1934 BTA LEXIS 1478">*1478 Held, upon the evidence, that a portion of petitioner's share of partnership earnings which was actually distributed to petitioner after actual receipt of the whole of such earnings by the partnership was taxable to the petitioner in the year in which it was distributed, notwithstanding that out of deference to another of the partners such portion was in that year placed in trust for the protection of such other partner against certain contingent liabilities, the petitioner all the while receiving and returning the income from the corpus of the trust.
29 B.T.A. 784">*785 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1926 in the amount of $13,535.34. This proceeding was consolidated with the proceeding of Le Roy E. Eastman, Docket No. 50159, for hearing only.
The following errors are alleged:
(a) Error in treating the gross sum of $285,533.33 (received by Petitioner's partners, Barton Smith and Rufus H. Baker, as Trustees' compensation in 1926) 1934 BTA LEXIS 1478">*1479 as partnership income of Smith, Baker, Effler and Eastman, immediately on receipt thereof by said Barton Smith and Rufus H. Baker.
(b) Error in treating the sum of $60,000.00 (which was a part of said $285,533.33, and which Petitioner was obliged to place in trust) as income to Petitioner in 1926.
(c) Error in construing the conditions attached to said $60,000.00 as conditions subsequent instead of conditions precedent.
(d) Error in treating the deposit of said $60,000.00 in trust as a reserve set up by Petitioner against expenses and losses incident to litigation against Barton Smith.
(e) Error in basing the determination merely on the form, and disregarding the substance of the transaction covering said $60,000.00.
FINDINGS OF FACT.
The petitioner is an individual, with residence at Ottawa Hills, Lucas County, Ohio.
During the entire year 1926 and continuously since, petitioner was and has been a partner in the law firm of Smith, Baker, Effler & Eastman, hereinafter referred to as the partnership, the partners being Barton Smith, Rufus H. Baker, the petitioner, and LeRoy E. Eastman. The partnership was created by virtue of written articles of partnership dated1934 BTA LEXIS 1478">*1480 December 29, 1924. Such articles provided, among other things, for fixed salaries for the partners and for the balancing of the books of the partnership on the last days of June and December of each year. Such articles also contained the following provision:
It is further agreed that said partners shall share in the net profits of said partnership, accruing from their practice as attorneys, counsellors and solicitors including the negotiation of money loans, and business growing out of the same; the renting, care, purchase and sale of real estate (excepting such real estate 29 B.T.A. 784">*786 as belongs to any of the members of said firm) and all personal fees, commissions and allowances of every nature, after all expenses, taxes, salaries and losses are paid, in the following proportions:
| Barton Smith | 28% |
| Rufus H. Baker | 16% |
| Erwin R. Effler | 28% |
| LeRoy E. Eastman | 28% |
It has been the uniform and consistent practice of the partnership and the individual members to interpret the above quoted provision of the articles of partnership as meaning that partnership earnings should include only the net amount realized by a particular member of the partnership from personal1934 BTA LEXIS 1478">*1481 fees, commissions, and allowances and not the gross amount of such fees, commissions, or allowances.
Barton Smith, one of the members of the partnership and a man of the highest character and of the highest standing at the bar, was sole trustee under the will of Martha H. Locke, who died in 1919. He was also trustee, with Rufus H. Baker and Maurice Allen, under the will of Robinson Locke. Barton Smith was also sole trustee under a trust created by Martha H. Locke during her lifetime, which trust is referred to as "the surviving trust." The corpus of each trust was composed in part of capital stock of the Toledo Blade Co. Barton Smith entered into negotiations for the sale of the stock held by these trusts and it became obvious that all of the outstanding stock of that company should be sold as a whole. Mabel Locke, who owned 15 shares of such stock, and Charles Locke, who owned 333 shares of such stock, each created a trust with Barton Smith as sole trustee and empowered him to sell the stock along with the stock in such company held by the other trusts. Mabel Locke and Charles Locke were also beneficiaries under the testamentary trusts. Altogether there were 1,500 shares1934 BTA LEXIS 1478">*1482 of the Toledo Blade stock outstanding, all of which was held by these various trusts except one share which Smith himself owned.
The bookkeeping for all the trusts was done by Smith's secretary in the office of the partnership. Smith personally took care of most of the details pertaining to the trusts. Substantially all of his working time was devoted to these trusts.
Baker, as one of the trustees under the will of Robinson Locke, employed the partnership to advise in legal matters and assist in the sale of the Toledo Blade stock and any other relevant matters having to do with that trust. The partnership performed services for the trust in 1926, as well as in prior years. Smith, as trustee under the trusts, employed the partnership to advise in the sale of the stock of the Toledo Blade Co. and the reinvesting of the proceeds.
The stock of the Toledo Blade Co. held by the trusts was sold to paul block of new York in June 1926 for approximately $ 3,000 a share. The negotiations leading up to the sale were handled by 29 B.T.A. 784">*787 Barton Smith in the office of the partnership. The sale of all the stock of the Toledo Blade Co. was handled by Smith and the partnership for1934 BTA LEXIS 1478">*1483 all of the stockholders. Smith was not present at the final closing of the deal. Baker consummated it.
Following the sale of the stock there were many discussions between the members of the partnership and the trustees as to how much compensation should be charged. It was finally decided that the compensation should be $200 per share of stock sold, or practically $300,000, and this rate of compensation was charged against the trusts late in the year 1926. The single share which was owned by Smith bore no part of the commission. Mabel D. Locke's account was settled first. She and Smith talked the matter over and she consented to a compensation of $200 per share. Thereafter Charles Locke agreed to $200 per share as a fair compensation. Smith made no mention to the other beneficiaries under these trusts of the compensation to be charged for the sale of this stock. However, he enclosed to them in February 1927 copies of his account filed in the probate court, and believed that these other beneficiaries would acquiesce as had Mabel D. Locke and Charles Locke and that the reasonableness of the amount would never be challenged by the beneficiaries.
Amounts totaling $285,533.331934 BTA LEXIS 1478">*1484 were paid by the trusts to the partnership. In each case, except the case of Mabel D. Locke, checks were drawn direct from the trust to the partnership. The amount of $285,533.33 was received by the partnership as follows:
| From Mabel D. Locke trust (in U.S. bonds on Nov. 1, 1926) | $3,000.00 |
| From Chas Locke trust (by check on Dec. 15, 1926) | 66,600.00 |
| From "The surviving trust" (by check on Dec. 21, 1926) | 66,600.00 |
| From Trust under will of Robinson Locke | |
| (by check on Dec. 21, 1926) | 28,533.33 |
| From Trust under will of Martha H. Locke | |
| (by check on Dec. 21, 1926) | 120,800.00 |
| Total | 285,533.33 |
Mabel D. Locke's $3,000 was paid by her turning over to Smith three United States Second 4 1/4 Liberty bonds, aggregating $3,000 par value. Smith immediately turned them over to the partnership.
Maurice Allen, one of the trustees of the Robinson Locke trust, also received compensation in the amount of $14,266.67.
On January 19, 1927, Barton Smith and Rufus H. Baker filed their accounts in connection with the testamentary trusts in the probate court of Lucas County, Ohio, which had jurisdiction over the trusts, for approval and confirmation; avd such accounts were1934 BTA LEXIS 1478">*1485 approved by the court on February 17 and February 24, 1927.
In the fourth account filed with the probate court and sworn to by Baker and Smith as trustees under the will of Robinson Locke, 29 B.T.A. 784">*788 there is shown an item of $28,533.33 which is represented therein as being cash paid on December 15, 1926, to the partnership in full of all services of the partnership and of the trustees in connection with the stock of the Toledo Blade Co. Such account also states that the trustees, pursuant to the terms of the will, employed the partnership.
The books of the partnership for the year 1926 contain the following entries of receipts:
| [Dec. 1.] Barton Smith, Trustee of Charles Locke, to services, | |
| in full of allowances of trustee for services of himself and his | |
| attorneys during the year 1926 | $66,600.00. |
| [Dec. 20.] Barton Smith, Trustee under the Will of | |
| Martha H. Locke, deceased, to services in full of allowance to | |
| trustee for services of himself and his attorneys during the | |
| year 1926 | 120,800.00. |
| [Dec. 20.] Trustees under the Will of Robinson Locke, deceased, | |
| to services and in full of allowances to trustees for services of | |
| themselves and their attorneys during the year 1926 | 28,533.33. |
| [Dec. 20.] Barton Smith, Surviving Trustee under the agreement of | |
| Martha Locke and Barton Smith and Robinson Locke, etc., to | |
| services in full of allowance to trustee for services of himself | |
| and his attorneys during the year 1926 | 66,600.00. |
1934 BTA LEXIS 1478">*1486 The above items were shown as credits to fees. There is also a credit to fees on November 1, 1926, representing the $3,000 bonds received from Mabel D. Locke. The items aggregating $285,533.33 appear in the firm's general ledger under profit and loss in December 1926.
No bill was rendered by the partnership to the trustees for legal services. The amount of $285,533.33 was not apportioned between trustees' compensation or allowances and legal fees to the partnership. The partnership, however, signed a receipt reciting that the amount of $285,533.33 was for trustees' fees and commissions and for legal services.
The commission charged to the trusts for the sale of the stock was of property of this character.
The books of the partnership show that the $285,533.33 was sisposed of by drawing checks to each of the members of the firm on December 21, 1926, as follows:
| Rufus H. Baker | $45,685.34 |
| Barton Smith | 79,949.33 |
| Petitioner | 79,949.33 |
| LeRoy E. Eastman | 79,949.33 |
The entry after each of the above names shows that cash was paid to them. The above distributions or disbursements appear in the partnership's books under profit and loss in December 1926. 1934 BTA LEXIS 1478">*1487 It has been 29 B.T.A. 784">*789 the uniform practice of the partnership to make distributions of earnings of the firm on the last day of June and the last day of December of each year at the time the books are closed, and never before the distribution of the $285,533.33 had the partnership distributed its receipts at the time they were received. This amount was distributed as soon as the most of it was received because of the peculiar situation that existed and the resultant special arrangement Smith insisted upon with regard to the shares of Eastman and the petitioner. This arrangement will be referred to hereinafter.
In June 1926 the profit and loss account of the partnership shows fees in the amount of $38,613.23 for the first six months of that year. The account for the last six months ending December 31, 1926, showed fees in the amount of $315,141.83. Both of those amounts were carried from the fees account to the profit and loss account. The profit and loss account at June 30, 1926, shows credits of $38,733.06, and at December 31, 1926, it shows credits of $318,745.21.
The books show that the partnership on June 30, 1926, declared a dividend of $337.36, composed of earnings1934 BTA LEXIS 1478">*1488 of the prior partnership, and that the partnership declared a dividend of $2,000 on July 22, 1926, a dividend of $6,000 on August 31, 1926, and a dividend of $285,533.33 on December 21, 1926.
Smith in 1926 was more than 70 years of age and was in poor health. He was desirous of closing out the trusts at the end of the year 1926 and filing his accounts with the probate court. He therefore wanted to have the situation as nearly complete and definite as possible in the year 1926. Furthermore, since the trusts would owe large taxes for the year 1926, due to the sales of stock, he wanted them to have the benefit of the deduction of all trustees' fees and allowances. This amount of $285,533.33 was placed upon the books of the partnership in the year 1926 because Smith wanted it of record to protect his trusts in taking the deductions. He also wanted to get the matter settled for the purposes of his own and Baker's individual income tax returns.
Growing out of the negotiations for the sale and the sale of the stock held by the trusts, certain claims in large amounts were asserted and suits were threatened thereon against the trustees individually. These claims were asserted at1934 BTA LEXIS 1478">*1489 and prior to the time the amount of $285,533.33 was paid out by the trusts. One of these claims was to the effect that Barton Smith had made an oral agreement with a local broker, Louie H. Gould, under the terms of which the broker was to endeavor to find a purchaser for the stock on terms agreed upon, obtaining his compensation from the purchaser, and Barton Smith was either to make the sale or to see that it was made to such purchaser. It was claimed by the broker that he found such a purchaser on the terms fixed; that such purchaser agreed to 29 B.T.A. 784">*790 pay the broker's commission of $250,000; and that Barton Smith refused to carry out his agreement with the broker, the stock being sold to someone else, by reason of which the broker lost his $250,000 commission. This claim was made the subject of a suit for damages in the sum of $250,000 and interest in the court of common pleas of Lucas County, Ohio, on August 15, 1927. The suit was brought against Smith personally rather than as trustee, because he negotiated the sale. This suit, after being disposed of in the court of common pleas in favor of Barton Smith, was carried to the court of appeals of Lucas County, Ohio, and while1934 BTA LEXIS 1478">*1490 there pending was settled in the fall of 1929. The amount paid in settlement of the broker's litigation was $15,000. Expenses were incurred also in employing two firms of outside counsel in that litigation. There were also other expenses and court costs. The petitioner was actively engaged in the work connected with this litigation in which Smith was involved.
The other of these claims was to the effect that Barton Smith had made a contract for an option with a prospective purchaser, Clem Miniger, procured by the broker, covering all of the stock of the Toledo Blade Co. This claim has never been brought to suit or disposed of in any way.
Smith believed that these claims were being made by persons who were not bluffing, that the suits would be long drawn out and expensive, and that he would probably be dead before they terminated. He therefore did not want to hold the moneys that would be coming to him as trustee's compensation in connection with these sales and have his estate charged with the accounting of it.
Smith refused to turn this $285,533.33 over to the partnership if it were going to be credited to and used by each of the members of the firm. He was very insistent1934 BTA LEXIS 1478">*1491 that Eastman and the petitioner should not touch in any way or use any of this money, at least to the extent of $60,000 each, until the claims against the fund by Gould and Miniger were disposed of and the report which he had filed in the probate court was approved. Smith did not object to Baker's receiving his share, since Smith felt that Baker was financially able to respond to any claims that might finally be adjudicated against the fund, but he did not feel that way about the petitioner and Eastman, and he insisted that some way be worked out by which the money could not be touched by them until those claims were finally disposed of.
The share of petitioner and Eastman in this amount of $285,533.33 was $79,949.33 each, but shortly before December 21, 1926, Smith laid before the petitioner and Eastman in his office a form of agreement by which each was to be allowed to have and use $19,949.33, and by which $60,000 in each case was to be placed in trust. The 29 B.T.A. 784">*791 petitioner protested about this, but, due partly to loyalty to Smith, petitioner and Eastman finally yielded to Smith's demands.
On December 21, 1926, the partnership issued checks to Smith, Eastman, and the1934 BTA LEXIS 1478">*1492 petitioner each in the amount of $79,949.33, and a check to Baker in the amount of $45,685.34. Petitioner endorsed his check for $79,949.33 and immediately deposited it. Then in accordance with Smith's demands, to which he had acceded, he drew his own personal check for $60,000, payable to the Home Bank & Trust Co., turned it over to Smith, and signed an indemnity agreement, which provided in part as follows:
KNOW ALL MEN BY THESE PRESENTS, That I, ERWIN R. EFFLER, am held and firmly bound unto BARTON SMITH, his heirs, executors, administrators and assigns, in the sum of ONE HUNDRED THOUSAND DOLLARS ($100,000) lawful money of the United States of America, to be paid to the said Barton Smith, his heirs, executors, administrators or assigns, to which payment well and truly to be made I bind myself, my heirs, executors and administrators and assigns firmly by these presents.
Dated this 21st day of December, A.D. 1926.
* * *
WHEREAS, During the year 1926 the said Barton Smith, as Trustee, sold the capital stock of The Toledo Blade Company, and has paid and does contemporaneously with the execution and delivery of this Agreement pay to said firm of Smith, Baker, Effler & Eastman1934 BTA LEXIS 1478">*1493 the following sums:
| As Trustee under the Will of Martha H. Locke, deceased | $120,800.00 |
| As and for the Trustees under the Will of Robinson Locke, deceased | 28,533.33 |
| As Surviving Trustee under the Agreement between | |
| Martha H. Locke and Barton Smith and Robinson Locke | |
| and the Survivor of them | 66,600.00 |
| As Trustee of Charles Locke | 66,600.00 |
| As Trustee of Mabel D. Locke | 3,000.00 |
| making a total of | $285,533.33 |
which amount said firm claims to be fair, reasonable and just compensation for the services and allowance to said Barton Smith under the said several trusts, and to said firm of Smith, Baker, Effler & Eastman and the several members of said firm during said calendar year 1926; and
WHEREAS, Said firm is now about to distribute said claimed earnings in accordance with the partnership contract under which said firm has been doing business during said year, and the amount which has been and is to be received by the undersigned during said year 1926 is the sum of Seventy-nine Thousand Nine Hundred Forty-nine and 33/100 Dollars ($79,949.33) and
WHEREAS, The amount of said earnings has not been adjudicated, and there is a possibility that claims for compensation1934 BTA LEXIS 1478">*1494 damages, and brokerage fees may be asserted against said Barton Smith, his executors, administrators or assigns; and
WHEREAS, The undersigned, in consideration of the distribution to him as a member of said firm of said sum of Seventy-nine Thousand Nine Hundred Forty-nine and 33/100 Dollars (79,949.33) as aforesaid, covenants and agrees to pay to said Barton Smith, his executors, administrators or assigns, twenty-eight (28) percentum of all and singular the loss, damages, deductions and 29 B.T.A. 784">*792 expenses which from time to time he or his executors, administrators or assigns may incur or become liable to pay by reason of said payment of said fees, commissions and allowances, to said firm of Smith, Baker, Effler & Eastman, * * * [Then follows a provision that if Effler pays his share of losses, etc. then this instrument is to be void.]
For the purpose of securing the performance of this Agreement and of each and every part thereof, the undersigned, ERWIN R. EFFLER, hereby agrees to and does hereby deposit the sum of SIXTY THOUSAND AND 00/100 DOLLARS ($60,000.00) with The Home Bank & Trust Company of Toledo, Ohio, its successor and successors, as Trustee, on the following terms1934 BTA LEXIS 1478">*1495 and conditions: [Then follow, among other provisions, provisions that the trustee is to pay Effler's share of any loss etc., that after Barton Smith shall be fully relieved from liability and all payments required to be paid by Effler have been paid, then the trust property is to be delivered to Effler, and that in the event that no claims are asserted against Barton Smith in any court proceedings within six years, then the trust property is to be delivered to Effler.]
Eastman was out of town on December 21, 1926. Before he left, however, he signed an indemnity agreement similar in all respects to the indemnity agreement signed by the petitioner, drew his personal check for $60,000, payable to the Home Bank & Trust Co., and left instructions for his check for $79,949.33 to be deposited in order to cover the $60,000 personal check which he had drawn.
Smith turned over both the checks signed by Eastman and the petitioner to the Home Bank & Trust Co.
The payments by the trusts to the partnership on December 21, 1926, the issuance of the checks to the members of the partnership, the drawing of the personal checks by Eastman and the petitioner payable to the Home Bank & Trust1934 BTA LEXIS 1478">*1496 Co., and the signing of the indemnity agreements were all done as a part of the same transaction.
The Home Bank & Trust Co. paid by cashier's checks to Eastman 4 percent interest upon the trust fund quarterly, and to the petitioner 4 percent interest semiannually. During 1927 and 1928 the interest thus received by the petitioner and Eastman was returned by them as taxable income.
In accordance with the indemnity agreements, the Home Bank & Trust Co., as trustee, paid out of each trust fund of $60,000 and interest thereon the 28 percent of the $15,000 settlement of the broker litigation which was due from the petitioner and from Eastman. Other items were also paid out. The shares of such settlement and expenses which were payable by Baker and Smith were paid by them since they had received, unqualifiedly, their full shares of the $285,533.33. After payment of his share of the settlement and expenses, the amount remaining in the trust for the petitioner was $53,901.95. This amount was released to the petitioner under date of November 2, 1929, in accordance with the following letter:
29 B.T.A. 784">*793 October 31, 1929
The Home Bank & Trust Co., Trustee
Toledo, Ohio.
Gentlemen:
1934 BTA LEXIS 1478">*1497 On the 21st day of December, 1926, I accepted an Indemnity Agreement from Erwin R. Effler, to protect me against certain threatened litigation, and on the same day Erwin R. Effler deposited with you in trust the sum of Sixty Thousand Dollars ($60,000.00) as security for the performance of his part of the Agreement.
Without releasing, modifying or limiting in any manner or form the aforesaid Agreement made between Mr. Effler and me at that time, and leaving said Indemnity Agreement in full force, I hereby consent to and authorize you to pay over to Erwin R. Effler the Sixty Thousand Dollars ($60,000.00) deposited with you as Trustee, and this shall be full release, acquitance and discharge to you from any duty under said trust.
Very truly yours,
[Signed] BARTON SMITH.
After payment of his share of the settlement and other expenses, the amount remaining in trust for Eastman amounted to $53,893. This amount was released to Eastman under date of October 31, 1929, in accordance with a letter to the Home Bank & Trust Co. from Smith, in every material respect similar to the letter quoted above written in regard to the petitioner.
Although the claim by the prospective purchased1934 BTA LEXIS 1478">*1498 had not been settled, Smith was willing to release the balance in each case to petitioner and Eastman because the indemnity agreement with a limitation of $100,000 was still in force and effect.
The petitioner and Eastman each returned the amount of such balance as income on his income tax return for the year 1929 and paid his tax thereon.
Baker received his 16 percent of the amount of $285,533.33 in 1926 and reported the same in his income tax return for that year. When he later had to pay a part of the expenses, he took deductions on his returns for the years in which he paid such expenses. Smith received his 28 percent of the $285,533.33 in 1926 and reported the same in his income tax return for that year.
In the return filed by Smith for the year 1926 for the trust under the will of Martha H. Locke, deceased, there were deducted the expenses for commissions paid or incurred upon the sale of the Toledo Blade stock in the amount of $120,800.
In the return for the year 1926 filed by Barton Smith, Rufus H. Baker and Maurice Allen, trustees under the will of Robinson Locke, there were deducted the trustees' compensation paid in the amount of $28,533.33 to Barton Smith1934 BTA LEXIS 1478">*1499 and Rufus H. Baker and also the amount of $14,266.67 which was paid to Maurice Allen as one of the trustees.
29 B.T.A. 784">*794 In the return filed for the year 1926, by Barton Smith, surviving trustee under the deed of Martha H. Locke, there were deducted the commissions or expenses paid on the sale of the Toledo Blade stock in the amount of $66,600.
In the income tax return filed by the partnership for the year 1926 there are shown fees received in the amount of $353,680.08 and net profits of $330,340.37.
In their income tax returns for the year 1926 the petitioner and Eastman each included only $19,949.33 as the portion of the item of $285,533.33 taxable to each in the year 1926.
The each of the returns filed by the partnership, the petitioner, and Eastman for the year 1926 is attached a statement explaining that due to certain claims and threatened suits against Smith, $60,000 of each of the shares of the petitioner and Eastman in the amount of $285,533.33 was placed in trust until the questions were settled, and that such amounts were still in trust at the time of filing the returns.
In determining the deficiency against the petitioner and Eastman, the respondent added1934 BTA LEXIS 1478">*1500 to the net income reported by each the amount of $60,000.
OPINION.
MCMAHON: We are here called upon to determine whether the respondent erred in including in the taxable income of the petitioner for the year 1926 the amount of $60,000 constituting a part of the amount of $285,533.33. This item of $285,533.33 is the aggregate of amounts which were actually paid by certain trusts to the partnership of Smith, Baker, Effler & Eastman in the year 1926, and constituted either fees to Smith and Baker, two of the members of the partnership, for their services as trustees, or such trustees' fees and, in addition, fees to the partnership for legal services. The greater part of this amount was paid by checks from the trusts to the partnership. A small amount was paid by transferring three United States bonds to the partnership. The books of the partnership show that the full amount of $285,533.33 was received in the year 1926 and it was treated therein as income in that year. The books of the partnership show that on December 21, 1926, a dividend of $285,533.33 was declared by the partnership. Each partner received in 1926 a check for his share of this amount of $285,533.33, the petitioner1934 BTA LEXIS 1478">*1501 receiving a check for $79,949.33, being his 28 percent share under the partnership agreement. The books of the partnership show that each partner received his share during 1926. In this regard the following testimony of Cecile B. Carmichael, bookkeeper of the partnership, is pertinent:
29 B.T.A. 784">*795 Q. So that the entire amounts of these several items of cash received including the $3,000 bonds, were put through the firm's books as fees received, is that right?
A. Yes, sir.* * *
Q. Now, what do your books show about the disposition that was made of this money, this $285,000?
A. On December 21st, 1926, journal page 138, I show checks drawn to the members of the firm:
| Rufus H. Baker | $46,685.34 |
| Barton Smith | 79,949.33 |
| Erwin R. Effler | 79,949.33 |
| LeRoy E. Eastman | 79,949.33 |
Before causing the trusts to pay the amount of $285,533.33 to the partnership, Smith insisted that the petitioner and Eastman agree to the placing of $60,000 of each of their shares in trust until certain claims against Smith arising out of the sale of1934 BTA LEXIS 1478">*1502 certain of the trust assets were settled. The petitioner and Eastman agreed to this. Petitioner and Eastman each deposited his check upon receiving it, but each immediately placed $60,000 in trust and signed an indemnity agreement. Smith and Baker each returned his partnership share of the amount of $285,533.33 as income in the year 1926. In the returns filed on behalf of the trusts for the year 1926 the amounts comprising the item of $285,533.33 were deducted as having been paid out in the year 1926.
The respondent held that the full amount of $285,533.33 constituted income of the partnership of Smith, Baker, Effer & Eastman in the year 1926 and that the petitioner is taxable in 1926 upon his 28 percent share, $79,949.33. Of this amount the petitioner returned as taxable to him in the year 1926 the amount of $19,949.33, and no question is raised as to the taxability of that amount, the controversy being as to the taxability in 1926 of the remainder, $60,000.
There is considerable controversy between the parties over the question of just what the item of $285,533.33 represents. The petitioner, in his brief, argues upon the theory that it represents solely trustees' fees, 1934 BTA LEXIS 1478">*1503 whereas the respondent contends that it was in payment of both fees to the trustees and legal fees to the partnership. However, we find it unnecessary to determine this question, since in either event it is our opinion that the amount of $285,533.33 constituted income of the partnership in the year 1926.
The income tax is imposed upon the income received in any particular accounting period, regardless of whether any particular transaction 29 B.T.A. 784">*796 which as a whole extends over a number of years results in a profit or loss.
In , the Supreme Court stated in part:
That such receipts from the conduct of a business enterprise are to be included in the taxpayer's return as a part of the gross income, regardless of whether the particular transaction results in net profit, sufficiently appears from the quoted words of Section 213(a) and from the character of the deductions allowed. Only by including these items of gross income in the 1920 return would it have been possible to ascertain respondent's net income for the period covered by the return, which is what the statute taxes. * * *
1934 BTA LEXIS 1478">*1504 In ; affirmed in ; certiorari denied, , we stated:
Questions of postponing tax liability until transactions have been concluded in later years have been before the Board in numerous cases and we have uniformly held that the income tax is imposed on an annual basis [emphasis supplied] and its imposition can not await the winding up of a business, but is imposed annually upon the gains which arise from transactions from year to year. ; ; ; ; ; ; affd., ; and .
In the last mentioned case the Board, in speaking of the principle for which petitioner is now contending, said (p. 197):
1934 BTA LEXIS 1478">*1505 * * * Upon the petitioner's theory its tax liability can be projected indefinitely into the future, and, in effect, the Government must assume the hazards of the business with no share in its management and must await collection of its revenue until it is petitioner's pleasure to conclude its operations. Speaking of an analogous contention, the Board said, in , that it "would enable a taxpayer to postpone indefinitely the return of income which has actually been received, which result, in our opinion, is inconsistent with the theory of the tax laws."
To the same effect is .
See also , and . In the latter case, the court stated:
* * * The true normal criterion to be applied in this class of case is the actual receipt and retention during the year in question of what was then considered to be income, not whether the taxpayer exposed himself to possible personal liability. [Emphasis supplied.]
Under the principles set forth in the above authorities, we think1934 BTA LEXIS 1478">*1506 it clear that the amount of $285,533.33 constituted income to the partnership in the year 1926.
The proof shows that the amount of $285,533.33 was actually paid over to the partnership in the year 1926 and, as heretofore stated, 29 B.T.A. 784">*797 that Smith and Baker, two of the members of the partnership, unqualifiedly received the benefit of their shares therein in the year 1926 and returned such shares as taxable income to them in that year. It is true that Smith, before causing the amount in question to be transferred to the partnership, insisted, and the petitioner and Eastman agreed, that the petitioner and Eastman should each place $60,000 in trust pending the settlement of claims against Smith. However, this does not affect the question of whether it was income to the partnership in the year 1926 under the revenue act. Even if it were considered that the full amount of $285,533.33 constituted in the first instance, fees to Smith and Baker as trustees, such amount became, under the partnership agreement, income of the partnership in the year 1926, the year such amount was earned and paid. It is true, as pointed out by the petitioner, that under the articles of partnership only1934 BTA LEXIS 1478">*1507 the net amount of the personal fees to the members of the partnership, after all expenses, taxes, salaries, and losses are paid, constituted partnership income. If expenses, taxes, salaries, or losses had been paid by Smith and Baker in the year 1926 in earning fees from the trust, then under the articles of partnership the amounts thereof would be deducted before computing the amount which inured to the benefit of the partnership. But no such expenditures were made by Smith or Baker in the year 1926 and, as hereinabove indicated, the trust did pay out the amount of $285,533.33 in 1926 as compensation either to the trustees or to the trustees and the partnership, and the partnership actually received it in 1926.
The fact that at the close of 1926 the probate court of Lucas County, Ohio, had not approved the trustees' reports, and the fact that at that time claims of Gould and Miniger against Smith had not been settled, do not serve to postpone the taxability of the amount of $285,533.33 beyond the year 1926. There is no showing here by petitioner that the authorization or approval by the probate court of the payment of $285,533.33 by the trustees was required before actual payment, 1934 BTA LEXIS 1478">*1508 and the prospect was that its approval after payment would not be challenged. Furthermore, for the purpose of applying the Federal revenue acts, those acts have their own criteria for the determination of what is taxable income, irrespective of local law. .
Under the provisions of section 218(a), (c) of the Revenue Act of 1926, 1 the full share of a partner in the partnership income of any 29 B.T.A. 784">*798 particular year is taxable to him whether distributed or not. Having held that the amount of $285,533.33 was income to the partnership in 1926, it follows that even if the petitioner's partnership share therein were not distributed to him it would be taxable to him. But here it was actually distributed to him. The fact that the petitioner placed a portion of his share in trust in accordance with the demand of Smith, does not relieve him of his liability to pay a tax thereon in 1926. Cf. , affirming , wherein the court stated:
To permit partners to distribute the profits otherwise than according to the partnership1934 BTA LEXIS 1478">*1509 agreement and thereby escape their liability imposed by law, would disrupt the scheme of taxation adopted by Congress.
See also .
It was the position of the petitioner that, at the time Smith made his demands, he, petitioner, could not and should not be compelled to agree thereto. He yielded to Smith's insistence without compulsion and out of deference to Smith. In this connection, the following testimony of the petitioner is enlightening:
A. * * * I told him [Smith], I did not think that that was quite a fair condition to impose. I have tried to say that we were dealing1934 BTA LEXIS 1478">*1510 with a man of advanced age and ill, and I think Your Honor will permit me to say that contact in the firm for many years with a man of that character - of the highest character - certainly forces a feeling of loyalty and perhaps some embarrassment when a paper is put before you as strenuous as this instrument was - Mr. Eastman, when he saw how Mr. Smith reacted, urged me to waive any objections, but I felt I should stand on the objection, and I said so. It finally resulted in our yielding to his insistence that he would hold that money in those trusts. * * *
We conclude that the action taken by the petitioner in placing $60,000 of his share in trust was his own act which could not be legally compelled, and, as pointed out above, such action, irrespective of how commendable his motives were, can not operate to relieve him of his tax liability upon his full share in the year 1926. When the petitioner in 1926 received a check for his full share he was, as a matter of law, free to do with it as he wished, and we are no more concerned with his motives in placing a part of it in trust as he did than we would be if he had placed it in trust for the benefit of some member of his family1934 BTA LEXIS 1478">*1511 or for some charitable or educational purpose.
The evidence shows that in years subsequent to 1926 the petitioner received interest upon the $60,000 which had been placed in trust and that he returned such interest as taxable income to him. This is wholly inconsistent with the theory now advanced by petitioner that he did not become the owner of the $60,000 in 1926, and it sustains our conclusion.
The fact that in later years a portion of the petitioner's share was required to be contributed toward the payment of the settlement of 29 B.T.A. 784">*799 the litigation against Smith, and other expenses, has no bearing upon the question of the taxability of his entire share in the year 1926. See , and
The petitioner concedes that the form of the transactions herein is against his contention, but contends that the substance of the transactions supports his view that the amount of $60,000 was not taxable to him in the year 1926. However, we believe that the form truly reflects the substance of the transactions. It is elementary that taxation is a practical matter1934 BTA LEXIS 1478">*1512 and that we must look to what actually happened. Tested by what actually happened here, the $60,000 was income to the petitioner in 1926.
The petition contains five assignments of error, all of which, however, are directed toward showing that the respondent erred in including the $60,000 in petitioner's taxable income for the year 1926. Our discussion above disposes of the contentions advanced by the petitioner in assignments of error (a), (b), and (e). Our holding above that the form reflects the substance, that Smith had no legal right to impose any condition upon the petitioner's use of his full share of the partnership income in question and that it was actually received by petitioner in 1926, makes further discussion unnecessary of the petitioner's contention in assignment of error (c) that the condition was a condition precedent to the vesting of title to the $60,000 in the petitioner. With regard to assignment of error (d), it matters not whether the $60,000 was set up by the petitioner as a reserve against expenses and losses incident to litigation against Smith. In any event such amount was first income to the petitioner.
Decision will be entered for the respondent.1934 BTA LEXIS 1478">*1513
Footnotes
1. Sec. 218. (a) Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the not income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year * * *.
* * *
(c) 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. ↩