Mauldin v. Commissioner

OPINION.

OppeR, Judge:

The only question is whether respondent’s refusal for the year 1940 to recognize the wife as a partner in the business conducted for many years by petitioner individually has been shown by the evidence to be unwarranted. Respondent has not determined that there was no partnership, but has given full credence to a newly formed partnership consisting of only petitioner and his son. He has attributed the wife’s alleged fourth share to petitioner, saying:

It is held that the amount of $14,980.28 representing one-fourth of the profits of the partnership, Rock Hill Coca Cola Company, Rock Hill, South Carolina, for the year 1940, constitutes income to you, since your wife, who reported the income, was not, in fact, a member of the partnership for profit sharing purposes. The amount of $14,980.28 has, accordingly, been included in your taxable income for the year 1940.

We are unable to conclude from the evidence that the wife was in fact a partner in the business. Although petitioner did execute the document called a “gift” to his wife and did execute another document purporting to be an agreement of partnership with his wife, there is no evidence which gives substance to these papers or indicates that a partnership with the wife was actually conducted or carried on within the meaning of the Internal Revenue Code.

It was expressly provided that the wife should contribute nothing by way of time or service to the business, and in fact she contributed nothing. Such capital as there had been in the business remained there. The wife brought nothing new to it.1 To say that there could be a business conducted as a partnership here because the wife “contributed” capital requires that we give an effect to the gift and “partnership agreement” which they did not have. The testimony shows that in every respect save one the business was conducted precisely as it had been theretofore. Not even the books of account were adjusted to reflect any new proprietary interest. See Miller v. Commissioner, 150 Fed. (2d) 823. Only the division of income was changed. But the earning of the income was in no respect altered by the formal documents which petitioner chose to execute. “It does not appear that the profits would have been any less had the agreement * * * never been executed.” Clarence L. Fox, 5 T. C. 242. And where the sole effect of such action is to attempt to attribute those profits, for tax purposes, to a different source, we think the effort can be no more effectual here than it was in Burnet v. Leininger, 285 U. S. 136.

If prior to the assignment to the wife the business was conducted as a sole proprietorship, as it clearly was, and if thereafter the conduct of the business was unchanged, as petitioner testified, we can not say that respondent erred in refusing recognition to so purely formal a gesture. As in Earp v. Jones (C. C. A., 10th Cir.), 131 Fed. (2d) 292; certiorari denied, 318 U. S. 764:

* * * The real purpose of the partnership was to minimize income taxes, It is well settled that it is not unlawful to avoid the attachment of taxes. * * * The change must, however, be real and substantial. One may not merely change the form but do business in substantially the same way. * * *

In fact, we can not tell whether the income of the business was not primarily the product of the personal services and connections of petitioner and possibly of his son, since on this phase of the issue there is no proof.2 Paraphrasing what was said in M. M. Argo, 3 T. C. 1120, 1132; affd. (C. C. A., 5th Cir.), 150 Fed. (2d) 67, “The company owned physical assets, such as land, building, machinery, and equipment, furniture and fixtures, delivery equipment, and inventories. * * * the company used physical assets3 of the value of approximately $20,000 [here $60,000] during five years. The books and partnership returns show that during the years 1937 to 1940, inclusive, the annual net earnings ranged from $15,986.88 in 1937 to $9,305.88 in 1940 [here $35,626.08 in 1935 to $54,158.14 in 1940]. Such annual earnings are 50 percent and more * * * of the capital investment in physical assets. * * * While the evidence affords no basis for a positive finding that the activities and services of the petitioner were the main factors in the production of the income, it points quite strongly in that direction. In this situation, if the petitioner would escape the tax on the distributive shares of his partners, we think that he should have shown that his activities and services were not the main factors in the production of the income of the company.”

Yet even assuming they were not so here, the agreement to divide the profits according to the supposed shares in the capital of the enterprise, while at the same time requiring full devotion of petitioner’s time and effort and those of his son to the business and the exclusion of participation by the wife, leads inevitably to the result that some— undisclosed — part of the earnings from their labor was being enjoyed by the wife — a contrivance which has long been viewed as inadmissible in dealing with the proper allocation of income tax burdens. Lucas v. Earl, 281 U. S. 111.

The fact that the wife was permitted to, and did, withdraw and use the major part of the income credited to her is not by itself significant, although the opposite may sometimes be an effective demonstration of unreality in the eyes of the parties themselves. But in all such cases, some derivative legal right, enforceable as between the parties, is recognized to exist without precluding an imposition of the tax burden upon the one actually responsible for the production of the income. Burnet v. Leininger, supra; Lucas v. Earl, supra; Clarence L. Fox, supra; M. M. Argo, supra; see Helvering v. Clifford, 306 U. S. 331; Helvering v. Horst, 311 U. S. 112.

The present facts are in many respects comparable to those in the recent case of Lewis Hall Singletary, 5 T. C. 365. The question, as we said there, is whether “they show that petitioner and his wife were ‘carrying on business in partnership’ (Sec. 181, I. R. C.) * *

* * * Testimony was also adduced indicating that petitioner felt impelled to make each gift by fairness to the respective recipients — in the case of the wife in recognition of the fact that she had aided, financially and otherwise, in the establishment of the business * * *. We would not discount a laudable show of gratitude; but, as we view it, the essential determination is more fundamental — was there a real carrying on of business in partnership?
* * * The wife brought in no new capital and contributed no services. * * * The business was carried on precisely the same after the document was executed as it had been carried on before. Moreover, it is not at all clear that the business was not largely personal in its nature, where capital was only incidental. Cf. Doll v. Commissioner, 149 Fed. (2d) 239. In any event the evidence falls far short of convincing us that the respondent erred in determining that the 1940 income from the business * * * was taxable in its entirety to petitioner.

The decision in N. H. Hazlewood, 29 B. T. A. 595, cited by petitioner, is to some extent similar to the case at bar, and it held that the wife and daughters were partners with the husband in a Coca-Cola bottling business and that the partners’ shares of the income of the business were not properly included in the husband’s taxable income. That decision was promulgated December 15, 1933, and, were it not for the later decisions heretofore cited, might require a similar decision for the taxpayer here. It is, however, not in harmony with the realistic attitude enjoined by those cases, and we are therefore constrained to reach a different conclusion.

We find that the wife was not a partner, and that respondent’s determination was correct.

Keviewed by the Court.

Decision will be entered for the respondent

Tyson, /., dissents.

In Clarence L. Fox, 5 T. C. 242, we said :

“We think that the respondent’s determination must be sustained. The manifest purpose of the petitioners in bringing their wives into the partnership set-up was that of reducing income taxes. The wives brought no capital into the business and contributed no services. The very definition of a partnership requires a contribution of capital or services, or both, by persons for the conduct of a business for the mutual benefit of the contributors. Plainly that requirement of a partnership relationship does not exist here.”

Many of the decisive figures remain obscure. For example, the 1940 agreement recites that the wife’s one-quarter contribution was $40,000. Yet almost simultaneously petitioner, for gift tax purposes, valued another one-quarter interest — that which he was then giving his son — at $25,000. Even assuming the higher figure, the wife’s “take” for 1940 of practically $15,000 was at the rate of 37% percent per annum on her “capital."

The only indication in the present case of physical assets employed, which derives from an income tax return for a prior year, shows an original undepreciated cost of less than $60,000. Computing the contribution of the wife on that basis, and conceding her a 10 percent return, the amount allocated to the earnings of her capital interest, if she had one, would be $1,500 a year instead of the $15,000 she was permitted to receive. The balance, presumably, was due to the services and management? contributed by the active partners.