Opinion
Docket No. 1504-67.
1969-04-29
FRED FRANKFORT, JR., AND RENEE FRANKFORT, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Robert S. Braunschweig, for the petitioners John K. Antholis and Marvin A. Fein, for the respondent.
Robert S. Braunschweig, for the petitioners John K. Antholis and Marvin A. Fein, for the respondent.
Held, certain amounts paid by T to his widowed mother in accordance with a partnership agreement previously entered into with his father constituted ‘unrealized receivables,‘ secs. 736 and 751, I.R.C. 1954, and were therefore deductible.
Respondent determined deficiencies in petitioners' income tax for the years 1961, 1962, and 1963 as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1961 ¦$1,310.51 ¦ +------+-------------¦ ¦1962 ¦1,562.17 ¦ +------+-------------¦ ¦1963 ¦1,099.03 ¦ +--------------------+
At issue is whether petitioner Fred Frankfort, Jr., is entitled to deduct certain amounts paid to his widowed mother in accordance with a partnership agreement which he had entered into with his father.
FINDINGS OF FACT
Some of the facts have been stipulated by the parties and are incorporated herein by reference.
Petitioners Fred Frankfort, Jr., and his wife Renee Frankfort resided in Nassau County, N.T., at the time of filing their petition herein. They filed their joint income tax returns for the years 1961, 1962, and 1963 with the district director of internal revenue, Brooklyn, N.Y., utilizing the cash receipts and disbursements method of accounting. Since Renee is a party to this proceeding only because she filed joint returns with her husband, Fred Frankfort, Jr., he will be referred to as petitioner.
Prior to 1960, petitioner's father, Fred Frankfort, Sr. (hereinafter sometimes referred to as Fred, Senior, or Senior), owned and operated a real estate brokerage and management business under the name of H. Frankfort & Son in Cedarhurst, N.Y. He also operated a small insurance agency in connection with his real estate activities at the same location under the same name. The business was originally founded in 1903 by petitioner's grandfather, Herman Frankfort. Fred, Senior, was well known in the community and was active in community affairs.
Petitioner began working as a full-time employee in his father's business sometime in 1949. He was paid a regular salary and was given a portion (usually 50 percent) of the commissions he earned as a sales broker. In 1960, petitioner asked his father if an arrangement could be worked out whereby he would become his father's partner rather than remain his employee. After Fred, Senior, discussed the matter with his attorney, he and petitioner executed a partnership agreement (sometimes referred to as the agreement) dated June 30, 1960. Fred, Senior, was 66 years of age at that time.
Upon the formation of the partnership, Fred, Senior, contributed $13,935.42 in uncollected real estate brokerage commissions to the partnership in addition to the furniture, fixtures, cash, and other assets previously held in the name of H. Frankfort & Son. Petitioner contributed $4,211.41 in uncollected sales commissions to the partnership. Net profits and losses were to be shared by petitioner and Fred, Senior, at the rates of 45 percent and 55 percent, respectively.
In the event of the death of either partner article Sixth of their agreement provided as follows:
SIXTH: (a) Upon the death of a partner, the surviving partner shall continue the partnership business, whether under the partnership name or otherwise, without interruption. The surviving partner shall pay to the estate of the deceased partner the value of the capital interest of the deceased partner as of the date of death less the deceased partner's share of the debts and obligations of the partnership. Such payment shall be made in twelve (12) equal monthly installments, the first installment payable on the first day of the month following the death of the partner, and monthly thereafter until the entire amount due is paid.
Upon the death of a partner, the representative of the deceased partner shall forthwith execute an assignment to the remaining partner of all of the deceased partner's right, title and interest in and to all the assets of the partnership, is good will and trade name, and the surviving partner shall assume and satisfy all debts and obligations of the partnership and hold the deceased partner and his estate harmless from all such debts and obligations.
(b) In addition to the foregoing payment, in the event of Senior's prior decease, if his spouse Regina W. Frankfort, is then alive, Junior (the petitioner) shall pay to said Regina W. Frankfort weekly, during her life or until her remarriage, or until the prior death of Junior, the sum of One Hundred ($100.00) Dollars. In the event of the remarriage of Regina W. Frankfort, the amount payable to her by Junior shall be the sum of Sixty ($60.00) Dollars weekly during her life or until the prior death of Junior. The obligation provided for herein shall be Junior's personal obligation and shall be payable in all events.
(c) In the event of Junior's prior decease, if his spouse, Renee Frankfort is then alive, Senior shall pay to said Renee Frankfort weekly, during her life, or until her remarriage, or until the prior death of Senior, the sum of Seventy-five ($75.00) Dollars. Said obligation shall be Senior's personal obligation and shall be payable in all events.
Regina W. Frankfort, referred to above, is petitioner's mother.
Fred, Senior, died on June 26, 1961. Regina became the executrix of the decedent's will and was the sole beneficiary of his estate. Pursuant to article Sixth (a) of the above agreement petitioner paid $44.91 to his father's estate. Upon his father's death petitioner assumed the operation of the business as a sole proprietorship under the name previously used, H. Frankfort & Son.
Pursuant to article Sixth (b) of the agreement, petitioner made the following payments to his mother in the years shown:
+------------+ ¦1961¦$2,600 ¦ +----+-------¦ ¦1962¦5,200 ¦ +----+-------¦ ¦1963¦3,200 ¦ +----+-------¦ ¦ ¦11,000 ¦ +------------+
Upon his father's death petitioner acquired all Fred, Senior's right, title, and interest in and to all of the partnership assets. The tangible assets had an aggregate depreciated book value of $4,831.98, and consisted of two used automobiles, two used typewriters, an air conditioner, furniture, carpeting, and leasehold improvements.
On June 26, 1961, the date of Fred, Senior's death, there were outstanding 25 contracts of sale in respect of which a net aggregate of $24,510 of real estate brokerage commissions was payable to the partnership. Such commissions were due at the respective times of the ‘closing’ or passing of title, which occurred after Fred, Senior's death. No further services or costs of any consequence were required or incurred after Fred, Senior's death in order to obtain payment of these commissions. Under the system of accounting employed by the partnership, the amounts of such commissions were not included in its income nor did they appear as an asset on its books prior to actual receipt. The following table sets forth the 25 items of commissions referred to above:
+-----------------------------------------------------------------------+ ¦ ¦Date commission¦ ¦Total ¦Net commission ¦ +----------------+---------------+-----------+----------+---------------¦ ¦Date of contract¦received ¦Seller ¦commission¦to H. ¦ +----------------+---------------+-----------+----------+---------------¦ ¦ ¦ ¦ ¦ ¦Frankfort & Son¦ +----------------+---------------+-----------+----------+---------------¦ ¦11/18/60 ¦7/10/61 ¦Dreifus ¦$2,000 ¦$1,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦11/17/60 ¦10/10/61 ¦Warren ¦1,000 ¦1,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦2/22/61 ¦8/16/61 ¦Kessler ¦1,500 ¦1,500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦2/10/61 ¦7/27/61 ¦Whitman ¦2,000 ¦2,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦2/26/61 ¦8/7/61 ¦Silberblatt¦1,700 ¦1,700 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦3/10/61 ¦8/3/61 ¦Zwerling ¦410 ¦410 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/3/61 ¦7/7/61 ¦Rattner ¦600 ¦300 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/6/61 ¦7/21/61 ¦Zipser ¦1,500 ¦750 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/11/61 ¦8/28/61 ¦Christenson¦2,000 ¦1,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/17/61 ¦7/27/61 ¦Dardeck ¦900 ¦900 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/21/61 ¦7/20/61 ¦Wolff ¦1,000 ¦1,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦4/29/61 ¦6/29/61 ¦Cohen ¦900 ¦900 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/4/61 ¦8/25/61 ¦Agata ¦1,000 ¦500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/11/61 ¦8/16/61 ¦Fraser ¦2,000 ¦1,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/12/61 ¦8/7/61 ¦Frankel ¦1,500 ¦1,500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/18/61 ¦7/6/61 ¦Maplewood ¦450 ¦450 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/18/61 ¦9/12/61 ¦Goldston ¦2,500 ¦1,250 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/24/61 ¦8/31/61 ¦Silvan ¦2,000 ¦2,000 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/24/61 ¦8/18/61 ¦Samuelson ¦1,500 ¦1,500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦6/7/61 ¦7/19/61 ¦Rosenbluth ¦500 ¦500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦6/12/61 ¦8/28/61 ¦Dubow ¦1,200 ¦800 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦6/13/61 ¦7/20/61 ¦Bendes ¦1,000 ¦800 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦6/14/61 ¦9/1/61 ¦Leeds ¦750 ¦750 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦6/14/61 ¦8/31/61 ¦Felt ¦1,500 ¦500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦ ¦ ¦ ¦31,410 ¦24,010 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦5/23/60 ¦1/7/63 ¦Rhoads ¦1,000 ¦500 ¦ +----------------+---------------+-----------+----------+---------------¦ ¦ ¦ ¦ ¦32,410 ¦24,510 ¦ +-----------------------------------------------------------------------+
Petitioner in fact received the $24,510 net commissions allocable to the partnership after his father's death on the various dates indicated in the foregoing table. He reported such commissions as income upon their receipt. He did not make separate payment of any part thereof to his mother.
The partners' capital accounts and the adjustments thereto from January 1, 1961, to the date of death of Fred, Senior, were as follows:
+-----------------------------------------------------------------------+ ¦ ¦Fred Frankfort, ¦Fred Frankfort, ¦ +-----------------------------------+-----------------+-----------------¦ ¦ ¦Jr. ¦Sr. ¦ +-----------------------------------+-----------------+-----------------¦ ¦Balance—Jan.1, 1961 ¦$3,046.95 ¦$4,133.33 ¦ +-----------------------------------+-----------------+-----------------¦ ¦Share of profit to date of death ¦9,946.20 ¦12,156.47 ¦ +-----------------------------------+-----------------+-----------------¦ ¦ ¦12,993.15 ¦16,289.80 ¦ +-----------------------------------+-----------------+-----------------¦ ¦Withdrawals to date of death ¦15,161.21 ¦16,289.80 ¦ +-----------------------------------+-----------------+-----------------¦ ¦Capital balance as of date of death¦(2,168.06) ¦1 0 ¦ +-----------------------------------+-----------------+-----------------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------+
1 There appears to be an unexplained discrepancy between the zero balance in Fred, Senior's capital balance as of the date of his death as shown above and the stipulated payment of $44.91 pursuant to article Sixth (a) of the partnership agreement in liquidation of his capital account. The $44.91 payment may be related to the liability in that precise amount that is reflected hereinafter in the June 30, 1961, balance sheet, but the latter item is not characterized in such manner as to identify it with Fred, Senior's capital account.
As of June 30, 1961, a balance sheet of H. Frankfort & Son shows that the business has assets, liabilities, and capital in the following amounts:
+-------------------------------------------------------------------+ ¦ASSETS ¦ +-------------------------------------------------------------------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------+---------+---------¦ ¦Cash ¦ ¦$1,006.94¦ +-----------------------------------------------+---------+---------¦ ¦Depreciable assets ¦$6,817.99¦ ¦ +-----------------------------------------------+---------+---------¦ ¦Less: Accumulated amortization and depreciation¦1,986.01 ¦4,831.98 ¦ +-----------------------------------------------+---------+---------¦ ¦Total assets ¦ ¦5,838.92 ¦ +-------------------------------------------------------------------+
LIABILITIES AND CAPITAL Mortgages, notes, and loans payable (short term): (a) Banks $7,000.00 (b) Others 44.91 $7,044.91 Payroll taxes, etc 530.97 Other liabilities 431.10 Partners capital accounts (2,168.06) 5,838.92
Petitioner did not establish any value for the goodwill of the business as of the date of Fred, Senior's death or as of June 30, 1961.
The partnership of Fred Frankfort, Jr., and Fred Frankfort, Sr., doing business at H. Frankfort & Son, filed a U.S. Partnership Return (Form 1065) for the period commencing January 1, 1961, to June 30, 1961, with the district director of internal revenue, Brooklyn, N.Y. No Federal partnership returns were filed for said partnership for any period subsequent to June 30, 1961.
Charitable contributions made during the period January 1, 1961, and June 30, 1961, by the partnership were allocated pursuant to the partnership agreement 55 percent for Fred Frankfort, Sr., and 45 percent for Fred Frankfort, Jr., and applied against the partnership income for that period. Subsequent to June 30, 1961, i.e., for the remainder of the 1961 taxable year, and for the taxable years 1962 and 1963, Fred Frankfort, Jr., claimed all of the amounts contributed by his Proprietorship as his personal deductions.
Petitioner deducted from his income the amounts paid his mother in accordance with article Sixth (b) of the partnership agreement in each of the years in issue as ‘Guaranteed Payments Under Section 707(c).’ In disallowing these deductions the Commissioner stated:
(a) It has been determined that the deductions claimed in 1961, 1962 and 1963 in the amounts of $2,600.00, $5,200.00 and $3,200.00, respectively, as guaranteed payments to the widow of deceased partner are not allowable within the purview of Sections 707 and 703 of the 1954 Code, and for the further reason that the payments constitute nondeductible personal expenses.
OPINION
RAUM, Judge:
We are again faced with the ‘distressingly complex and confusing’ provisions of subchapter K, David A. Foxman, 41 T.C. 535, 551 fn. 9, affirmed 352 F.2d 466 (C.A. 3), and our task has not been lightened by petitioners' various alternative arguments which were not developed with clarity in their briefs. However, we think that petitioners are entitled to prevail by reason of the provisions relating to ‘unrealized receivables' in sections 736 and 751, set forth in the margin below.
SEC. 736. PAYMENTS TO A RETIRING PARTNER OR A DECEASED PARTNER'S SUCCESSOR ON INTEREST.(a) PAYMENTS CONSIDERED AS DISTRIBUTIVE SHARE OR GUARANTEED PAYMENT.—Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, except as provided in subsection (b), be considered—(1) as a distributive share to the recipient of partnership income if the amount thereof is determined with regard to the income of the partnership, or(2) as a guaranteed payment described in section 707(c) if the amount thereof is determined without regard to the income of the partnership.(b) PAYMENTS FOR INTEREST IN PARTNERSHIP.—(1) GENERAL RULE.— Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, to the extent such payments (other than payments described in paragraph (2)) are determined, under regulations prescribed by the Secretary or his delegate, to be made in exchange for the interest of such partner in partnership property, be considered as a distribution by the partnership and not as a distributive share or guaranteed payment under subsection (a).(2) SPECIAL RULES.— For purposes of this subsection, payments in exchange for an interest in partnership property shall not include amounts paid for—(A) unrealized receivables of the partnership (as defined in section 751(c)), or(B) good will of the partnership, except to the extent that the partnership agreement provides for a payment with respect to good will.SEC. 751. UNREALIZED RECEIVABLES AND INVENTORY ITEMS.(a) SALE OR EXCHANGE OF INTEREST IN PARTNERSHIP.— The amount of any money, or the fair market value of any property, received by a transferor partner in exchange for all or a part of his interest in the partnership attributable to—(1) unrealized receivables of the partnership, or(2) inventory items of the partnership which have appreciated substantially in value, shall be considered as an amount realized from the sale or exchange of property other than a capital asset.(b) CERTAIN DISTRIBUTIONS TREATED AS SALES OR EXCHANGES.—(1) GENERAL RULE.— To the extent a partner receives in a distribution—(A) partnership property described in subsection (a)(1) or (2) in exchange for all or a part of his interest in other partnership property (including money), or(B) partnership property (including money) other than property described in subsection (a)(1) or (2) in exchange for all or a part of his interest in partnership property described in subsection (a)(1) or (2),such transaction shall, under regulations prescribed by the Secretary or his delegate, be considered as a sale or exchange of such property between the distributee and the partnership (as constituted after the distribution).(2) EXCEPTIONS.— Paragraph (1) shall not apply to—(A) a distribution of property which the distributee contributed to the partnership, or(B) payments, described in section 736(a), to a retiring partner or successor in interest of a deceased partner.(c) UNREALIZED RECEIVABLES.— For purposes of this subchapter, the term ‘unrealized receivables' includes, to the extent not previously includible in income under the method of accounting used by the partnership, any rights (contractual or otherwise) to payment for—(1) goods delivered, or to be delivered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capital asset, or(2) services rendered, or to be rendered.
At the date of Fred, Senior's death, the partnership had already performed the services entitling it to brokerage commissions on the sales of 25 parcels of real estate, but payment of those commissions was not due until the actual closings of the sales. In fact, however, such closings did occur and net commissions aggregating $24,010 were actually received no later than October 1961 in respect of 24 sales. A $500 commission in respect of the 25th contract of sale was received in January 1963. Although these commissions were not recorded on the books of the business until received, they nevertheless represented a valuable asset as of the date of Fred, Senior's death. And since they did not appear on the books as an asset, the payment for the decedent's capital interest under article Sixth (a) of the partnership agreement did not include anything in respect of those commissions. However, additional payments were required under article Sixth (b) to the decedent's widow, and we find it difficult to believe that such payments were not intended at least in part to reflect the decedent's interest in those commissions. Certainly, to the extent of decedent's interest in those commissions, petitioner's obligation to make payments to his mother was no different from a like obligation that might have been negotiated at arm's length between unrelated partners and was not based on a moral obligation as contended by the Government. Cf. Autenreith v. Commissioner, 115 F.2d 856 (C.A. 3); Edwards v. Commissioner, 102 F.2d 757 (C.A. 10).
In our view, the commissions were ‘unrealized receivables,‘ and the decedent's 55-percent partnership interest therein exceeded the total amount ($11,000) paid to the widow during the 3 years before us. Leaving out of consideration the $500 commission paid in 1963, which at best appears to have been a highly doubtful item as of decedent's death (June 26, 1961), the remaining 24 items aggregating $24,010 appear to have been worth very close to their net face amount as of June 26, 1961. One was in fact paid on June 29, 1961; nine were paid in July 1961; eleven were paid in August 1961; two were paid in September 1961; and the last one was paid on October 10, 1961. Thus, although we recognize that in determining the amount attributable to the unrealized receivables full account must be taken of the estimated cost of completing performance as well as the time between the sale and the time of payment (sec. 1.751-1(c)(3), Income Tax Regs.), there did not in fact appear to be any additional costs nor was there any lapse of time of consequence between decedent's death and the collection of the commissions. In our judgment the decedent's 55-percent interest in the $24,010 unrealized commissions had a fair market value in excess of the aggregate of the $11,000 payments to his widow involved herein. Accordingly, since the payments made to her during the tax years did not exceed the amount of the decedent's interest in these unrealized receivables, they are deductible by petitioner.
See sec. 1.736-1(b)(2), Income Tax Regs.;(2) Payments made to a retiring partner or to the successor in interest of a deceased partner for his interest in unrealized receivables of the partnership in excess of their partnership basis, including any special basis adjustment for them to which such partner is entitled, shall not be considered as made in exchange for such partner's interest in partnership property. Such payments shall be treated as payments under section 736(a) and paragraph (a) of this section. For definition of unrealized receivables, see section 751(c).See also 3A Mertens. Law of Federal Income Taxation, sec. 21.27; cf. Miller v. United States, 181 Ct.Cl. 331 (20 A.F.T.R.2d 5569, 67-2 U.S.T.C.par. 9685).
It must be remembered that the uncollected commissions represented the largest asset of any consequence owned by the partnership, and unless they are to be charged against the payments required to be made under article Sixth (b), the decedent's interest therein would remain entirely uncompensated. It therefore seems particularly appropriate to allocate these unrealized receivables to the article Sixth (b) payments. In so holding, we wish to make clear that we are not passing upon the question whether the partners may effectively spell out in their agreement to what payments, if any, the unrealized receivable may or may not be allocated and thus fix as among themselves their respective tax liabilities upon the liquidation or sale of a partnership interest. Cf. David A. Foxman, supra. We do not here rule whether in such circumstances the unrealized receivables must automatically be allocated to any particular consideration received if the partnership agreement provides otherwise. We hold simply that in the absence of any such provision in the agreement it is appropriate to make the allocation, particularly where the evidence strongly suggests that such an allocation is in accord with the probable intentions of the parties.
In view of our conclusion set forth above, we do not consider any of the other grounds urged by petitioners to support the claimed deductions.
Decision will be entered under Rule 50. 1. There appears to be an unexplained discrepancy between the zero balance in Fred, Senior's capital balance as of the date of his death as shown above and the stipulated payment of $44.91 pursuant to article Sixth (a) of the partnership agreement in liquidation of his capital account. The $44.91 payment may be related to the liability in that precise amount that is reflected hereinafter in the June 30, 1961, balance sheet, but the latter item is not characterized in such manner as to identify it with Fred, Senior's capital account.