Hallahan v. Commissioner

14 B.T.A. 584, 1928 BTA LEXIS 2953

• Court: United States Board of Tax Appeals
• Decided: December 6, 1928
• Docket: Docket Nos. 6848-6851.
• Status: Published

Opinions

OPINION.

Smith :

In filing their income-tax returns for the years 1917, 1918, 1919, and 1920, each of the petitioners excluded the payments made to the estates of Arthur B. Gilmore and William T. Ulman in computing the amount of partnership income available for distribution to themselves, whereas the respondent, for each of those years, added to the amount of net income reported by the partnership the amounts paid to the estates of Gilmore and Ulman and included in the gross income of each of the partners a proportionate part of such amounts.

The petitioners insist that the payments made to the estates represented partnership profits, the two estates having a right to participate in earnings of the partnership during those years and that the amounts paid were not distributable to partners as profits in the partnership.

The agreement of November 30, 1907, creating the partnership of Gilmore, Pope and Ulman, contained the following provisions:

Ninth, In ease of the decease of any one of the partners the two surviving partners shall have an option upon the share or interest in the partnership of the deceased partner, and the price to he paid therefor shall be the proportionate share of the deceased partner in the profits of the business for the three years succeeding the date of his decease, or at their option a cash payment equivalent thereto if the same can be determined upon by the survivors and the legal representatives of the deceased. Said option shall be exercised, if at all, within sixty days of said decease.

Tenth, Upon the decease of one of the partners, in case said option shall not bo so exercised or the termination of the partnership from any other cause, a true and perfect account of all matters connected with said partnership shall bo made, and the expenses, leases, profits and partnership assets shall be divided between the partners in the same proportions as at that time shall govern the division of any profits.

These provisions were ratified and continued in force by the agreement of April 1,1910, under which Alfred M. Bullard was admitted to the partnership, and they were in effect at the time of the deaths of the two partners, Gilmore and Ulman, in December, 1916. They were also ratified and continued in effect by the new partnership agreement of February 10, 1917.

Upon the death of Gilmore and Ulman the old partnership stood dissolved. The surviving partners and the estates of the two deceased partners were the owners of the partnership assets. Each had a right to demand an accounting and a distribution of the assets, but such action' would have destroyed to a large extent the value of the main asset of the partnership, which was its life as a going business. It was manifestly to the interest of the parties to effect some arrangement whereby this asset would be conserved. It was also realized that the business could not continue without the acquisition of new partners to give the personal services formerly rendered by the two deceased partners.

To meet this situation a new partnership was formed under the agreement of February 10, 1917, which consisted of Pope, Bullard, Snow, Hallahan, and Perkins. The two first named contributed to this new partnership their interests in the partnership assets of the old firm, together with their services, and the three last named contributed their services. The estates of the deceased partners, Gilmore and Ulman, through their representatives, who participated in the arrangement, contributed to the new partnership their interests in the assets of the old partnership under an agreement whereby each estate was to share in the profits of the new partnership to the extent of 22% per cent each for the three calendar years 1917, 1918, and 1919, it being understood and agreed that they were not parties to the partnership agreement as such and assumed no liability thereunder. These two estates were also paid the amounts which the two deceased partners had contributed to the cash capital of the old partnership.

These two estates were not parties to the agreement of February 10, 1917, but the proof shows that they actualfy jjarticipated through their executors in the arrangement made, and the latter executed on the same day a written acknowledgment of their agreement to the arrangement effected and following this they accepted and were paid the specified proportion of the profits of the business for the years 1917, 1918, and 1919.

The partnership agreement of February 10, 1917, and the agreement made with the partnership by the executors of the two estates did not result in the creation of a partnership relation as to those estates in view of the expressed intention of the parties that no such relationship should exist, and it is admitted by all of the parties to the proceedings before us that at no time was either of the estates a partner in the firm of Cyrus Brewer <& Co.

It is insisted by the petitioners that the option given surviving partners to purchase the interest of a deceased partner was not exercised and could not be exercised, as it was conditional upon the death of one partner and could only be exercised by the remaining partners in the continuance by them of the partnership. They contend that the death of two partners created a condition which made the exercise of the option impossible.

However, it is not necessary to determine whether or not the option in question could have been exercised, as we are of the opinion that the settlements made with the estates of the two partners were occasioned by and were in substantial accord with the provisions of the several partnership agreements relative thereto. Even should it be considered that the agreement with the estates was an undertaking of the surviving general partner, Pope, and special partner, Bullard, and the three new partners, Snow, Hallahan, and Perkins, who constituted the new partnership of Cyrus Brewer & Co., our decision with respect to the relationship of all parties concerned would not necessarily be altered thereby.

We have previously held in Willard C. Hill et al., 14 B. T. A. 572, which case presented substantially the same agreement as the one here under review, that the agreement therein considered provided for the sale of the interest of a deceased partner to the surviving partners; that the transaction constituted a purchase of capital assets, and that there should be included in the net income of each surviving partner his distributive share of all amounts paid in accordance with the terms of the partnership agreement to the estate of a deceased partner. In the instant case we are convinced that the intention of all parties concerned, including the parties to both the old and new partnership agreements, was to prevent an accounting and distribution upon dissolution of the partnership, which action would have been less beneficial to all of them and which would have prevented- the estate of a deceased partner from getting out of the partnership the real value of the deceased partner’s interest. Consequently, we hold that here the partnership agreements under review and the separate agreement made with the new partnership and the executors of the estates of Gilmore and Ulman constituted a sale of the interests of the two estates to the new partnership.

The net income of a partnership, under all the revenue acts, is to be computed in the same manner and on the same basis as in the case of an individual, and in the case of an individual it is provided that in computing net income there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. Since the payments made to the estates of Gilmore and Ulman obviously are not deductible expenses, they must be included in the net income of the partnership available for distribution.

It is contended, however, that the payments to the two estates consisted of profits'paid to them as such and that the petitioners were not and should not be held liable to income tax in respect thereof. Relative to this position of petitioners we said, in Willard C. Hill et al., supra;

* * * profits of a partnership belong to the partners. They may choose to make any disposition which they wish of such profits. They may bind themselves to pay over those profits or a portion of them for the acquisition of a capital asset. We think that no valid claim may be made that the partners are not liable to income tax in respect of their shares of the partnership profits merely because by an agreement voluntarily entered into they have bound themselves to pay those profits for the acquisition of such capital asset. A partner may not avoid the income tax under an agreement by which his share or a portion of his share of the profits of the partnership are to be paid to the estate of a deceased partner in the acquiring of such deceased partner’s interest in the assets of a prior partnership.

The amounts distributable to the partners who participated in partnership profits on a percentage basis, namely, Pope, Snow, Hal-laban, and Perkins, were computed by the respondent in accordance with the following percentages:

Per cent

Arthur K. Pope_ 41.46

Francis S. Snow-' 24.24

Stephen J. I-Iallahan- 22. 20

Holten B. Perkins- 12.10

100. 00

The foregoing percentages were determined by considering the whole amount available for distribution to the partners as being-equal to 100 per cent of the net income of the partnership and adding to the percentages specified in the partnership agreement of February 10, 1927, that figure which would result in the same relationship among the partners on the basis of 100 per cent as resulted under the partnership agreement on a basis of 54% per cent, that is, the formula employed in each case was as follows: The percentage provided for in the partnership agreement bore the same relation to 54% per cent as the percentage employed by the respondent in computing the deficiency bore to 100 per cent.

With this method employed by the respondent we can not agree. An examination of the history of Cyrus Brewer & Co. reveals the fact that the interest therein of Arthur W. Pope and, subsequent to his death, that of his estate, was from the beginning greatly in excess of that of any other partner, and the partnership agreement of February 10,1917, clearly indicates that the business, at least up until December 81, 1919, was considered by all to be principally that of Pope, inasmuch as that agreement provided for the major portion of the business, namely, the name and good will of Cyrus Brewer & Co., the lease, physical property and records were to go to him and that Snow, Hallaban, and Perkins were to receive only the brokerage accounts on which each had received a commission during the last year that the old partnership was in existence. It is further noted that the partnership entered into under the agreement of February 10, 1917, terminated coincident with the expiration of the three-year period that payments were to be made to the estates of Gilmore and Ulman. While there was no direct evidence on this point, we are convinced that the interest of the two estates in the old partnership which were purchased by the new partnership ultimately went to Pope and that, considering the effect of the agreement of February 10,1917, as a whole, the interest of Snow, Hallahan, and Perkins in the partnership which terminated December 31, 1919, was limited to ownership of the brokerage accounts on which each received a commission on the 1916 books. Consequently, we are of the opinion that the net income of the partnership for income-tax purposes should be distributed as follows:

Per cent

Pope___ 68. 00

Snow- IS. 26

Hallaban_ 12.13

Perkins_ 6. 61

100. 00

Arthur K. Pope, one of the petitioners, assigns error on the part of respondent in including as a part of his taxable income for the years 1917, 1918, 1919, and 1920, that portion of the profits received by him in these years from the partnership of Cyrus Brewer. & Co. which he in turn paid over to his mother and brother under an agreement made with his father, from whom he received his original partnership interest, that he would hold the same in trust for the latter’s estate.

The father of this petitioner originally owned the interest in the old firm of Cyrus Brewer & Co. now represented by the interest of this petitioner in the present firm. The petitioner received this interest under an agreement to hold it in trust for the estate of his father and the latter died intestate, leaving a widow, a minor son, and petitioner as his surviving heirs. The record shows that this agreement has been acted upon and given effect continuously since the death of the father, the petitioner each month paying over to his mother and brother an agreed and definite portion of the profits received by him from the partnership.

Respondent takes the position that the transaction was in effect an assignment by petitioner of a portion of his income and accordingly the total amount is taxable to him individually under the rule laid down in Ormsby McKnight Mitchel, 1 B. T. A. 143, as approved in Mitchell v. Bowers, 9 Fed. (2d) 414. In this respondent has overlooked the fact that petitioner’s mother and brother did not receive their interest in the share of the partnership standing in the name of petitioner from the latter, but inherited it from Arthur W. Pope. Petitioner received that interest under an express agreement to hold it in trust for the estate of his father, tie and his mother and brother were the sole heirs and entitled to the estate. The authorities are uniform that in the case of property, title to which is taken under an express agreement to hold in trust for one or more beneficiaries, an express trust is created and the one in whose name the property stands is no more than a trustee. Odell v. Moss, 70 Pac. 547; 137 Cal. 542; Gritten v. Dickerson, 66 N. E. 1090; 202 Ill. 372; Newman v. Schwerin, 109 Fed. 942; Craig v. Harless, 76 S. W. 594; 33 Tex. Civ. App. 257; Rice v. Rice, 65 N. W. 103; 107 Mich. 241; Wilkinson v. Stitt, 56 N. E. 830; 175 Mass. 581.

This petitioner, under the rule stated, is, as to the interests of his mother and brother in the parnership interest passing to him on his father’s death, merely a trustee and any profits distributed to him are received in trust to the extent of their interests just as any other income of trust property is received. He has no beneficial interest in them. He has surrendered no interest when he pays them over to his mother and brother and the latter did not receive them as the result of an agreement made by them with petitioner. Their rights accrued as heirs of Arthur W. Pope and their agreement with petitioner as to the proportionate amounts to be paid over to them was but an incident in the performance of the trust assumed by petitioner. The rights of the parties in interest to determine an equitable division can not be questioned.

Can it be said, merely because they are profits upon a partnership interest standing in petitioner’s name, that they are distributable to him and must be included in the net personal income upon which he individually must pay a tax? We have had substantially this same situation presented to us before and have drawn definitely the distinction between those cases of which Ormsby McKnight Mitchel, supra, is an example, where the beneficial interest in the income alone has been assigned by the party owning the corpus, and those in which the income is produced by property belonging to two jointly, although the ownership of only one was disclosed and the total income actually collected by that party, who then accounted to his undisclosed co-partner in interest for the latter’s share. In these cases we have held the individual receiving the total income taxable on only the portion in which he individually had the beneficial interest, the portion paid his associate being merely received by him in trust for such party. C. R. Thomas, 8 B. T. A. 118; see also William W. Parshall, 7 B. T. A. 318; Ralph L. Hinckley, 6 B. T. A. 312; Harry P. Kelley, 9 B. T. A. 832.

In accordance with the foregoing, we hold that one-half of petitioner Arthur K. Pope’s distributive share of the profits of Cyrus Brewer & Co. should not be included in his taxable income.

The deficiency will be redetermined in accord with the foregoing findings of fact and opinion.

Reviewed by the Board.

Judgment will be entered under Rule 50.