Opinion
Docket No. 17210.
1949-05-12
ESTATE OF SAMUEL MNOOKIN, DECEASED, DORA MNOOKIN, EXECUTRIX, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John H. McEvers, Esq., G. Lee Burns, Esq., and Reece A. Gardner, Esq., for the petitioner. Gene W. Reardon, Esq., for the respondent.
1. Decedent in 1942 and in all prior years after opening business books in 1920 kept his books on the accrual basis of accounting. His income tax returns in 1942 and in all prior years after 1920 were made on the accrual basis, except that income from credit sales was reported on the cash basis. For 1942 respondent determined that income from credit sales should also be reported on the accrual basis and included in decedent's gross income for 1942 the credit sales for prior years of $103,456.73, which were evidenced by accounts receivable as of January 1, 1942, and which were never Previously reflected in taxable income. Held, that respondent erred in so doing. Greene Motor Co., 5 T.C. 314, followed.
2. Decedent, a member of a partnership with a fiscal year June 1, 1943, to May 31, 1944, died December 1, 1943. The articles of partnership as amended provided that upon the death of a partner neither the partnership nor the interest therein of the deceased partner should terminate. Upon decedent's death, the surviving partner continued the partnership business until distribution of decedent's estate on March 15, 1945. Held, that under the law of Missouri the partnership did not terminate on December 1, 1943, and respondent erred in including in decedent's taxable income for the period January 1 to December 1, 1943, any part of the income of the partnership for the period June 1 to December 1, 1943. John H. McEvers, Esq., G. Lee Burns, Esq., and Reece A. Gardner, Esq., for the petitioner. Gene W. Reardon, Esq., for the respondent.
The respondent determined a deficiency in income and victory tax of Samuel Mnookin, deceased, for the period January 1 to December 1, 1943, in the amount of $54,974.38. The computation also involves income for 1942, pursuant to the Current Tax Payment Act of 1943. Petitioner assails this determination and also claims a refund of $12,523.55.
The questions at issue are:
(1) Did respondent, in determining decedent's gross income for 1942 on an accrual basis, properly include the credit sales for prior years of $103,456.73, which were evidenced by accounts receivable as of January 1, 1942, and were never previously reflected in taxable income, decedent having previously in his returns reported income from credit sales on a cash basis, though otherwise reporting income on an accrual basis and keeping his business books on an accrual basis?
(2) Where decedent was a member of a partnership with a fiscal year June 1, 1943, to May 31, 1944, and died December 1, 1943, did respondent err in including what respondent determined to be decedent's allocable share of partnership profit for the period June 1 to December 1, 1943, in his taxable income for the period January 1 to December 1, 1943?
Petitioner in its petition also raised the issue of whether respondent had erroneously decreased decedent's inventory as of January 1, 1942, by $160.47. This issue was conceded by petitioner.
A part of the facts have been stipulated. The written stipulation is incorporated herein by reference.
FINDINGS OF FACT.
Samuel Mnookin, a resident of Kansas City, Missouri, died testate on December 1, 1943. Dora Mnookin, widow of Samuel Mnookin, is the duly appointed, qualified, and acting executrix of his estate. The income tax return of the decedent for the period January 1 to December 1, 1943, was filed by the executrix with the collector of internal revenue at Kansas City, Missouri.
For many years prior to June 23, 1942, Samuel Mnookin as a sole proprietor had carried on a retail clothing and jewelry business under the firm name and style of ‘Fashion Credit Clothing & Jewelry Company.‘ On June 23, 1942, Samuel Mnookin assigned, transferred, and conveyed to his son, Leo L. Mnookin, a one-third interest in this business, and on that date Samuel Mnookin and Leo L. Mnookin entered into a written partnership agreement under which they were to make capital contributions and share profits and losses in the proportion of Samuel Mnookin, two-thirds, and Leo L. Mnookin, one-third. The agreement also contained, among others, the following provisions:
(2) The partnership shall begin as of the close of business on June 23, 1942, and continue unless terminated prior thereto for a period of twenty-five years.
10. The partnership shall operate on the basis of a calendar year. On the last day of each year, a general account shall be taken of the assets and liabilities of the partnership and of all dealings and transactions of the same during the then preceding calendar year, or portion thereof * * * . The profits arising from the business as determined by such account shall be carried to the credit of the partners in the proportions hereinbefore specified on the books of the partnership immediately after each annual account shall have been taken and signed and may be drawn out at pleasure after deducting therefrom all prior withdrawals.
11. This agreement shall be binding upon the parties hereto and their respective heirs, executors, administrators, and assigns. * * *
On September 28, 1942, by an instrument in writing, Samuel Mnookin and Leo L. Mnookin amended their partnership agreement of June 23, 1942, to include the following provisions:
13. If either partner shall die during the existence of the partnership, neither the partnership nor the interest therein of the deceased partner shall terminate, but shall continue, subject to the terms and conditions hereinafter set forth:
(a) Upon the death of either partner, the partnership shall immediately pay all the debts of the partnership which existed on the date of the death of such deceased partner.
(b) After the death of a partner, neither his legal representatives, nor his trustees shall have any power of management of the continued enterprise, and the surviving partner shall have the sole and uncontrolled power of management of the partnership until the interest of the deceased partner or any part of it is distributed to his heirs, legatees or trust beneficiaries, as the case may be.
(c) Neither the general estate of the deceased partner nor any trust estate of his shall be liable for any debts of the continued enterprise, and all rights of creditors of the continued enterprise shall be limited to and satisfied only from the assets of the partnership, in so far as any part of the deceased partner's interest which is held by his legal representatives or trustees is concerned.
(d) While the deceased partner's interest, or any part thereof, is held by his legal representatives or his trustees, the legal representatives or trustees, as the case may be, shall be entitled to the deceased partner's proportionate interest in the profits of the partnership, and all losses shall proportionately be charged to the deceased partner's interest, or part thereof, in the continued enterprise, but only to the extent of such interest, or part thereof, so held by the deceased partner's legal representatives or trustees.
(e) There shall be no administration of the partnership estate whatsoever, but the partnership shall continue for the purposes and under the conditions and in the manner set forth in the Articles of Partnership. The surviving partner shall not be deemed to be a trustee of the deceased partner's interest, but all of the capital of the partnership shall be subject in its entirety to claims of the creditors of the partnership, but to creditors of the partnership only.
(f) From and after the time when the deceased partner's interest, or any part thereof, is distributed to the deceased partner's heirs, legatees or trust beneficiaries, as the case may be, such heirs, legatees, or beneficiaries shall, in proportion to the interest in the partnership which they receive, have all of the rights and powers and be Subject to all of the liabilities which the deceased partner had before his death.
From June 23, 1942, to December 1, 1943, inclusive, Samuel Mnookin and Leo L. Mnookin carried on the partnership pursuant to agreement under the firm name and style of ‘Fashion Credit Clothing & Jewelry Company.‘ After the formation of the partnership Samuel Mnookin made withdrawals of partnership funds, which were debited to his drawing account. These withdrawals amounted to $25,514.14 as of December 1, 1943.
From the death of Samuel Mnookin on December 1, 1943, until May 31, 1944, Leo L. Mnookin continued to carry on the business without interruption. No change from what had been the custom prior to that time was made during this period in the manner of keeping the books of the business or in the time or basis of filing the partnership returns. There was no distribution of any part of the interest of the estate of Samuel Mnookin in the partnership to the deceased partner's heirs, legatees, or trust beneficiaries by petitioner as executrix of the estate until March 15, 1945.
Samuel Mnookin, doing business under the firm name and style of ‘Fashion Credit Clothing & Jewelry Company,‘ had opened a regular set of books for his business on April 15, 1920. From that time to May 31, 1944, the books of the business were kept on the accrual method of accounting. Up to the time of his death (December 1, 1943) Samuel Mnookin always kept his books and filed his income tax returns on the basis of a calendar year. Prior to May 31, 1943, Samuel Mnookin and Leo L. Mnookin, as partners, determined to keep their books and make their partnership returns of income on the basis of a fiscal year ending May 31, and for that fiscal year and thereafter the partnership books were so kept.
The income tax returns of Samuel Mnookin for the calendar years 1919 to 1941, inclusive, reported the income from his business on the accrual basis, except that in such returns receipts from credit sales were reported on a cash receipts basis. Substantial portions of the gross sales of the business from 1619 to December 311941, and during the period January 1, 1942, to May 31, 1944, inclusive, were made on a credit basis, and the amount of such credit sales was always entered on the books as accrued income.
The income tax return of Samuel Mnookin for the calendar year 1942 reported the income from the business for the period January 1 to June 23, 1942, and the partnership returns of Fashion Credit Clothing & Jewelry Co. for the fiscal years ended May 31, 1943, and May 31, 1944, reported the income from the business for the periods June 24, 1942, to May 31, 1943, and from June 1, 1943, to May 31, 1944, respectively. On each of these three returns income was reported on the accrual basis, except that receipts from credit sales were reported on a cash receipts basis. On these returns, opening and closing inventories were used as factors in determining the gross profits derived from business, and Samuel Mnookin had used the same system for all years prior to 1942. Nevertheless, these three returns and the returns for prior years stated that they were filed on a cash basis. However, prior to 1940 gross receipts were not actually broken down on the return into receipts from cash sales and receipts from credit sales.
Respondent mailed notice of deficiency in decedent's income tax for the taxable year January 1 to December 1, 1943, to petitioner on November 13, 1947. Petitioner and respondent had on December 23, 1946, entered into an agreement extending the time to June 30, 1948, within which respondent could make assessment against the estate of Samuel Mnookin, deceased, Dora Mnookin, executrix, for the taxable year January 1 to December 1, 1943. At the time of respondent's investigation and examination of petitioner's returns for 1942 and 1943 the statute of limitations upon assessment and collection of income tax deficiencies against decedent for the year 1941 and prior years had expired. A partial or spot examination had been made of decedent's 1941 return and the return had been accepted as filed.
Respondent determined that the decedent correctly kept his business books on the accrual basis, but that he improperly reported business income on a hybrid basis and that he incorrectly reported in his return for 1942 receipts from credit sales of business on the cash receipts basis. Consequently, respondent determined that the business income should be reported on an accrual basis, that sales of merchandise should be reported on an accrual basis, and that credit sales ($103,456.73) evidenced by accounts receivable as of January 1, 1942, which had not previously been reported in taxable income, should be added to the net business profit computed for the period January 1 to June 23, 1942, on the accrual basis in computing decedent's taxable income for 1942. Respondent's determination of decedent's taxable income from the said business enterprise for 1942 may be computed as follows:
+-----------------------------------------------------------------------------+ ¦Net profit from business per return ¦ ¦$25,518.81¦ +------------------------------------------------------+-----------+----------¦ ¦Less: ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Collections from credit sales reported in return ¦$73,286.61 ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Credit sales 1-1-42 to 6-23-42, per books ¦54,951.80 ¦18,334.81 ¦ +------------------------------------------------------+-----------+----------¦ ¦Net profit per books for period 1-1-42 to 6-23-42 ¦ ¦7,184.00 ¦ +------------------------------------------------------+-----------+----------¦ ¦Add credit sales evidenced by accounts receivable as ¦ ¦ ¦ ¦of 1-1-42, which had not previously been reported in ¦$103,456.73¦ ¦ ¦taxable income ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Decrease in inventory 1-1-42 ¦160.47 ¦103,617.20¦ +------------------------------------------------------+-----------+----------¦ ¦Taxable income from business for the year 1942 ¦ ¦110,801.20¦ +-----------------------------------------------------------------------------+
Respondent also determined that the net profit of the partnership business for the fiscal year ended May 31, 1943, was as reflected in the books on the accrual basis rather than on the hybrid basis as reported. He further determined that the death of the decedent so terminated the partnership then carried on by Samuel Mnookin and Leo L. Mnookin as partners as to require petitioner to accrue and include in the income tax return filed on behalf of Samuel Mnookin, deceased, for the period January 1 to December 1, 1943, the amount of $6,436.34 which respondent determined to be the decedent's allocable share of the income of the partnership for the period June 1 to December 1, 1943.
OPINION.
HARLAN, Judge:
Petitioner's first contention is that respondent erred in including in decedent's gross income for 1942 the accounts receivable as of January 1, 1942. It maintains that, since respondent was determining Samuel Mnookin's income for 1942, he had no right to include this item, which represented credit sales of prior years.
It is our opinion that on this issue the case at bar is controlled by Greene Motor Co., 5 T.C. 314. In that case the taxpayer had consistently followed an accrual method of accounting. It had, in the years prior to 1939, improperly set up certain so-called special reserves and made additions thereto which were claimed and allowed as deductions on its income tax return for 1938. In auditing the 1939 return the Commissioner added the amounts of these reserves as shown on the taxpayer's books as of December 31, 1938, to its income for 1939. The taxpayer appealed to this Court. It conceded that under the accrual method of keeping its books the so-called reserves were improper deductions and that the amount of $3,149.06, carried by petitioner in the so-called reserves as of December 31, 1938, was never returned as income. It contested, however, the respondent's right to include in its 1939 income amounts claimed as a deduction in its 1938 return and erroneously allowed in that year by the respondent. In supporting the taxpayer this Court said (p. 317):
(Respondent) apparently makes no contention that the amounts deducted as such reserves were income in 1939. He attempts to justify his action, rather, on the ground that if the erroneous deductions are not included in petitioner's gross income for 1939 they will never be taxed. * * * The amounts of the so-called special reserves improperly deducted and allowed in the prior year or years unlawfully reduced taxable income of the petitioner for those respective years only. Those amounts were properly includible in income of the earlier years— not of the taxable year.
In the case at bar Samuel Mnookin had, just as had the taxpayer in Greene Motor Co., supra, consistently followed the accrual method of accounting and his books clearly reflected his income. No change in his method of accounting was ever requested or made. In prior years Samuel Mnookin had treated credit sales on a cash basis in his returns. In determining that credit sales should be treated on the accrual basis for 1942, the Commissioner also added the amount of the accounts receivable evidencing unpaid credit sales as shown on Samuel Mnookin's books on January 1, 1942, to his income for 1942, for the reason that if these accounts receivable were not included in Samuel Mnookin's income for 1942 they would never be taxed. We see no more justification for allowing this action on the part of the Commissioner in the case at bar than in Green Motor Co., supra.
Respondent relies on William Hardy, Inc. v. Commissioner (C.C.A. 2d Cir., 1936), 82 Fed.(2d) 249; Schuman Carriage Co., Ltd., 43 B.T.A. 880; and C. L. Carver, 10 T.C. 171; affd. (C.A., 6th Cir.), 173 Fed.(2d) 29. Both William Hardy, Inc. v. Commissioner, supra, and Schuman Carriage Co., Ltd., supra, were distinguished by this Court in Green Motor Co., supra, and they are similarly distinguishable from the case at bar, as is C. L. Carver, supra.
In Schuman Carriage Co., supra, the taxpayer kept its books on a hybrid basis, i.e., part accrual and part cash, and reported its income in its returns according to the manner in which it kept its books. The Commissioner determined that the method of accounting of the taxpayer did not clearly reflect its income, that its books should be kept and its returns filed on the accrual basis, and that there should be included in its income for 1934 interest collections for that year plus uncollected interest at December 31, 1934. This Court held that the Commissioner had acted within the powers conferred upon him in section 41 of the code.
SEC. 41. GENERAL RULE.The net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *
Both William Hardy, Inc. v. Commissioner, supra, and C. L. Carver, supra, involved adjustments made by the Commissioner as the result of changes in the method of keeping books from the cash to the accrual basis. In the case at bar, as already stated, Samuel Mnookin had consistently followed the accrual method of accounting, and he neither requested nor made any change in that method. Accordingly, neither William Hardy, Inc. v. Commissioner, supra, nor C. L. Carver, supra, is in point.
We therefore hold that respondent erred in including in the gross income of Samuel Mnookin, deceased, for 1942 credit sales for prior years of $130,456.73, which were evidenced by accounts receivable as of January 1, 1942.
Petitioner's second contention is that the respondent erred in including in decedent's income for the period January 1 to December 1, 1943, the amount of $6,436.34 which respondent determined to be petitioner's allocable share of the income of the partnership doing business under the name of Fashion Credit Clothing & Jewelry Co. for the period June 1 to December 1, 1943. Petitioner urges that the articles of partnership as amended provided that upon the death of either partner the partnership and the interest therein of a deceased partner would continue, and not terminate; that because of these provisions the surviving partner was not required to close the partnership books, compute the partners' share of the income for the period June 1 to December 1, and file a partnership return for the period; and that, therefore, no income accrued to decedent from the partnership for the period June 1 to December 1 which petitioner was required to report.
The respondent contends that under the partnership agreement as amended the death of decedent dissolved the then existing general partnership, and thereafter, at most, a limited partnership existed, with the surviving partner and the legal representatives or trustees of the deceased partner as members of the new partnership; that the withdrawals made by decedent, to the extent of profits, were in the nature of current receipts of business profits; that these sums were withdrawn by decedent under a claim of right and he was under no obligation to make restitution; that the decedent's estate would not be required to include such business profits in its taxable income under the provisions of section 126 of the code; that a determination that the profits of the partnership business for the period June 1 to December 1, 1943, allocable to the decedent are not taxable to him might readily lead to a situation where this portion of the business profits would escape taxation; and that the decedent's allocable share of these profits is includible in his taxable income.
The pertinent provisions of the Internal Revenue Code are set forth in the margin.
SEC. 126. INCOME IN RESPECT OF DECEDENTS.(a) INCLUSION IN GROSS INCOME.—(1) GENERAL RULE.— The amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period shall be included in the gross income, for the taxable year when received, of:(A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent;(B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; * * *SEC. 181. PARTNERSHIP NOT TAXABLE.Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.SEC. 182. TAX OF PARTNERS.In computing the net income of each partner, he shall include, whether or not distribution is made to him—(c) His distributive share of the ordinary income of the partnership * * *SEC. 188. DIFFERENT TAXABLE YEARS OF PARTNER AND PARTNERSHIP.If the taxable year of a partner is different from that of the partnership, the inclusions with respect to the net income of the partnership, in computing the net income of the partner for his taxable year, shall be based upon the net income of the partnership for any taxable year of the partnership (whether beginning on, before or after January 1, 1939) ending within or with the taxable year of the partner.
Ordinarily, death dissolves a partnership. But in Missouri and elsewhere it has been held that, where it is provided in the articles that both the partnership and the interest of the partner shall continue after his death, such a provision will be given effect. Edwards v. Thomas, 66 Mo. 468; Hax v. Burns, 98 Mo.App. 707; 73 S.W. 928; Hidden v. Edwards, 313 Mo. 642; 285 S.W. 462. And in E. R. Hawkins & Co. v. Quinette, 156 Mo.App. 153; 136 S.W. 246, the court said that ‘though death ordinarily operates a dissolution of a partnership, it accomplishes naught with respect to that matter in cases such as this one where by an express stipulation in the articles of copartnership the partners have agreed the partnership shall continue.‘ See also Henderson's Estate v. Commissioner, 155 Fed.(2d) 310; and Robert E. Ford6 T.C. 499 501.
Here, the articles of partnership as amended specifically provided:
13. If either partner shall die during the existence of the partnership, neither the partnership nor the interest therein of the deceased partner shall terminate, but shall continue, subject to the terms and conditions hereinafter set forth. * * *
The amended partnership articles clearly manifest an intention that the partnership continue and not terminate upon the death of a partner and that the surviving partner at that time take over and manage the business without making any change in the method of bookkeeping, the partnership's fiscal year, or the basis of preparing the partnership return. While the general rule is that the death of a partner dissolves a partnership and fixes the date as of which the surviving partners are required to account for the profits (Guaranty Trust Co. of New York v. Commissioner, 303 U.S. 493), it has been held that the taxable year of the partnership, as far as the surviving partners are concerned, is not affected by the death of a partner where a partnership continues until the winding up of the partnership affairs is completed. Heiner v. Mellon, 304 U.S. 271; Mary D. Walsh, 7 T.C.205. In Henderson's Estate v. Commissioner, supra, reversing Estate of Hunt Henderson, 4 T.C. 1001, the articles of partnership provided that the partnership was to continue for one year after the death of any partner, and the Louisiana code provided that every partnership ends of right by the death of one of the partners, unless an agreement has been made to the contrary. The Circuit Court of Appeals for the Fifth Circuit disagreed with the view of this Court that the partnership terminated with the death of one of the partners and that a new partnership came into being. The Circuit Court, pointing to the provision of the Louisiana code, stated that, while the continuance of the firm after the death of a partner is a legal fiction, a Federal court ‘should not look askance at legal fictions under state laws so long as it maintains the fiction that a corporation is a citizen of the state of its incorporation,‘ and held that no tax year ended for the partnership with the death of the decedent and that no partnership gain or loss had to be reported for the period immediately preceding death.
In Missouri, where the Mnookin partnership was created and engaged in business there has never been any statutory provision that a partnership can continue after the death of a partner if there is an agreement to that effect. However, as heretofore noted, the courts of that state have so held, and under such circumstances we deem it immaterial that the statutes do not contain such a provision. Moreover, consistency would seem to require that, if upon the death of a partner a partnership year does not end for surviving partners, where the only purpose of continuance is to wind up the affairs of a partnership, it should not end for the deceased partner where the partnership agreement provides, as it does in this proceeding, that the firm itself and the interest of a deceased partner shall continue after his death. Following Henderson's Estate v. Commissioner, supra, we hold that the tax year of the partnership did not end with the death of the decedent, and there was no partnership gain to be included in the return of decedent for the period from June 1 to December 1, 1943.
The fact that decedent had made substantial withdrawals prior to his death does not seem to us to require any different conclusion. These withdrawals were merely advances or borrowings from the partnership funds. Under the partnership agreement they were to be deducted from the share of profits distributable at the close of the partnership fiscal year. We do not share the respondent's concern that earnings attributable to the decedent's share may escape taxation. Under the provisions of section 182, supra, the estate of the decedent must include these earnings in its income for 1944, ‘whether or not distribution is made to‘ it.
The respondent erred in including $6,436.34 in the income of the decedent for the period January 1 to December 1, 1943.
Reviewed by the Court.
Decision will be entered under Rule 50.
OPPER, J., dissenting: I can not distinguish this case from Schuman Carriage Co., Ltd., 43 B.T.A. 880, where likewise a hybrid system of reporting income was disapproved by respondent, and amounts on the books which should have been reported in prior years were included in the current year's income. It is altogether different from Greene Motor Co., 5 T.C. 314, which involved erroneous reserve accounts and was controlled by such cases as S. Rossin & Sons, Inc. v. Commissioner (C.C.A., 3d Cir.), 113 Fed.(2d) 652.
In Schuman Carriage Co., Ltd., supra, we said:
* * * We think that it is immaterial that the stipulated facts in this case show that the petitioner has never recorded in its books of account interest accrued but only interest collected.
* * * The facts are, however, that there was an amount of accrued interest income upon the petitioner's books of account at January 1, 1934, which had never been returned for taxation. Manifestly, this amount must be included in the gross income of some year. The failure of the petitioner to make its returns consistently upon the accrual basis may place it in an unfortunate position. But for this situation the petitioner is alone to blame.
If we substitute for ‘interest‘ the ‘credit sales‘ account here in controversy, the identical statements would have to be made in this case. Unless we are prepared to overrule Schuman Carriage Co., Ltd., supra, I think it should be followed here.