals ¦$5,407.16¦$17,347.50¦$22,254.89¦ +------------------------------------------+
A deduction of $175 was taken for legal expenses in 1945.
In her income tax returns for the years 1944, 1945, and 1946 Carolyn reported as income from the trust the amounts shown as distributable to her in the trust returns. In her tax returns for 1944, 1945, and 1946 Rose Cohen also reported as income from the trust the same amounts reported as distributable to her by the trust returns with the exception of the year 1945 when she reported $10,378.50 as her share.
Of its gross income of $5,407.16 in 1944 the trust actually distributed $2,880 to Rose Cohen and $1,125 to Carolyn Cohen. No other withdrawals were made so that at the close of the year the trust had a balance of $1,402.16. Of its 1945 gross income of $17,347.50, the trust paid legal expenses of $175 and also distributed $10,561.80 to Rose and $7,700 to Carolyn. Thus the amounts turned over to the beneficiaries in these two years were not on a 60-40 basis. The trust ledger at the close of 1945 shows that of the $312.86 balance, a total of $206.86 was due Carolyn and $106 was due Rose. These amounts plus the actual sums paid out equal a 60-40 distribution. In 1946 various expenses plus the purchase of stock totaling $9,895.60 left $12,902.15 available for distribution to the beneficiaries. Cash in the amount of $10,300 was paid to Rose and $500 to Carolyn, leaving a trust balance of $2,102.15. Though distributions in this year were not on a 60-40 basis, yet a notation in the trust ledger shows that Carolyn had a balance due of $4,742.58 and that Rose had overdrawn her share by $2,640.43.
In 1946, Nafziger, Sticelber, and petitioner attended a convention of the American Bakeries Association in Chicago. At that time they received an offer to purchase the Nafziger Machine license for $100,000 plus a $2 per bag royalty from the Do-Nut Corporation of America. In the event of a sale petitioner, as trustee, was entitled to one-third of the sale price.
In his personal tax returns for 1944, 1945, and 1946 petitioner did not report any income from the trust. On his return for 1946 petitioner claimed a medical expense deduction of $213.33. In his notices of deficiency in 1944, 1945, and 1946 respondent determined that the net income of the Morris Cohen Trust of $5,407.16 in 1944, $17,172.50 in 1945 and $22,439.89 in 1946 was taxable income to petitioner in the respective years. Respondent also disallowed the medical expense deduction claimed by petitioner in his 1946 tax return.
OPINION.
HILL, Judge:
A trust instrument executed by petitioner on February 21, 1944, states in effect that petitioner thereby transfers to himself as trustee, (a) his entire right, title and interest in the agreement then existing between Interstate and himself relative to Design Patent No. 136,653, and Patent Applications. Serial Nos. 429,764 and 441,580, and (b) his entire right, title and interest in the supplementary agreement dated February 15, 1944, between Nafziger, Sticelber and himself. The entire income reported by the Morris Cohen Trust in 1944, 1945, and 1946 with the exception of $185 in dividends is attributable to these trust assets. Petitioner contends that none of the trust income in these three years is taxable to him individually because this income is attributable to income-producing property he irrevocably transferred to the trust. Respondent argues, first, that the entire net income of the trust in each of these years is taxable to petitioner, with the exception of the dividends, on the ground that petitioner merely made an assignment to himself as trustee of future income he was entitled to receive. In the alternative respondent invokes the doctrine of Helvering v. Clifford, 309 U.S. 331, and contends that the entire net income of the trust during the years 1944-1946 is taxable to petitioner as settlor-trustee.
Three principal questions arise for our determination in this proceeding:
(1) Did petitioner's transfer to himself as trustee of his entire interest in the agreement between Interstate and himself constitute an assignment of his right to future compensation for past services rendered by him to Interstate, or an assignment of his entire interest in a royalty agreement with Interstate?
(2) Was petitioner's transfer to himself as trustee of his entire interest in the supplementary agreement of February 15, 1944, between Sticelber, Nafziger, and himself an assignment of his right to future compensation for past services rendered by him to Sticelber, an assignment of future income from his one-third equity in the license granted to Sticelber by Interstate or an assignment of his equitable interest in the license itself?
(3) Did petitioner retain such a ‘bundle of rights‘ in the Morris Cohen Trust that the entire income thereof was taxable to him under the Clifford doctrine?
Turning first to the transfer by petitioner to himself as trustee of his interest in the agreement existing between Interstate and himself, we think that this constituted an assignment of future income derived from personal services of petitioner and thus the payments received by the trust in 1944, 1945, and 1946 attributable to this assignment are taxable to him under section 22(a). The employer-employee agreement between Interstate and petitioner provides in substance that all improvements, inventions, and discoveries made by petitioner while in the employ of Interstate or within one year thereafter shall become the property of Interstate. It further provides that Interstate will pay to petitioner a sum equal to one-half of the net profits, if any, received by Interstate from persons or corporations, other than Interstate or its subsidiaries, in connection with the exploitation of any of the inventions or improvements. This was in addition to petitioner's salary as engineer. Prior to the execution of the trust instrument petitioner assigned to Interstate his entire interest in Design Patent No. 136,653, and Patent Applications, Serial Nos. 429,764 and 441,580. It is clear that on February 21, 1944, the only interest petitioner had under the agreement with Interstate relative to the aforesaid patent and patent applications was a contract right to receive a percentage of any net profits from their exploitation by an outside company. It constituted simply a right to additional compensation for past services rendered. Arthur N. Blum, 11 T.C. 101, affd., 183 Fed. (2d) 281. We find no merit in petitioner's argument that the employer-employee agreement was in the nature of a royalty agreement.
It follows that the assignment by petitioner of his rights under the agreement with Interstate to the trust, being but an assignment of a contract right to future compensation for past services, is an assignment of future income rather than of income-producing property. Helvering v. Eubank, 311 U.S. 122, and Strauss v. Commissioner, 168 Fed.(2d) 441, certiorari denied, 335 U.S. 858. To paraphrase the language of the latter case, pages 442, 443, petitioner's interest in the patent and patent applications was never greater than a contract right to be paid certain ascertainable sums of money. From first to last his pay for his services was to be only in money determinable in amount by reference to such royalty agreements covering the patent and patent applications as Interstate made with other companies. Since compensation derived from past personal services is taxable to the one who performed the services whether or not he actually receives the compensation or transfers the right to receive it before it is paid, we hold that the payments received by the Morris Cohen Trust from Interstate in 1944, 1945, and 1946 are taxable to petitioner.
Turning to the second question, respondent's position is that the transfer by petitioner to himself as trustee of his entire interest in the supplementary agreement of February 15, 1944, between Sticelber, Nafziger, and himself constituted an assignment of his right to compensation for past services he had rendered Sticelber, and consequently payments by Sticelber to the Morris Cohen Trust in 1944, 1945, and 1946 were taxable to petitioner under the rationale of Helvering v. Eubank, supra, and Strauss v. Commissioner, supra. If it be held that petitioner had a one-third equitable interest in the license granted by Interstate to Sticelber, then respondent asserts that the transfer by petitioner to the trust of his interest in the supplementary agreement of February 15, 1944, amounted to an assignment merely of his future right to income from his equity in the license, and as a result the payments by Sticelber to the trust were taxable income to petitioner under Helvering v. Horst, 311 U.S. 112. On the other hand, it is petitioner's contention that he owned a one- third equitable interest in the license granted to Sticelber by Interstate, and his transfer to himself as trustee of his interest in the supplementary agreement constituted an assignment of income-producing property in the form of his equitable interest in the license so that the payments by Sticelber to the trust were not taxable to him. He relies on the rationale of Blair v. Commissioner, 300 U.S. 5. We think petitioner's contention is correct.
A joint venture has often been defined as a ‘special combination of two or more persons, where, in some specific venture, a profit is jointly sought without an actual partnership or corporate designation.‘ Tompkins v. Commissioner, 97 Fed.(2d) 396; Aiken Mills, Inc., v. United States, 144 Fed. (2d) 23, and Estate of L. O. Koen, 14 T.C. 1406. The terms of such a venture may be informal and need not be reduced to writing. Tompkins v. Commissioner, supra, and Denny v. Guyton, 327 Mo. 1030, 40 S.W.(2d) 562. Furthermore, the rights of co-adventurers in property acquired or used in connection with the joint enterprise depend primarily upon the agreement of the parties. Dierks & Sons Lumber Co. v. Bruce, 239 S.W. 133. Guided by these legal concepts we are convinced from a review of all the evidence that Sticelber, Nafziger, and petitioner exploited the license from Interstate as a joint venture, though they never formally labeled it as such, and that prior to the execution of the trust instrument petitioner owned a one-third equitable interest therein. Inherent in this conclusion is our rejection of respondent's view that the payments made by Sticelber to the trust were compensation for past services rendered by petitioner.
The testimony of Sticelber and petitioner makes clear the terms of the oral agreement reached by them and Nafziger in January 1944. They agreed that Nafziger and petitioner would obtain a license from Interstate for Sticelber to manufacture and sell the Nafziger Dough Process Machine, and that each should own a third interest in such license and share equally in the profits from its exploitation. The absence of an express agreement to share in losses is not material, since such an agreement may be implied from their agreement to share profits. Denny v. Guyton, supra. It is true that Interstate issued the license to Sticelber alone, but this was done only because Nafziger and petitioner were employees of Interstate. Sticelber himself admitted that all three of them had equal interest therein. Even though title was taken in the name of one of the co-adventurers, this did not destroy the rights of the other two therein. The effect of their property agreement was that Sticelber held legal title to the license as trustee for all of them. Dierks & Sons Lumber Co. v. Bruce, supra. Petitioner could have specifically enforced his one-third equitable interest in the license at any time.
The written supplementary agreement of the parties on February 15, 1944, providing for distribution of one-third of the net profits from the manufacture and sale of machines under the license, lends further support to the view that the enterprise was a joint venture whereby each of the trio owned a one-third equity in the license. It states that for the past 15 years Nafziger, Sticelber and petitioner have been working closely together on patents and inventions for the baking business, Nafziger furnishing cash, Sticelber time and money, and petitioner time and engineering experience. That the agreement provided the books of the venture were open to inspection by Nafziger and petitioner and they had a voice in determining the time for distribution of profits also suggest a joint venture. The agreement significantly states only that the license had been taken in the name of Sticelber. No reference is made to compensation or commissions but rather to equal sharing in net profits as previously agreed. Thus in the absence of profits Nafziger and petitioner would receive no payment.
That the trio were co-adventurers in the exploitation of the license is also borne out by the minutes of the special meeting of the board of directors of Interstate on December 11 and 12, 1944. At this meeting Nafziger stated that the manufacture and marketing of the Nafziger Dough Process Machine was a joint undertaking in which he had a one-third interest with Sticelber.
It is clear from the record that the word ‘commissions‘ both in the journal and ledger book of the Sticelber venture in reference to payments to the Morris Cohen Trust was a misnomer and that actually the amounts paid to the trust were not deducted in computing net profits. Respondent's contention is further rebutted by Sticelber's testimony that these payments were due to the interest in the license rather than to compensation for services rendered by petitioner.
Testimony of Sticelber and petitioner that had the license been sold the payment would have been split three ways also lends credence to the view that each of the co-adventurers had an equal equitable interest therein.
Having determined that exploitation of the license was a joint venture between Sticelber, Nafziger, and petitioner whereby petitioner had a one-third equitable interest in the license, we next pass to the problem whether the transfer by petitioner to himself as trustee of his entire interest in the supplementary agreement amounted in substance to an assignment of income-producing property in the form of his equity in the license or to an assignment merely of future income therefrom. The law is clear that where a taxpayer merely assigns his right to future income on property he retains, he is taxable thereon, whereas if he assigns all his interest in the income-producing property, he escapes taxation on the future income which it produces. Blair v. Commissioner, supra; Harrison v. Schaffner, 312 U.S. 579; and Helvering v. Horst, supra.
If we were bound by the strict language of the trust instrument alone, our conclusion could only be that petitioner assigned his right to share in future profits from the license while retaining his own interest therein. It does not mention petitioner's interest in the license but assigns his interest in a supplementary agreement which provides solely for the distribution of profits from the manufacture and sale of the Nafziger Dough Process Machine. But in tax matters the rule is well established that we must look beyond the terms of a written instrument to the real transaction and examine all evidence explaining its true nature. Helvering v. F. & R. Lazarus & Co., 308 U.S. 252; Tex-Penn Oil Co. v. Commissioner, 83 Fed.(2d) 518.
In determining the true intent of petitioner in making this assignment to the trust, we find special significance in petitioner's statement he attached to his Federal gift tax return filed a year thereafter. He sets forth the assignment under consideration in the following language:
Donor has transferred to Morris Cohen, Trustee, all of donor's right, title and interest in and to Patent license granted by Interstate Bakeries to Merlin A. Sticelber, Scarritt Building, Kansas City, Missouri, (donor's interest in said license being one-third thereof), * * *
We also have given due weight to petitioner's testimony that if the proposed sale of the license had become a reality, he would have received one-third of the sale price as trustee rather than in his individual capacity. We have not been impressed with certain testimony seemingly contradictory to this, for it is apparent therein that no distinction was being made between petitioner as trustee and as an individual. Other evidence alluded to by petitioner and respondent in support of their respective interpretations of petitioner's language of assignment in the trust instrument is too vague and inconclusive to be of any real help.
Despite the paucity of reliable evidence we feel certain that it was not petitioner's intent in creating the trust to assign anything less than his entire interest in the license. Therefore, under established principles, we hold that having made a transfer of his income-producing property, petitioner is not taxable on the payments of Sticelber to the trust in 1944, 1945, and 1946 arising from this property.
Passing to the final question, respondent contends in the alternative that the entire net income of the Morris Cohen Trust for the taxable years 1944, 1945, and 1946 was taxable to petitioner as settlor-trustee under section 22(a) by virtue of the doctrine of Helvering v. Clifford, supra. He points out that the declaration of trust authorized petitioner to withhold from distribution to the trust beneficiaries such amounts of trust income as he in his sole discretion might deem necessary to protect the trust properties. Furthermore he notes that the trust instrument provided for the distribution, on termination of the trust, of the trust corpus, including accumulated income, to the heirs-at-law of the surviving trust beneficiary. Thus he asserts that petitioner as trustee might withhold income and distribute such accumulated income to remaindermen who might not be, so far as some of the accumulated income is concerned, the heirs of the trust beneficiary from whom the trust income had been withheld. Respondent concludes that this power in the settlor-trustee to accumulate income in favor of remaindermen against a life beneficiary constitutes a power retained by petitioner over the disposition of the trust income, a power retained by petitioner over the disposition of the trust income, which, when combined with the fact the beneficiaries were members of his family and the trust instrument granted petitioner broad powers of management over the trust properties, renders petitioner taxable on the entire net income of the trust. In support of his argument respondent chiefly relies on Stockstrom v. Commissioner, 148 Fed.(2d) 491, certiorari denied, 326 U.S. 719.
The basic question, whenever the Clifford case is invoked to tax trust income to the settlor-trustee under section 22(a), is whether the ‘bundle of rights‘ vested in the taxpayer by the trust instrument is so substantial as to be equivalent in substance to a retention of economic ownership of the trust property. In the instant case after careful analysis of the terms of the trust and all the circumstances attendant upon its creation and operation, we are convinced that petitioner did not retain such control over the properties transferred to the Morris Cohen Trust as to render him taxable on the income therefrom under section 22(a) in 1944, 1945, or 1946. It is clear from the terms of the trust instrument and petitioner's conduct during the taxable years that he had neither the power to nor attempted to revoke the trust, alter or amend its terms, avail himself of the income or change the beneficiaries. Furthermore, the duration of the trust was not short term but for the lives of the two beneficiaries. The reversionary interest of the grantor in the trust corpus was so remote as to be virtually non-existent. Thus the only tenable basis for taxing the trust income to petitioner lies in the two facts emphasized by respondent, that is, the settlor-trustee was granted broad powers of management over the trust income and was given discretion whether to distribute or withhold trust income to the beneficiaries.
It is true that in the Stockstrom case, supra, the Court laid great emphasis upon the combination of these two powers in a grantor-trustee. Nevertheless, close examination of the facts of the Stockstrom case and the instant one reveals such fundamental differences that we do not regard that case as controlling the present issue. In the Stockstrom case, the settlor-trustee had an absolute, uncontrolled discretion to accumulate or distribute income. The trust instrument did not specify any regular time for the distribution of income, nor the proportions thereof to be received by each beneficiary. As a practical matter he more than once withheld all income from certain beneficiaries during the years under consideration. In the present case the trust indenture specifically provides that the entire net income is to be distributed to the two life beneficiaries no less than quarterly and enumerates the percentage thereof to be turned over to each. Discretion to withhold the income is strictly limited to occasions when protection of the trust property requires it. Thus the trust provisions set a definite standard of necessity by which to judge the exercise of this discretion by petitioner so that a court of equity to which petitioner was subject as trustee could readily determine whether the discretion was abused. The evidence makes it clear that at no time subsequent to the formation of the trust has petitioner made an attempt to accumulate income in favor of remaindermen in abuse of his discretion. This discretion was designed to protect the trust estate for the benefit of the two life beneficiaries, and a court of equity would protect their rights. It was not and could not be exercised as petitioner saw fit. See. L. M. Fischer, 14 T.C. 792.
Furthermore, the taxpayer in the Stockstrom case possessed other excessively broad powers not granted to petitioner in the instant case, including the right to deal with trust corpus as if he were the individual owner thereof, to hold the trust assets without divulging the trusts and to retain possession of the trust properties, removing them to any place he chose. Thus the ‘bundle of rights‘ retained by petitioner in the instant case is in nowise comparable with that retained by Stockstrom.
We therefore hold that under the circumstances of this case the fact that petitioner as settlor-trustee had broad powers of management and limited discretion as to the distribution of income did not render the trust income taxable to him under section 22(a). See Alex McCutchin, 4 T.C. 1242, affd., 159 Fed.(2d) 472.
There must be a recomputation of petitioner's deficiencies under Rule 50 in accordance with the holding we have made. In such proceedings the medical expense deduction of petitioner for 1946 can be determined.
Reviewed by the Court.
Decision will be entered under Rule 50.