Opinion
Docket No. 4444.
1946-06-4
JOHN LANG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Henry D. Moyle, Esq., and Walter G. Moyle, Esq., for the petitioner. Earl C. Crouter, Esq., for the respondent.
Family partnership.— Petitioner's wife and four minor children were not partners with him within the meaning of the Internal Revenue Code in conducting the business and earning the income of the Lang Co. during 1941. Henry D. Moyle, Esq., and Walter G. Moyle, Esq., for the petitioner. Earl C. Crouter, Esq., for the respondent.
The Commissioner determined a deficiency in the petitioner's income tax for 1941 in the amount of $30,486.35. The only question for determination is whether the Commissioner erred in taxing to the petitioner all of the 1941 income of a machinery, equipment, and repair business, or whether he should have recognized a family partnership in which the petitioner's wife and their four children each had a one-sixth interest.
FINDINGS OF FACT.
The petitioner has been a resident of Salt Lake City, Utah, since 1913. He filed his 1941 income tax return with the collector of internal revenue for the district of Utah.
The petitioner was married to his wife, Dora, on February 4, 1922. They have four children: John Robert, born October 24, 1922; Mary Millicent, born February 5, 1925; William Allen, born April 22, 1926; and Mildred Carol, born November 15, 1930.
The petitioner started a small business in Salt Lake City in 1914. The business expanded so that by the end of 1940 it comprised the custom fabrication of iron and steel and the sale, service, and maintenance of industrial machinery and equipment of other manufacturers, with a specialization particularly in mining, smelting, oil-refining, and road-building equipment, truck bodies, and machinery and equipment for the distribution of petroleum products from refinery to consumer. The business was conducted in plants owned by Lang. Substantial inventories of industrial machinery and equipment, repair and replacement parts, and supplies were carried. There were five departments of the business— the manufacturing and repair, the oil equipment, the truck equipment, the machinery, and the industrial equipment. Each department was in charge of a head who was responsible to Lang for its conduct and operation and who had authority to hire and discharge the employees therein. The business had approximately 150 employees. The trade area served by the business comprised Utah, southern Idaho, western Wyoming, and eastern Nevada. The business was highly competitive.
The petitioner was a member of a partnership known as the ‘Machinery Division of The Lang Company‘ at the end of 1940. This partnership, which had been formed on September 1, 1937, consisted of the petitioner and Arthur E. Smith, each having a one-half interest therein. The partnership sold and serviced certain kinds of machinery and equipment not handled by the Lang Co. sole proprietorship.
The petitioner's wife, during the first few years of their married life, assisted the petitioner by keeping the books of his business, doing secretarial work, taking inventories, preparing financial statements, and collecting some of the bills. Thereafter, she did not actively participate in the business. The petitioner discussed important business matters with her at home. He wanted his children to become interested in the business as they grew up. He and his wife constantly tried to impress upon them that they should take an interest in the business. Each was given a job at the plant during vacations and at odd times after reaching the age of 12. The work assigned them depended upon the ability of the child, and the compensation was fixed accordingly.
The petitioner developed a heart and nerve condition early in 1938 as a result of strain and overwork. This necessitated a reduction in his business activities. Thereafter he relieved himself of much of the responsibility for details by allocating more responsibility to the key men in the organization, and he devoted his time principally to the broader matters of management, supervision, and the formulation of policies. He discussed with his wife and business friends and associates the matter of setting up a partnership with the members of his family for the conduct of the business he was carrying on under the name of the Lang Co. The petitioner and his wife concluded that the children had shown sufficient interest in the business to indicate that they might find their careers in it and that they had reached sufficient maturity, with the possible exception of the youngest, to understand what was meant by a partnership and the partnership relation. The petitioner informed his wife and the children, during the Christmas season of 1940, of his intention to make them gifts of an undivided one-sixth interest each in the business and assets of the Lang Co., and that he had instructed his attorney to prepare a partnership agreement effective as of the first of 1941, under which they would become partners with him in the business.
The balance sheet of the Lang Co. at December 31, 1940, showed the following:
+------------------------------------------------------------+ ¦ASSETS ¦ +------------------------------------------------------------¦ ¦Current assets: ¦ ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Cash ¦$14,661.08¦ ¦ +-------------------------------------+----------+-----------¦ ¦Accounts receivable, less reserve ¦226,492.62¦ ¦ +-------------------------------------+----------+-----------¦ ¦Merchandise and material inventories ¦94,104.33 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Deposit on bids ¦220.00 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦ ¦ ¦$335,478.03¦ +-------------------------------------+----------+-----------¦ ¦Plant and equipment: ¦ ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Land ¦25,672.05 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Buildings, less reserve ¦51,372.76 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Automobiles and trucks, less reserve ¦11,628.03 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Machinery and equipment, less reserve¦6,507.03 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Furniture and fixtures, less reserve ¦12,294.18 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Small tools ¦210.00 ¦ ¦ +-------------------------------------+----------+-----------¦ ¦ ¦ ¦107,774.05 ¦ +-------------------------------------+----------+-----------¦ ¦Investment in corporations ¦ ¦5,000.00 ¦ +-------------------------------------+----------+-----------¦ ¦Deferred charges ¦ ¦1,334.26 ¦ +-------------------------------------+----------+-----------¦ ¦ ¦ ¦ ¦ +-------------------------------------+----------+-----------¦ ¦Total ¦ ¦449,586.34 ¦ +-------------------------------------+----------+-----------¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------+
LIABILITIES AND NET WORTH Accounts payable 69,508.72 Notes payable 69,384.90 Federal and state income taxes payable 7,991.07 146,884.69 Net worth--John Lang, proprietor 302,701.65 Total 449,586.34
The petitioner, his wife, and the children signed the following instrument on different dates in 1941. John Robert, the last to sign, signed on or about April 15.
AGREEMENT OF PARTNERSHIP
THIS AGREEMENT OF PARTNERSHIP made and entered into this 2nd day of January, A.D. 1941, by and between JOHN LANG, DORA A. LANG, JOHN ROBERT LANG, WILLIAM ALLEN LANG, MARY MILLICENT LANG, and MILDRED CAROL LANG, all of Salt Lake City and County, State of Utah.
WITNESSETH:
WHEREAS John Lang is the owner of and operates in his own right the business known as the Lang Company in Salt Lake City and County, State of Utah, which said business is and has heretofore been operated by John Lang as sole proprietor,
AND WHEREAS it is the desire and intention and purpose of John Lang by these presents to convey to DORA A. LANG, JOHN ROBERT LANG, WILLIAM ALLEN LANG, MARY MILLICENT LANG, and MILDRED CAROL LANG each an undivided one-sixth (1/6) interest in and to said business, together with all of its assets and property, real, personal and otherwise, as more particularly shown by the books and records of The Lang Company, and hereafter to operate and maintain the business of The Lang Company as a co-partnership with John Lang, Dora A. Lang, John Robert Lang, William Allen Lang, Mary Millicent Lang, and Mildred Carol Lang as co-partners, each owning an undivided one-sixth (1/6) interest therein, pursuant to the terms and conditions of this partnership agreement,
NOW, THEREFORE, the said John Lang hereby and by these presents sells, assigns, transfers and conveys unto Dora A. Lang, his wife, John Robert Lang and William Allen Lang, his sons, and Mary Millicent Lang and Mildred Carol Lang, his daughters, each an undivided one-sixth (1/6) interest in and to The Lang Company, its assets and property, both real, personal and otherwise, as more particularly shown by the books and records of The Lang Company, in consideration of the love and affection which he bears toward them, and in consideration of the premises and of the mutual covenants and conditions herein contained to be performed by the parties hereto, it is mutually agreed that from and after the date hereof the said John Lang, Dora A. Lang, John Robert Lang, William Allen Lang, Mary Millicent Lang and Mildred Carol Lang, associate themselves together as co-partners, and hereby and by these presents agree to conduct and operate said business as co-partners under the firm name and style of ‘The Lang Company.‘ The terms and conditions of said co-partnership shall be as follows, to-wit:
1. John Lang shall continue to manage said co-partnership business throughout the life of this co-partnership agreement.
2. The compensation to be paid by said partnership to the said John Lang for his services as manager thereof shall be Ten Thousand Dollars ($10,000.00) per annum. In addition thereto the said John Lang shall be reimbursed by said partnership for all his expenses incurred in the management of said partnership, and for this purpose may draw on the partnership account in advance for such expenses. All of said compensation shall be paid before any distribution of earnings to said co-partners.
The compensation to be paid to the other co-partners for any and all services rendered or to be rendered by them to said co-partnership shall be determined by the said John Lang so long as he is manager, and paid by the co-partnership.
3. That each of the co-partners shall be entitled to share and share alike in the earnings of said co-partnership.
4. That each of the co-partners shall share and share alike in the obligations, liabilities and losses of the co-partnership.
5. That any contributions to be made to said co-partnership by said co-partners or any of them shall be made in direct proportion to the interest of each in said co-partnership.
6. The term of this co-partnership shall continue for a period of ten (10) years unless sooner terminated by law.
IN WITNESS WHEREOF, the co-partners have executed these presents in sextuplicate the day and year first above written.
The petitioner's capital account on the books of the Lang Co. on April 30, 1941, showed a credit balance of $302,601.65. His account was debited with $252,251.35 on that date. Capital accounts were set up for his wife and the children and each was credited with $50,450.27 with the explanation: ‘To make division of Net Worth as per partnership agreement dated 1-2-41.‘ The balance remaining in petitioner's capital account after the foregoing entries was $50,350.30.
Dora owned property at the beginning of 1941 worth about $50,000. This included the family home. The four children owned a small amount of property, consisting of savings accounts, defense bonds, and interest in an automobile.
Most of the key men employed in the business were notified in the early part of 1941 that a partnership had been formed. Those with whom the company dealt were notified of the change at the time of the first contact made after the execution of the partnership agreement. The business carried on by the petitioner under the name of the Lang Co. prior to 1941 continued to be carried on under that same name during 1941. The character of the business was not changed. The petitioner continued to manage and control the business in 1941 as he had previously. His assistants performed the same duties as previously. The bank account continued to be carried in the same name, and substantially the same persons, including the petitioner's wife, were authorized to draw checks on that account during 1941 as he had had that authority prior to 1941. The petitioner's children were not authorized to draw checks on the account. A license from the State of Utah issued to the petitioner as a sole proprietor remained in effect during 1941. Authority given the petitioner to carry on business under an assumed name was the same in 1941 as in prior years. Policies of insurance, bonds, and licenses to operate motor vehicles were not changed to show the existence of a partnership until after 1941. Dun & Bradstreet, Inc., was not notified of the change until after 1941. Title to certain real estate and a lease on real estate used in the business remained in the petitioner's name until after 1941.
The petitioner frequently discussed business matters of consequence at home when his wife and some or all of the children were present. He continued to do that during 1941. The petitioner's wife and his children did not actively participate in the management of the business. The principal activity of the petitioner's wife in 1941 was as a housewife. Some of the children worked during vacations and at odd times in minor capacities for the Lang Co. and received small amounts as wages for their services. The children were all in school during 1941. The children resided with their parents, who provided the money for their support and education during 1941.
One-sixth of the profits of the Lang Co. for 1941 and subsequent years was credited at the close of the year to the account of the petitioner, to the account of his wife, and to the account of each of the four children. $10,596.82, or one-sixth of total profits of $63,580.91, was credited to each account at the end of 1941. $24,545.15 was the amount credited to each account for 1942, and $42,474.52 was the amount credited to each account for 1943. The petitioner withdrew about $10,000 from the business during 1941. Neither his wife nor any of the children made any withdrawals during that year. Federal and state income taxes of the petitioner, his wife, and the four children were paid with funds withdrawn from the partnership for 1942 and 1943. Some additional funds in small amounts were withdrawn in 1943 to buy Government bonds for the children or for their personal use. The petitioner withdrew some funds for his personal use in 1942 and 1943 and gave his note for a part thereof. His wife also withdrew some funds for her personal use and gave her note for a part thereof. The credit balances of the six accounts remained about equal.
The petitioner filed a gift tax return for 1941, on which he reported total gifts of $252,251.35 and a tax of $20,858.25. The total was made up of five gifts reported to have been made on January 2, 1941, each of an undivided one-sixth interest in the Lang Co. having a value of $50,450.27. The Lang Co. filed a partnership return for 1941, showing its profits to be distributable in equal shares to the petitioner, his wife, and their four children. It also showed the payment of a salary to the petitioner and wages in a small amount to three of the children. The six individuals filed individual tax returns for 1941 on each of which was reported one-sixth of the income of the partnership. That was the only income reported on those returns by the wife and the children.
John Robert and Mary Millicent, on September 1, 1943, executed separate affirmations of the partnership agreement of January 2, 1941, and ratified all matters and transactions of the Lang Co. subsequent to January 2, 1941.
The Commissioner determined that no recognizable partnership relation existed among the petitioner and the members of his family, for income tax purposes, and that the entire net income of the Lang Co. for 1941 was includible in the income of the petitioner for that year.
The petitioner's wife and four minor children were not members of a partnership with him for Federal income tax purposes in the operation of the Lang Co. during 1941 or in earning its income for 1941.
OPINION.
MURDOCK, Judge:
This is another case in which the Commissioner has refused to recognize for income tax purposes a family arrangement in the form of a partnership agreement under which the wife and minor children rendered no services and brought no capital to the business owned and conducted by the husband, except as he attempted to divide among them a part of his existing interest in the business. It is now well established that all of the income of the business under such circumstances is taxable to the husband. Commissioner v. Tower, 327 U.S. 280; Lusthaus v. Commissioner, 327 U.S. 293; Floyd D. Akers, 6 T.C. 693; W. M. Mauldin, 5 T.C. 743; affd., 155 Fed.(2d) 666. Cf. Francis A. Parker, 6 T.C. 974.
It is not contended that the children or the wife contributed anything to the business except what they had simultaneously received by alleged gifts from the petitioner. Some of the children worked during vacations and at odd times for the Lang Co., but the services they rendered were trivial, were adequately compensated for by small wages, and certainly would not show that the children were active partners in the business. The wife was not employed in the business, but it is said that the petitioner discussed all important matters with her and the children after the formation of the partnership. One of the children was ten years old. The oldest was eighteen. Obviously, the petitioner obtained no important aid from them in making the decisions which he had to make in running the business. The wife, in the Akers case, supra, likewise took an interest in the affairs, entertained business associates, and attended some meetings. The wife in the present case did no more after the formation of the partnership than she did before it was formed. She did not contribute services of a partner. We hold, upon authority of the cases cited, that the Commissioner did not err. There was no partnership for income tax purposes among the petitioner and the members of his family.
It is unnecessary, in view of the above holding, to consider other questions which might arise in this case, such as, for example, questions arising under the law of Utah in regard to the earnings of minor children and their rights and obligations under agreements such as the one here involved.
Reviewed by the Court.
Decision will be entered for the respondent.