[225]*225OPINION.
Smith:
The decision on the first question involved in these proceedings is governed by the Board’s decisions in Charles Colip, 5 B. T. A. 123, and Walter A. DeCamp, 6 B. T. A. 897. In accordance therewith the question must be resolved adversely to the petitioners.
The second question relates to the “ earned income ” of each petitioner for the calendar year 1924. Each was a member of a partner[226]*226ship which provided in its partnership agreement for the payment of salaries to members. Under the agreement each of the three partners was to receive a salary of $8,000 per year. By reason of the fact that Leo Schwartz rendered more valuable services to the partnership than those rendered by the other partners, the partnership agreement provided, as indicated in the findings of fact, that certain credits should be made to the account of Schwartz and deducted from the stock accounts of Rich and Joseph for the purpose of adequately compensating him for services performed. So far as the record shows these credits were to be made to Schwartz even though the net result of the partnership operations was a loss in any year. Schwartz claims that his earned income for the year 1924 was $8,000 from the partnership and $3,500 additional from Rich and Joseph. Rich claims that his earned income for the year was $8,000.
Section 218(a) of the Revenue Act of 1924 provides in part:
Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.
Subsection (c) of the same section provides:
The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (10) of subdivision (a) of section 214 shall not be allowed.
Section 209 of the Act provides in part as follows:
(a) For the purposes of this section—
(1) The term “earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income.
(2) The term “ earned income deductions ” means such deductions as are allowed by section 214 for the purpose of computing net income, and are properly allocable to or chargeable against earned income.
(3) The term “ earned net income ” means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpaj'er’s net income is not more than $5,000, his entire net income shall be considered to be earned net income, and if his net income is more than $5,000, his earned net income shall not be considered to bo less than $5,000. In no case shall the earned net income be considered to be more than $10,000.
*******
(c) In the case of the members of a partnership the proper part of each share of the net income which consists of earned income shall be determined [227]*227under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary and shall be separately shown in the return of the partnership and shall be taxed to the member as provided in section 218.
The only regulations which the respondent has promulgated relating to this section are articles 1661 and 1662 of Regulations 65. The former provides—
* * * The earned income credit will be allowed to the members of a partnership with respect to the share of the net income belonging to each which consists of earned income. There must be included in the return of the partnership a statement showing (1) the amount of earned income as defined in article 1662, and (2) the names of the members and the amounts of their respective shares of earned income.
Article 1662 provides in part:
The term “ earned income ” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, a reasonable allowance in compensation for personal services actually rendered by the taxpayer shall be considered as earned income, but the total amount which shall be treated as the earned income of the taxpayer from such trade or business shall, in no case, exceed 20 per cent of his share of the net profits of such trade or business.
Although subdivision (c) of section 209 of the taxing statute contemplates that the Commissioner shall make regulations for the purpose of determining the earned income of a partner, the application of the above quoted regulations to the case at bar is somewhat obscure. The fair inference to be drawn from them is that where partners are engaged in a trade or business in which both personal services and capital are material income-producing factors, the 20 per cent limitation on the share of the profits which may be considered earned income provided for by subsection (1) of paragraph (a) of section 209 of the taxing statute is applicable. That the Commissioner has so interpreted his regulations is clear from the fact that form 1065-A, upon which partnerships were required to make returns for 1924, provides that any amounts paid as salaries to partners shall be included in the distributable net income and that they shall not be deducted from gross income in arriving at the net income.
In Mimeograph 3283, C. B. IY-I, p. 14, Ruling No. IV-9-2045, it is stated:
(c) In tbe case of a partnership which is engaged in a trade or business in which both capital and labor are material income-producing factors, each partner who renders services may consider as reasonable compensation for such services an amount not in excess of 20 per cent of his share of the net profits of the partnership. A member of the partnership who does not render services to the partnership may not consider any part of his share of the profits as yarned income.
[228]*228(e) Attention is called to the fact that in the forms for 1924, salaries paid to the individual members of a partnership are not to be deducted in computing the net profits of the partnership, and the members do not report the salaries received from the partnership in item 1, Form 1040, as salary, but include such salary in the profits from the partnership, which are reported in item 4, Form 1040. If the partnership is engaged in a business in which capital is not a material income-producing factor, it will not be necessary for column 4 of item 13, Form 1065, to be filled in, since the 20 per cent limitation does not apply.
Free access — add to your briefcase to read the full text and ask questions with AI
[225]*225OPINION.
Smith:
The decision on the first question involved in these proceedings is governed by the Board’s decisions in Charles Colip, 5 B. T. A. 123, and Walter A. DeCamp, 6 B. T. A. 897. In accordance therewith the question must be resolved adversely to the petitioners.
The second question relates to the “ earned income ” of each petitioner for the calendar year 1924. Each was a member of a partner[226]*226ship which provided in its partnership agreement for the payment of salaries to members. Under the agreement each of the three partners was to receive a salary of $8,000 per year. By reason of the fact that Leo Schwartz rendered more valuable services to the partnership than those rendered by the other partners, the partnership agreement provided, as indicated in the findings of fact, that certain credits should be made to the account of Schwartz and deducted from the stock accounts of Rich and Joseph for the purpose of adequately compensating him for services performed. So far as the record shows these credits were to be made to Schwartz even though the net result of the partnership operations was a loss in any year. Schwartz claims that his earned income for the year 1924 was $8,000 from the partnership and $3,500 additional from Rich and Joseph. Rich claims that his earned income for the year was $8,000.
Section 218(a) of the Revenue Act of 1924 provides in part:
Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.
Subsection (c) of the same section provides:
The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (10) of subdivision (a) of section 214 shall not be allowed.
Section 209 of the Act provides in part as follows:
(a) For the purposes of this section—
(1) The term “earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income.
(2) The term “ earned income deductions ” means such deductions as are allowed by section 214 for the purpose of computing net income, and are properly allocable to or chargeable against earned income.
(3) The term “ earned net income ” means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpaj'er’s net income is not more than $5,000, his entire net income shall be considered to be earned net income, and if his net income is more than $5,000, his earned net income shall not be considered to bo less than $5,000. In no case shall the earned net income be considered to be more than $10,000.
*******
(c) In the case of the members of a partnership the proper part of each share of the net income which consists of earned income shall be determined [227]*227under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary and shall be separately shown in the return of the partnership and shall be taxed to the member as provided in section 218.
The only regulations which the respondent has promulgated relating to this section are articles 1661 and 1662 of Regulations 65. The former provides—
* * * The earned income credit will be allowed to the members of a partnership with respect to the share of the net income belonging to each which consists of earned income. There must be included in the return of the partnership a statement showing (1) the amount of earned income as defined in article 1662, and (2) the names of the members and the amounts of their respective shares of earned income.
Article 1662 provides in part:
The term “ earned income ” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, a reasonable allowance in compensation for personal services actually rendered by the taxpayer shall be considered as earned income, but the total amount which shall be treated as the earned income of the taxpayer from such trade or business shall, in no case, exceed 20 per cent of his share of the net profits of such trade or business.
Although subdivision (c) of section 209 of the taxing statute contemplates that the Commissioner shall make regulations for the purpose of determining the earned income of a partner, the application of the above quoted regulations to the case at bar is somewhat obscure. The fair inference to be drawn from them is that where partners are engaged in a trade or business in which both personal services and capital are material income-producing factors, the 20 per cent limitation on the share of the profits which may be considered earned income provided for by subsection (1) of paragraph (a) of section 209 of the taxing statute is applicable. That the Commissioner has so interpreted his regulations is clear from the fact that form 1065-A, upon which partnerships were required to make returns for 1924, provides that any amounts paid as salaries to partners shall be included in the distributable net income and that they shall not be deducted from gross income in arriving at the net income.
In Mimeograph 3283, C. B. IY-I, p. 14, Ruling No. IV-9-2045, it is stated:
(c) In tbe case of a partnership which is engaged in a trade or business in which both capital and labor are material income-producing factors, each partner who renders services may consider as reasonable compensation for such services an amount not in excess of 20 per cent of his share of the net profits of the partnership. A member of the partnership who does not render services to the partnership may not consider any part of his share of the profits as yarned income.
[228]*228(e) Attention is called to the fact that in the forms for 1924, salaries paid to the individual members of a partnership are not to be deducted in computing the net profits of the partnership, and the members do not report the salaries received from the partnership in item 1, Form 1040, as salary, but include such salary in the profits from the partnership, which are reported in item 4, Form 1040. If the partnership is engaged in a business in which capital is not a material income-producing factor, it will not be necessary for column 4 of item 13, Form 1065, to be filled in, since the 20 per cent limitation does not apply. An individual who is engaged in a trade or business on his own account should not deduct in Schedule A, Form 1040, any compensation paid to himself. All of the profits from the business should be reported in item 2, Form 1040.
As above indicated the respondent has computed the deficiencies upon the basis that the last sentence of section 209(a)(1) of the taxing statute applies to each petitioner. This is objected to by the petitioners on the ground that it is the partnership which is engaged in a trade or business and not each petitioner and that a partnership is not a “ taxpayer ” within the meaning of the taxing statute. That a partnership is not a taxable entity is of course conceded. In United States v. Coulby, 251 Fed. 982, it was stated:
This law [Revenue Act of 1913], therefore, ignores for taxing purposes the existence of a partnership. The law is so framed as to deal with the gains and profits of a partnership as if they were the gains and profits of the individual partner. The paragraph above quoted so provides. The law looks through the fiction of a partnership and treats its profits and its earnings as those of the individual taxpayer. Unlike a corporation, a partnership has no legal existence aside from the members who compose it. The Congress, consequently, it would seem, ignored, for taxing purposes, a partnership’s existence, and placed the individual partner’s share in its gains and profits on the same footing as if his income had been received directly by him without the intervention of a partnership name.
On appeal the above statement was approved, but with the following reservation, 258 Fed. 27:
* * * We concur in and adopt the conclusion reached. However, the statement made in the opinion that a partnership has no legal existence, aside from the members who compose it, is too broad, as, for instance, in view of the Bankruptcy Act (Act July 1, 1898, c. 541, 30 Stat. 544 [Comp. St. §9585 et seq.]), yet as applied to the particular portion of the statute and the question in hand it is correct, and with this explanation we approve the reasoning of the opinion.
We think that the language of section 209(a) (1) is applicable to each of these petitioners.
Under the partnership agreement Leo Schwartz received in 1924, $8,500 more than his share of the partnership profits. This money was to compensate him in part for services performed to the partnership. It was charged to the stock accounts of the other two partners. It was payable without regard to profits or losses made or sustained [229]*229by the partnership. We think that the amount was “ earned income ” of Schwartz.
In our opinion the respondent has correctly determined that the earned income of Rich for the year 1924 was the amount of $5,000.
Judgment will be entered on 16 days’ notice, under Bule 50.