Opinion
Docket No. 111723.
1944-05-18
M. W. SMITH, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John E. Adams, Esq., for the petitioner. Frank M. Thompson, Jr., Esq., for the respondent.
In consideration of love and affection and the assumption by his wife of equal and joint liability on his obligations petitioner, by an acknowledged written instrument, transferred to his wife a one-half interest in a lumber-manufacturing business theretofore owned by petitioner in sole proprietorship and immediately thereafter they entered into a partnership agreement under which the petitioner put into the business his remaining one-half interest and his wife put into the business the one-half interest so transferred to her, the profits and losses to be thereafter shared equally by petitioner and his wife. Held, that the petitioner made a complete, irrevocable, and bona fide gift to his wife of a one-half interest in his business; held, further, that the wife became an equal owner, as a partner; in the business; held, further, that no portion of the amount of the wife's shares of profits in the business in the taxable years is taxable to petitioner. John E. Adams, Esq., for the petitioner. Frank M. Thompson, Jr., Esq., for the respondent.
Respondent determined deficiencies in income tax against petitioner as follows: For 1937, $5,563.33; for 1938, $4,992.58; for 1939, $9,682.67; and for 1940, $81,451.38.
These deficiencies result from respondent's determination that petitioner is taxable ‘on the entire net income derived from the business operated under the name of 'M. W. Smith, Jr.’ and/or 'M. W. Smith Lumber Company' for the taxable years‘ involved and minor adjustments which are not in controversy. The net income referred to includes capital gains of that business.
Petitioner contests the determination that he is taxable on the entire net income of the business, on the ground that the business was owned and operated as a partnership comprised of himself and his wife, each owning an equal share therein. In the event of an adverse determination on this issue, petitioner alleges, by amended petition, that the respondent erred in failing to allow as a credit certain amounts paid by petitioner's wife to the State of Alabama as income tax on that portion of the business income here claimed by petitioner to have been his wife's but determined by respondent to have been his.
FINDINGS OF FACT.
On and prior to March 31, 1937, petitioner was the sole owner of a lumber-manufacturing business having its principal office at Jackson, Clarke County, Alabama, which business had been established by him in 1934 with a then net worth of about $30,000. He also owned an equity in a farm in Wilcox County worth about $15,000. He had a wife and two children, the children being respectively 12 and 10 years old. His wife had no property of her own.
The net worth of petitioner's lumber business on March 31, 1937, was $74,126.63. Petitioner was then operating two sawmills with an output of 35,000 to 40,000 feet of lumber per day. It was the first time he had been able to accumulate such an amount of property. He knew that the value of the property owned by him exceeded the amount which would be exempt from estate tax in the event of his death and that he could make a gift to his wife of property not exceeding $40,000 in value without payment of a gift tax. Beginning with a few months prior to March 1937, he discussed with his attorney and accountant the effect that such a gift would have on his income tax liability and learned from them that the formation and operation of a partnership with his wife would decrease such liability. Taxes were not a problem to petitioner at that time and were a secondary consideration, although he did look into the tax angle of the situation.
On March 31, 1937, the following instruments prepared by petitioner's attorney were executed and acknowledged by petitioner and his wife, respectively:
STATE OF ALABAMA
CLARKE COUNTY.
KNOW ALL MEN BY THESE PRESENTS THAT I, M. W. Smith, Jr., of Jackson, Alabama, for and in consideration of the love and affection which I bear toward my wife, Sybil H. Smith, do hereby give, grant, assign, deliver and convey to the said Sybil H. Smith an undivided one-half interest in and to all property of every kind, and character of which I am seized and possessed whether real, personal or mixed, and wherever located excepting property in Wilcox County, Alabama; there being included herein and conveyed hereby an undivided one-half interest in and to all money, all choses in action, and any and all other property, property rights and/or interests in property belonging to me, both tangible and intangible, excepting only such property as I own in Wilcox County, Alabama, none of which is hereby conveyed.
TO HAVE AND TO HOLD the same unto the said Sybil H. Smith, her heirs and assigns in fee simple FOREVER.
As a part of the consideration for this conveyance and transfer, in addition to that hereinabove expressed, it is agreed that the said Sybil H. Smith does assume equal and joint liability with the undersigned for the payment of all debts and obligations now owing by the undersigned, whether the same constitute liens upon the property of the undersigned or not; it being the true intent and purpose of this instrument to vest in the said Sybil H. Smith an undivided one-half interest in and to all property and assets of the undersigned, except such as is located in Wilcox County, Alabama, but by accepting such gift and transfer, the said Sybil H. Smith also accepts liability, jointly with the undersigned, to pay and discharge all debts and demands owing by the undersigned.
Witness my hand and seal on this the 31 day of March, 1937.
M. W. SMITH, Jr. (SEAL)
(Notary's certification.)
I, Sybil H. Smith, do hereby accept the gift, transfer and conveyance of property from my husband, M. W. Smith, Jr., as evidenced by the foregoing instrument, and in consideration of such gift, transfer and conveyance; I do hereby agree and bind myself, equally and jointly with my said husband, for the payment of any and all debts and demands now owing by him; and I further agree that any property thus transferred and conveyed to me shall be and remain liable for the payment of debts and demands of my said husband in all respects to the same extent as if this transfer and conveyance had not been executed, it being expressly made known hereby that there is no purpose nor intent that such transfer and assignment shall in any manner operate to the prejudice of the rights of creditors of my said husband.
Witness my hand and seal on this the 31 day of March, 1937.
SYBIL H. SMITH (SEAL)
(Notary's certification.)
(Revenue stamps $20 affixed and canceled.)
The reason for excepting the property in Wilcox County, Alabama, from the document was because it was farming property, unconnected with the lumber business. The instrument was not recorded, on the advice of petitioner's attorney that recording would entail needless expenses and was unnecessary inasmuch as petitioner's wife would have to join him in any conveyance he made. Petitioner delivered the instrument to his wife, who kept it at her home until about February 1938 and then took it to the office of the business, where the bookkeeper filed it for her in a fireproof cabinet for safekeeping.
When petitioner made the transfer to his wife he thought her interest would remain in the business. There was no agreement, secret or otherwise, between petitioner and his wife that the transfer did not represent a bona fide gift from petitioner to his wife.
After the execution of the above instrument, and on the same day, petitioner and his wife executed ‘Articles of Partnership,‘ prepared by the same attorney, as follows:
ARTICLES OF PARTNERSHIP
STATE OF ALABAMA
CLARKE COUNTY.
THIS AGREEMENT OF PARTNERSHIP, Made and entered into on this the 31st day of March, 1937, by and between M. W. Smith, Jr., and Sybil H. Smith, (said parties being husband and wife), WITNESSETH:
1. That the said M. W. Smith, Jr., and Sybil H. Smith have this day agreed to associate themselves together as a co-partnership for the purpose of engaging in the lumber business. The principal place of business is to be at Jackson, in Clarke County, Alabama, and the name and style of the firm, under which the partnership will do business shall be ‘M. W. Smith, Jr.‘
The term of the partnership is to commence on the 1st day of April, 1937, and shall continue until dissolved by mutual consent or by death of either partner.
2. It is agreed that the said M. W. Smith, Jr., has heretofore operated said business as an individual, but having accumulated assets of greater value than his debts and liabilities, he has given and transferred to the said Sybil H. Smith an undivided one-half interest in all his property and assets; (excepting that which he owns in Wilcox County, Alabama); and each partner is putting into the partnership business all property and assets owned by each or either of said partners, excepting property of M. W. Smith, Jr., located in Wilcox County, Alabama; and it is agreed that the partnership shall assume, and does hereby assume the payment of debts, demands and liabilities heretofore owing by the said M. W. Smith, Jr., as an individual; and it is further agreed that the partners shall share equally the profits and losses of the business.
3. It is agreed that neither partner shall draw any salary from the business and that any sum or sums withdrawn from the business by either partner shall be charged on the books of the partnership to such partner and shall be treated as a partial distribution of profits or assets to such partner.
4. Upon termination of this partnership the business of the firm shall be wound up and the profits and losses divided as the respective interests of the said partner may appear.
Executed in duplicate on this the 31st day of March, 1937.
ATTEST:
(Signed) INEZ P. SULLIVAN
RENA H. JACKSON
(Signed) M. W. SMITH, Jr.; (SEAL) SYBIL H. SMITH (SEAL)
The original of the foregoing ‘Articles of Partnership‘ was lost. On discovery of the loss petitioner made a reproduction thereof from his office copy, which reproduction, bearing the same date as the original, was executed by petitioner and his wife on or about April 23, 1940.
Petitioner filed a gift tax return and his wife an information return for the year 1937, reporting the gift of one-half the assets of the lumber business and scheduling the value of the gift at $37,063.31.
An agent of respondent called on petitioner six or eight months after the gift tax return was filed and checked his records in connection therewith. He did not state whether the return was being accepted or questioned, but stated that it seemed to be in order. Petitioner had no knowledge that the bona fides of the gift, or the partnership was being questioned by the respondent until sometime between January 1 and March 14, 1941.
No changes or entries on the books of the business were made to reflect execution of the deed of gift and ‘Articles of Partnership‘ until January 1938. Petitioner's bookkeeper was without any experience or training as such, except what she had acquired in the office of the business. Neither his bookkeeper nor petitioner knew how to reflect those transactions on the book records, but were advised in January 1938 by a public accountant, who petitioner had then, for the first time, employed to audit his books, that certain entries should have been made to reflect the transactions. This accountant, after inspecting the deed and ‘Articles of Partnership,‘ prepared the proper entries to be made on the books showing the establishment of a partnership. Under the accountant's instructions capital accounts were entered on the books for both the petitioner and his wife showing credited to each of $37,063.31. Under such instructions, these entries, though made in January 1938, were dated as of March 31, 1937. In January 1938 a drawing account was opened on the firm's books for petitioner's wife; The capital accounts of petitioner and his wife were credited at the end of the fiscal years ended March 31, 1938, 1939, 1940, 1941, and 1942, with that part of each one's share in the business profits which remained after deducting their respective withdrawals during the year involved. Petitioner's wife had authority to draw checks on the bank account of the firm at all times after March 31, 1937.
Petitioner's wife taught school before their marriage, had no other business experience, and did not participate in any way in the operation or management of the business either before or after March 31, 1937. Full control was at all times exercised by petitioner over the management of the business affairs of the firm. Except as to the book entries reflecting the partnership and book entries showing capital and drawing accounts of petitioner and his wife and the wife's authority, and her exercise of same, to draw checks on the bank account of the firm, the general operation of the business continued unchanged.
Prior to March 31, 1937, petitioner had made no financial provision for his wife other than giving her an allowance for her needs varying from $125 to $175 per month. After March 31, 1937, when his wife became authorized to draw checks against the firm's bank account, petitioner discontinued these monthly allowances. She thereafter made withdrawals at her pleasure from the business funds, petitioner making no effort to control the withdrawals either as to amount or purpose. Petitioner never examined his wife's drawing account in detail and was informed as to the amounts thereof only from his accountant's reports; Neither petitioner nor his wife made large withdrawals compared with the earnings of the business and those earnings, less the withdrawals, were used to meet the rapidly expanding needs of the business. Neither petitioner nor his wife made withdrawals for the purpose of making investments. In general, the withdrawals of both were for household and living expenses, family maintenance, life insurance, vacation money, and tax payments. Petitioner's wife also made withdrawals for the purchase of an automobile for her personal use. Theretofore she had owned an automobile which was purchased by petitioner and given to her. She also made withdrawals to use for other of her individual needs and for a down payment on a truck for her father, and about $125 for work done in his home. Prior to the time the drawing account was opened in her name on the books in January 1938, the expenditures for the family in 1937 were charged to petitioner's account. No book adjustment has been made as to such charges.
The accounts of petitioner and his wife show withdrawals for miscellaneous purposes and for payment of income tax in the following total amounts:
+-------------------------------------------------------------------+ ¦ ¦Petitioner ¦Wife ¦ +-------------------+-----------------------+-----------------------¦ ¦Year ended Mar. 31-¦ ¦ ¦ ¦ ¦ +-------------------+-------------+---------+-------------+---------¦ ¦ ¦Miscellaneous¦Income ¦Miscellaneous¦Income ¦ +-------------------+-------------+---------+-------------+---------¦ ¦ ¦ ¦tax ¦ ¦tax ¦ +-------------------+-------------+---------+-------------+---------¦ ¦1938 ¦$5,901.02 ¦( ) ¦ ¦ ¦ +-------------------+-------------+---------+-------------+---------¦ ¦1939 ¦3,558.10 ¦$1,633.32¦$2,049.96 ¦$1,530.87¦ +-------------------+-------------+---------+-------------+---------¦ ¦1940 ¦2,387.37 ¦2,543.99 ¦2,794.66 ¦2,474.64 ¦ +-------------------+-------------+---------+-------------+---------¦ ¦1941 ¦24,299.03 ¦( FN1 Included in “Miscellaneous.”
) ¦6,260.08 ¦11,586.71¦ +-------------------+-------------+---------+-------------+---------¦ ¦1942 ¦5,505.32 ¦51,005.98¦5,397.33 ¦49,208.84¦ +-------------------------------------------------------------------+
From March 31, 1937, to April 23, 1940, approximately 50 tracts of timber land were purchased by the firm with its funds. Petitioner's attorney who prepared the partnership agreement prepared the deeds for those tracts of land in each case the grantee was named as ‘M. W. Smith, Jr.‘
In September 1938 a new superintendent of the office suggested a change in name as more appropriate to a partnership business; Following this suggestion, letter and invoice heads and other forms of stationery were then printed styling the business as ‘M. W. Smith Lumber Company‘ and naming petitioner and his wife as the members of the firm. Petitioner's attorney was not informed of this action at the time. Some confusion resulted from such action and later on a public accountant called attention to the fact that there had been no formal or official action taken in the adoption of the new name. Consequently, on April 23, 1940, petitioner and his wife executed a ‘Supplemental Agreement of Partnership.‘
The ‘Supplemental Agreement‘ recited that the parties thereto had executed a partnership agreement on March 31, 1937 under which the partnership was to do business under the style of M. W. Smith, Jr. It referred to the confusion resulting from the adoption of the name, ‘M. W. Smith, Jr.,‘ and the acquisition of property in that name while the firm was, at the same time, transacting other business as ‘M. W. Smith Lumber Company.‘ It cited that to clarify such situation the supplemental agreement was executed. The agreement confirmed the fact that all property acquired since March 31, 1937, in the name of ‘M. W. Smith, Jr.‘ had been acquired by the partnership in conformity with the name of the partnership as designated in the original agreement, had been purchased with partnership funds, and actually belonged to the partnership. The agreement stated further that petitioner had individually acquired no property since March 31, 1937. The agreement formally changed the firm name to ‘M. W. Smith Lumber Company‘ and ratified a prior oral modification of the original partnership agreement to allow petitioner a reasonable salary for his services.
After the execution of the supplemental agreement of April 23, 1940, about 24 tracts of land were purchased by the firm, the grantee being designated in the deeds as ‘M. W. Smith, Jr; and Sybil H. Smith doing business as M. W. Smith Lumber Company.‘ The same attorney who had prepared all the other written instruments mentioned above prepared the deeds for these properties.
The invested capital in the business, in addition to a cash reserve, was in land and standing timber, plant, sawmills and equipment, logging equipment, stocks of manufactured lumber, and accounts receivable. A lumber business can not be profitably operated without a substantial investment of capital in proportion to the business transacted— such as in standing timber, machinery, logging equipment, accounts receivable, and a considerable stock of manufactured lumber, which latter it is necessary to keep on hand in order to maintain a regular flow of business. The stock of manufactured lumber kept on hand by the business in 1937 was from one to one and one-half million feet and this increased to about eight million in 1940. From July to October 1940 the price of lumber more than doubled. Large profits made in 1940 resulted primarily from war generated boom in the lumber market at a time when the firm had accumulated the 8,000,000 feet of manufactured lumber. Rapid enlargement of plant and equipment and the acquisition of large reserves of standing timber enabled the firm to manufacture and sell large quantities of lumber while the market continued highly advantageous.
The following tabulation shows the amount and character of the firm's invested capital at and during various periods subsequent to the formation of the partnership:
+---------------------------------------------------------------------------+ ¦ ¦Mar. 31, 1937¦Mar. 31, 1939¦Mar. 31, 1940¦Mar. 31, 1941¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Cash ¦$5,966.67 ¦$30,602.67 ¦$9,811.46 ¦$81,558.88 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Receivables ¦15,666.65 ¦30,401.02 ¦29,158.98 ¦51,509.23 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Inventory ¦21,884.86 ¦60,014.57 ¦64,600.33 ¦87,934.01 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Land and timber ¦31,632.63 ¦18,270.83 ¦85,390.92 ¦109,914.03 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Plant and equipment¦10,856.15 ¦15,541.86 ¦36,829.21 ¦37,588.36 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Miscellaneous ¦ ¦1,803.74 ¦10,474.37 ¦12,256.66 ¦ +-------------------+-------------+-------------+-------------+-------------¦ ¦Total ¦86,006.96 ¦156,634.69 ¦236,265.27 ¦380,761.17 ¦ +---------------------------------------------------------------------------+
The business was operated on a fiscal year basis ending on each anniversary of the execution of the partnership agreement, and income tax returns on a partnership basis for each of such years were regularly filed with the collector for the district of Alabama, showing the respective distributive shares of net income accruing as partners to petitioner and his wife. The partnership income tax returns for the fiscal years ended March 31, 1938, 1939, and 1940, were filed in the name of ‘M. W. Smith, Jr.‘ Those for the fiscal years ended March 31, 1941 and 1942, were filed in the name of ‘M. W. Smith Lumber Company.‘ Petitioner and his wife were designated as partners in all those returns.
Petitioner's and his wife's individual income tax returns were reported on the calendar year basis, beginning with the year 1938. Petitioner and his wife each reported as partners individual income from the business in the amounts and for the calendar years as follows:
+-------------------------------------------------------+ ¦1938 ¦$13,379.62¦ +--------------------------------------------+----------¦ ¦1939 ¦19,029.98 ¦ +--------------------------------------------+----------¦ ¦1940 (including capital gains of $12,346.78)¦41,974.11 ¦ +--------------------------------------------+----------¦ ¦1941 (including capital gains of $1,180.00) ¦93,192.43 ¦ +-------------------------------------------------------+
Included in petitioner's returns for each of those years was an additional amount of $3,600 as received from the business and presumably as a salary in each year, although not so designated in the returns; The returns for 1938, 1939, and 1940 stated the partnership to be ‘M. W. Smith, Jr;‘ and those for 1941 stated the partnership as :M; W. Smith Lumber Co;‘ These individual returns were also filed with the collector for the district of Alabama.
Employer's quarterly tax returns under Title VIII of the Social Security Act were filed with the collector for the district of Alabama. Those filed prior to September 30, 1938, were filed and signed in the name ‘M. W. Smith, Jr.‘ On September 30, 1938, a similar tax return was filed in the name ‘M. W. Smith Lumber Co.‘ and signed in that name by one designated as ‘Clerk.‘ After December 1, 1938, all returns under Title VIII of the Social Security Act were signed ‘M. W. Smith Lumber Company, M. W. Smith, Jr.‘ These returns were signed for most part by clerks in the office, only one or two being signed by petitioner.
After receipt of the return filed September 30, 1938, and under date of November 21, 1938, the collector for the district of Alabama wrote the ‘Smith Lumber Co.‘ calling attention to the change of name on the September 30, 1938, return and inquiring whether M. W. Smith, Jr., was the owner of the ‘M. W. Smith Lumber Company‘ or whether it was ‘operating under a different ownership.‘ Under date of December 1, 1938, petitioner replied in a letter that: ‘This company is owned and operated by M. W. Smith, Jr.‘ The letterhead on the sheet upon which the letter was written had the names of petitioner and his wife printed on the left hand margin below the firm name, ‘M. W. Smith Lumber Company.‘ After December 1, 1938, all returns filed under Title VIII of the Social Security Act were signed in the name of ‘M. W. Smith Lumber Company, M. W. Smith, Jr.‘
Under Title IX of the Social Security Act an excise tax return for the calendar year 1937 was filed with the collector for the district of Alabama in the name ‘M. W. Smith, Jr., ‘ and signed by petitioner. The ‘form of organization‘ was checked therein as ‘individual.‘ A similar return for 1938 was filed in the name ‘M. W. Smith Lumber Co.,‘ and was signed ‘M. W. Smith Lumber Co.,‘ by one designated as ‘Clerk.‘ The ‘form of organization‘ was checked therein as ‘individual.‘ A similar return for 1939 was filed in the name ‘M. W. Smith Lumber Company, ‘by the same ‘Clerk,‘ and had the ‘form of organization‘ checked as ‘partnership.‘ A similar return for 1940 was also filed in the same name, with the ‘form of organization‘ checked as ‘partnership.‘
Six or eight months prior to the time when petitioner first learned that the respondent was questioning the bona fides of the gift in the partnership petitioner discussed with his attorney the advisability of drafting wills for both himself and wife containing provisions which would permit the continued operation of the business in the event of the death of either of them, he having been advised that the death of a partner ordinarily terminated a partnership and required its liquidation. Prior to his discussions with his attorney he had discussed the matter of making such wills with the president of the trust department of the First National Bank of Mobile, which bank he proposed to make executor of his will, but that officer said the bank would not become an executor under the proposed provision of the will that the business be operated by it after the death of petitioner, because the bank would become responsible if there was a loss in the business.
The petitioner's wife paid income taxes to the State of Alabama in the sum of $530.12 on her income for the year 1938, $767.59 on her income for the year 1939, and $2,015.08 on her income for the year 1940, all of which income the respondent is treating as income of the petitioner and has computed his tax accordingly without allowance or deduction for those taxes paid by petitioner's wife to the State of Alabama.
On March 31, 1937, petitioner made a completed, valid, and irrevocable gift to his wife of a one-half interest in his lumber-manufacturing business and during the taxable years such business, operating as ‘M. W. Smith, Jr.‘ and later as ‘M. W. Smith Lumber Company,‘ was a bona fide partnership in which the petitioner and his wife were members, each owning a one-half interest therein.
OPINION
TYSON, Judge:
The primary and only issue, if such issue is decided favorably to petitioner, is whether the firm engaged in the lumber-manufacturing business under the name ‘M. W. Smith, Jr.‘ and/or ‘M. W. Smith Lumber Company‘ was in substance and reality a bona fide partnership, the income of which is divisible for tax purposes between petitioner and his wife, or whether all of said income is properly taxable to petitioner.
There is no dispute that under the laws of Alabama husband and wife may be partners in any lawful business. J. D. Johnston, Jr., 3 T.C. 799.
In a long line of cases it has been consistently held that a husband engaged, either as a sole proprietor or with others as partners, in a merchandising, manufacturing, or other business requiring the investment of substantial capital may constitute his wife a partner in such business by making her a bona fide gift of an interest therein and then, in agreement with his wife, or, if there are other partners, in agreement with those partners and his wife, continuing operation of the business, with the wife contributing the interest which had been given her by her husband as her capital investment in the business. Commissioner v. Barnes' Estate, 30 Fed.(2d) 289, affirming 7 B.T.A. 924; Rose v. Commissioner, 65 Fed.(2d) 616; Tracy v. Commissioner, 70 Fed.(2d) 93; James R. Cray, 7 B.T.A. 322; Estate of John Barnes, Jr., 7 B.T.A. 924; affd., 30 Fed.(2d) 289; L. S. Cobb, 9 B.T.A. 547; B. M. Phelps, 13 B.T.A. 1248; R. E. Hinshaw, 16 B.T.A. 1236; Alfred T. Wagner, 17 B.T.A. 1030; Glenn M. Harrington, 21 B.T.A. 260; Albert G. Dickinson, 23 B.T.A. 1212; Richard H. Oakley, 24 B.T.A. 1082; N. H. Hazlewood, 29 B.T.A. 595; Jasper Sipes, 31 B.T.A. 709; Walter W. Moyer, 35 B.T.A. 1155; and Robert P. Scherer, 3 T.C. 776. Cf. Copland v. Commissioner, 41 Fed(2d) 501; Kell v. Commissioner, 88 Fed.(2d) 453; and J. D. Johnston, Jr., supra.
While there is no question here as to a gift of an interest in his business by a father to his children, it is worthy of note, in connection with a consideration, as here, of the bona fides of gifts made by one of an interest in his business to members of his immediate family, that there is also a line of cases holding with reference to such gifts to children, either direct or through the medium of trusts, to the same effect as do the cited cases with reference to such gifts to children, either direct or through the medium of trusts, to the same effect as do the cited cases with reference to such gifts made by a husband to his wife. Commissioner v. Olds, 60 Fed.(2d) 252, affirming 15 B.T.A. 560; Rose v. Commissioner, supra; R. E. Hinshaw, supra; John Peters, 16 B.T.A. 895; Albert G. Dickinson, supra; Richard H. Oakley, supra; N. H. Hazlewood, supra; Justin Potter, 47 B.T.A. 607; and Robert P. Scherer, supra. Cf. Kell v; Commissioner, supra.
In Walter W. Moyer, supra, at page 1160, a situation very much like the one presented here was thus commented on:
* * * The fact that the business is conducted in the name of the husband does not defeat the partnership. J. Kammerdiner, 25 B.T.A. 495, and Leonard M. Gunderson, 23 B.T.A. 45, and partners may agree to lodge in one partner the sole management of the business. Richard H. Oakley, 24 B.T.A. 1082. We have also held that a husband may constitute his wife his partner by giving her an interest in the business. Jasper Sipes, 31 B.T.A. 709, and Richard H. Oakley, supra. An agreement or transaction is not rendered ineffectual merely because entered into or motivated by a purpose to avoid taxes. Commissioner v. Gregory, 69 Fed.(2d) 809; affd., Gregory v. Commissioner, 293 U.S. 465. The question to be determined, therefore, is whether the petitioner actually made a gift to his wife of an interest in the business in the amount of $100,000. If he did make a gift to his wife, she made a contribution to the business and hence had an interest in the partnership. * * *
The situation presented in the Robert P. Scherer, supra, case, so far as the wife of petitioner in that case is concerned, differs in no material respect from the situation presented in the instant case.
We think the facts here require the application of the principles applied in the cited cases. In many of those cases the gifts were made orally and the resulting partnerships were further evidenced merely by entries on the books of the businesses reflecting such transactions, as well as by other entries reflecting apportionment of profits and losses in the business as thereafter operated, to the partners. Here, the facts evidencing the gift are much stronger than those evidencing the gifts in many of the cited cases, in that here the gift was evidenced by proof of the strongest character, i.e., by a written instrument signed by petitioner and his wife, duly acknowledged by both, and delivered to the wife; and as showing the partnership are the additional facts that the business was continued in operation under a partnership agreement between petitioner and his wife and entries were made on the books of the business of capital accounts for each, of withdrawals made by each, and of credits to the capital account of each at the end of each fiscal year, for their respective shares of profits from the business after deductions of their respective withdrawals therefrom.
There is a line of cases holding that a husband engaged in a business the income from which is derived from his personal services may not, as stated in Robert P. Scherer, supra, ‘make his wife a partner in such business and have his personal service earnings taxes as partnership income.‘ Mead v. Commissioner, 131 Fed.(2d) 323; Schroder v. Commissioner, 134 Fed.(2d) 346; Earp v. Jones, 131 Fed.(2d) 292; Tinkoff v. Commissioner, 120Fed.(2d) 564; Thomas M. McIntyre, 37 B.T.A. 812; and Francis Doll, 2 T.C. 276 (on appeal, C.C.A., 8th Cir.). Cf. Jones v. Page, 102 Fed.(2d) 144; certiorari denied, 308 U.S. 562.
Respondent relies on the Mead, Schroder, and Earp cases. We do not think those cases or any of the cases cited in the immediately preceding paragraph apply here, for the reasons equally applicable here, as stated in J. D. Johnston, Jr., supra, with reference to a partnership arrangement between a husband and wife, as follows:
Unlike Mead v. Commissioner, 131 Fed.(2d) 323; Schroder v. Commissioner, supra; and Earp v. Jones, 131 Fed.(2d) 292, relied on by respondent, this was not an arrangement between only a husband and wife to engage in an exclusively or predominantly personal service business, the income from which was due entirely to the husband's personal efforts. Manifestly, the income of petitioner's wife was an attribute of and flowed from her capital interest in the business rather than from the efforts and energy expended by petitioner in the taxable years. * * *
We think it is obvious that the income from the business here involved and distributable to petitioner and his wife as partners so ‘flowed‘ from their ‘capital interest in the business rather than from the efforts and energy expended by petitioner‘ as to preclude application of the principle applied in the Mead and similar cases above cited; those capital interests being represented, inter alia, by the manufacturing plants, machinery, land, and standing timber, logging equipment, and the large stocks of manufactured lumber kept on hand to meet sale requirements. It is also of interest to note that such personal services as petitioner rendered were evidently recognized and compensated for, as such, by the $3,600 received by him annually from the firm, apparently as an agreed salary in addition to his share of the partnership profits. Among other facts in the Mead and other similar cases cited above distinguishing those cases from the instant case are that, during the taxable years there involved, in the Mead and other similar cases cited above distinguishing those cases from the instant case are that, during the taxable years there involved , in the Mead and Schroder cases it is affirmatively shown that the wives had no drawing accounts, while in the Earp, Tinkoff, McIntyre, and Doll cases it is not affirmatively shown that the wives had drawing accounts; and in none of those cases is it shown that during the taxable years the wife had authority to draw checks on the firm's bank account.
We hold, and have so found as facts, that on March 31, 1937, petitioner made a completed and irrevocable gift to his wife of a one-half interest in his lumber-manufacturing business, and that during the taxable years such business was a bona fide partnership in which petitioner and his wife each owned a one-half interest.
Our recent holdings in Francis E. Tower, 3 T.C. 396; O. William Lowry, 3 T.C. 730; and Frank J. Lorenz, 3 T.C. 746, are not, in our opinion, opposed to our holding here, since, as was said in Robert P. Scherer, supra, ‘The basis of those decisions was that no completed gifts had been made by the husbands of the capital contributors which the wives purportedly contributed to the partnership business.‘
Respondent says, on brief, that petitioner ‘when he executed the deed of gift knew that all the property covered thereby was to stay in the business.‘ Even if such knowledge on the part of petitioner were material, there is no evidence showing that there was any understanding between petitioner and his wife that the wife would permit the donated interest to remain in the business or that the gift had any such condition attached to it. Petitioner and his wife both testified that there was no secret, or other, understanding that the gift was other than a complete, bona fide one; and, while petitioner testified that he thought the interest donated to his wife would remain in the business, such a thought would be perfectly natural under the circumstances then and theretofore existing, which clearly indicated that a continued investment by the wife in the business would be highly profitable to her and consequently very desirable. Moreover, in so far as petitioner's expectations have any significance, the comment of the court in Richardson v. Smith, 102 Fed.(2d) 697, is applicable:
* * * but the donor's belief, though well founded, that he can prevail upon the donee to comply with his demands, is alone not enough (to invalidate the gift); it does not put the donee's will under any constraint, and the property becomes unconditionally his. Marshal v. Commissioner, 6 Cir., 57 F.2d 633; Smith v. Commissioner, 7 Cir., 59 F.2d 533; Kell v. Commissioner, 5 Cir., 88 F.2d 453; Bardach v. Commissioner, 6 Cir., 90 F.2d 323. (Brackets supplied.)
The fact that prior to September 30, 1938, employer's quarterly tax returns under Title VIII of the Social Security Act were filed with the collector for the district of Alabama and signed in the name ‘M. W. Smith, Jr.‘ and thereafter were filed and signed in the name ‘M. W. Smith Lumber Company‘ is of no significance, since prior to September 30, 1938, the business was operated in the name ‘M. W. Smith, Jr.,‘ which name had been formally adopted in the articles of partnership as the firm's name, and the subsequent returns of the same character were signed in the name ‘M. W. Smith Lumber Company‘ after the firm began transacting some of its business in the latter name. All these returns under Title VIII, except one or two, were signed by clerks in the office. Neither do we regard it as of material significance that, in making its excise tax returns for 1937 and 1938 under Title IX of the Social Security Act, the form of organization of the firm was checked as ‘individual,‘ while in those for 1939 and 1940 the form of organization was checked as ‘partnership.‘ Of these returns under Title IX, the one for 1937 was signed by petitioner and the ones for 1938 and 1939 were signed by a ‘clerk,‘ while it is not shown who signed the one for 1940. Nor do we regard the statement made in petitioner's letter of December 1, 1938, to the collector as of weighty significance. The inaccurate statements in the returns made under the Social Security Act and in the letter can not serve to fix the status of the business or affect the ownership of income to be recognized for Federal income tax purposes, when, as here, the actual facts, shown by other abundant evidence, establish clearly that the firm was being operated as a partnership during the taxable years. Cf. Calvin Zimmerman, 31 B.T.A. 754, 757; J. W. Brackman, 24 B.T.A. 259. Such inaccurate statements did not affect the tax liability of the firm under the Social Security Act. Moreover, the collector to whom the letter was written and with whose office the returns under the Social Security Act were filed had information from the partnership income tax returns and the individual income tax returns of petitioner and his wife, which had also been filed with his office, that the firm was operating as a partnership comprised of petitioner and his wife.
There is no suggestion by respondent that the deed of gift of March 31, 1937, was legally inadequate. The only contention offered is the fact that it was not recorded. That fact is of no importance. Rose v. Commissioner, supra; Center v. Planters & Merchants Bank, 22 Ala. 743; Perry v. Graham, 18 Ala. 822; Gaunt v. Tucker's Executors, 18 Ala. 27; and Enslen v. Thornton, 182 Ala. 314; 62 So. 525.
We hold that petitioner is not taxable on that portion of the net income of the partnership in question which represents the distributive share of his wife in such income as a member of that partnership and that respondent erred in including such portion in petitioner's income. In view of our holding on this primary issue, consideration or decision of the other issue with regard to the amount paid as income tax by petitioner's wife to the State of Alabama is unnecessary.
Reviewed by the Court.
Decision will be entered under Rule 50.
STERNHAGEN, J., dissents.
HARRON, J., dissenting: A partnership between husband and wife must be real and bona fide in every respect; An important element in the creation of a partnership between husband and wife is the contribution of capital to the partnership by the wife. Contribution of services by the wife is important, also, but here the wife contributed none. Where a husband owns all of the property in a business which he has conducted as a sole proprietorship, an alleged contribution by the wife of part of the property to a newly formed partnership, created to carry on the same business, should meet every test of reality. If the property which the wife is said to have contributed to the partnership is part of the property already in an existing business and the husband has made a purported gift of part of his property only as a step in creating a family partnership, the effect which he, a taxpayer, desires to result from the arrangement should be found to exist only if he has completely divested himself of every element of ownership and control of the property. See Francis E. Tower, 3 T.C. 396; O. William Lowry, 3T.C. 730; Frank J. Lorenz, 3 T.C. 746; Mead v. Commissioner, 131 Fed.(2d) 323.
In this case, petitioner executed a document under the terms of which he gav his wife ‘an undivided one-half interest in and to all money, all choses in action, and any and all other property, property rights, and/or interests in property belonging to me, both tangible and intangible, excepting only such property as‘ he owned in Wilcox County. Under this broad conveyance of an undivided one-half interest of all of petitioner's property, the exception being immaterial to the issue, petitioner avers that he made a gift of one-half of all of the property in his lumber business. The document was never recorded. Creditors of the lumber business had no notice whatsoever of any change in the ownership of the assets of the lumber business. The petitioner's manner of handling the arrangement indeed left everything wholly within his control. The partnership agreement, being silent upon the extent of the powers retained by petitioner in the management of the business, was ambiguous. At least, the door was left open for petitioner to argue, when it suited him, that he retained the right to sell, pledge, and dispose of the property in the business. I can not find a transfer to the wife of complete dominion and control over one-half of the assets of the lumber business in the two documents and under the surrounding facts, which is necessary to support a holding that the wife made a contribution of capital to the partnership.
Prior to the arrangements, petitioner paid his wife's bills. He thereby satisfied his legal obligation to support her. After the arrangement, the form was different, the wife withdrawing the funds she desired for her needs and her general personal use. The effect was the same, however. Family income was put to the same uses, but it was reallocated to fit the pattern of the partnership arrangement; There is no evidence to support a holding that the wife had unfettered control over a share of the income of the business, such as would follow from a bona fide ownership of one-half of the property in the business and of one-half of the business itself.
I respectfully dissent from the holding of the majority that petitioner made a complete and bona fide gift to his wife of one-half of the assets and business of the lumber business. I would hold, on this record, that he did not; that the wife did not contribute capital to the business; and that the marital partnership should not be recognized for purposes of Federal income tax.