1927 BTA LEXIS 2482">*2482 Under the evidence held that the payments involved herein made by the petitioners to their mother in the years 1921 and 1922, are not proper deductions in computing the petitioner's net income for those years.
9 B.T.A. 955">*955 These proceedings are for the redetermination of deficiencies in income taxes asserted by the respondent against the petitioners for the years 1921 and 1922 as follows:
| Year | Amount | |
| Robert L. Scott | 1921 | $2,608.50 |
| Robert L. Scott | 1922 | 2,518.48 |
| Frederick H. Scott | 1921 | 2,577.16 |
| John W. Scott | 1921 | 3,394.92 |
| John W. Scott | 1922 | 2,762.68 |
The proceedings were consolidated for hearing and decision.
9 B.T.A. 955">*956 FINDINGS OF FACT.
The petitioners are the sons and only children of John E. Scott, deceased, who was from the year 1891 until August 1, 1907, a member of the partnership of Carson, Pirie, Scott & Co., which was engaged in the wholesale and retail dry goods business at Chicago, Ill. John E. Scott from time to time gave to his sons a part of his interest in the partnership, 1927 BTA LEXIS 2482">*2483 and as they successively arrived at what he considered the age of discretion, they were admitted as partners. John W. Scott was the only one of the sons who had actually been taken into the partnership prior to August 1, 1907.
On August 1, 1907, a new partnership agreement was formed. John E. Scott withdrew as a partner and his son, Robert L. Scott became a partner. On the books of the new partnership John W. Scott had an interest of 17 1/2 per cent, of which 7 1/2 per cent was held by him as trustee for Frederick H. Scott, who had not yet been admitted to the partnership, and Robert L. Scott had an interest of 17 1/2 per cent of which 10 per cent belonged to the father, John E. Scott. The interest of the sons had either been given them by their father or had been inherited from their uncle, Robert S. Scott.
By the terms of the agreement of August 1, 1907, each partner was entitled to his proportionate share of the net profits of the business, but each partner had a drawing account which he could not exceed without the consent of the other partners. Profits not withdrawn were to be left in the business as surplus. Under the agreement John W. Scott and Robert E. Scott each1927 BTA LEXIS 2482">*2484 had a drawing account of $4,500 per month, or $54,000 per year. The amounts drawn by them included the drawings of Frederick H. Scott and John E. Scott, respectively.
On January 10, 1911, and while the partnership agreement of August 1, 1907, was still in force, John E. Scott and his sons executed the following trust instrument with reference to the 10 per cent interest which John E. Scott still owned in the partnership of Carson, Pirie, Scott & Co.
THIS AGREEMENT, made this tenth day of January, 1911, by and between John E. Scott, of the City of Pasadena, State of California, party of the first part, Robert L. Scott, of the City of Evanston, County of Cook and State of Illinois, party of the second part, and Frederick H. Scott of the same place and John W. Scott of the Village of Glencoe, County of Cook and State of Illinois, parties of the third part, WITNESSETH:
THAT WHEREAS, the party of the first part heretofore owned in his own right a certain share in the capital of the copartnership heretofore composed of the following persons as copartners: John T. Pirie, Andrew McLeish, Samuel C. Pirie, John E. Scott, John T. Pirie, Jr., and John W. Scott, which heretofore did business1927 BTA LEXIS 2482">*2485 in the City of Chicago, under the name and style of Carson, Pirie, Scott & Company;
9 B.T.A. 955">*957 AND WHEREAS, the party of the first part likewise owned in his own right a portion of a certain fund, known as "surplus" which fund was employed in the business of the said copartnership, (said share of the party of the first part in the said capital and surplus being in addition to a certain share held by him in said capital and surplus for and on account of his son, Frederick H. Scott);
AND WHEREAS, the said copartnership was heretofore dissolved, and a copartnership composed of Samuel C. Pirie, John T. Pirie, Jr., John W. Scott, Robert L. Scott and Andrew McLeish, as copartners, was heretofore formed, under an agreement made and executed on the first day of August, A.D. 1907, for the purpose of continuing the business theretofore conducted by the said copartnership of Carson, Pirie, Scott & Company, and under the same name;
AND WHEREAS, the said party of the first part heretofore agreed that the said party of the second part should reinvest the said capital and surplus so belonging to him in the said new copartnership (said interest so held by said party of the second part being1927 BTA LEXIS 2482">*2486 in addition to the interest held by him in his own right in the capital and surplus of the said new copartnership);
AND WHEREAS, the said party of the first part wishes to transfer to the said party of the second part all of the said capital and surplus so owned by him in his own right and invested by the party of the second part in the said new copartnership, upon the terms of the trust agreement hereinafter contained;
NOW, THEREFORE, the party of the first part herein, for and in consideration of One ($1.00) Dollar in hand paid and for other good and valuable considerations, the receipt whereof is hereby acknowledged, has transferred and assigned, and does hereby transfer and assign unto the said party of the second part, as Trustee, all his right, title, and interest in and to the said capital and the said surplus now by the said party of the second part invested in the said copartnership formed on the 1st day of August, A.D. 1907, upon the following trusts, purposes, and conditions, to-wit:
First: The said party of the second part shall pay to the said party of the first part all sums which shall be paid to the party of the second part, during the life of the party of the1927 BTA LEXIS 2482">*2487 first part, as net profits and earnings upon the said capital and surplus so held by the party of the second part in trust, as and when the same shall be paid to the party of the second part under and by virtue of the copartnership agreement dated the first day of August, 1907.
Second: If, prior to the date of the death of the party of the first part, the said copartnership of Carson, Pirie, Scott & Company, formed under the agreement dated the first day of August, 1907, shall have been terminated, then the party of the second part, or his successor or successors in trust, may invest the proceeds of the property hereby assigned and transferred to the party of the second part as Trustee, or any part thereof, in any copartnership succeeding to said business now being carried on under the said name, or in such securities and property, real or personal, as in the judgment of the said party of the second part, or his successor or successors in trust, shall best serve the interests of the said trust estate, paying all the income from the said fund so reinvested to the said party of the first part during his life.
Third: After the death of the said party of the first part, said party1927 BTA LEXIS 2482">*2488 of the second part, or his successor or successors in trust shall immediately divide said capital and surplus transferred hereunder to the said party of the second part, into three (3) equal parts, and shall thereupon pay over one of the said parts to the said John W. Scott, one of the said parts to the said Frederick H. Scott, and one of the said parts shall be reserved by the said party of the second part, and the trust hereby created shall thereupon cease and determine.
9 B.T.A. 955">*958 Fourth: If the party of the second part, or either of the parties of the third part, shall have died prior to the date of the death of the party of the first part, then the share of the person or persons so dying in and to the property assigned by the party of the first part to the party of the second part, under this trust agreement, and which would have been paid to him or them at the date of the death of the party of the first part had he or they been then living, shall go and descend to such person or persons as he or they may designate in his or their will or wills; it being understood that the persons so designated may be the Trustees designated by and under the wills of such persons and that1927 BTA LEXIS 2482">*2489 such Trustees shall hold such property for the persons therein named and under the trusts therein and thereby created; provided, however, that no such trust shall be created for a longer term than the lives of the parties of the second and third parts and their children now living and twenty-one (21) years thereafter.
Fifth: If the party of the second part, or either of the parties of the third part, shall have died prior to the date of the death of the party of the first part, without making any valid provision in his will designating the person or persons who are to take the said interest which would have been paid to such party under the terms of this agreement, had he or they been living, then in such event the said interest shall go and descend to the children of such deceased person who shall be living at the date of the death of the party of the first part, share and share alike.
Sixth: For and in consideration of the said provisions in this trust agreement contained, the said party of the second part agrees to carry out the terms of the said trust in accordance with the directions of the said party of the first part; and the said parties of the second and third parts, 1927 BTA LEXIS 2482">*2490 jointly and severally, agree on the part of themselves, their heirs, executors and administrators, to pay to Harriet Emma Scott, the wife of the party of the first part, the sum of Twenty Thousand ($20,000.00) Dollars per year, in monthly installments, each and every year after the death of the party of the first part, during her life.
Seventh: The said party of the first part hereby reserves the right to revoke this trust agreement, either in whole or in part, on giving written notice to the parties of the second and third parts, or their legal representatives, of his intention so to do, in which event the agreement of the parties of the second and third parts to make said payments of Twenty Thousand Dollars per year, as provided for under the last preceding clause of this agreement, shall thereupon become null and void.
Eighth: In case of the death of the party of the second part, prior to the termination of this trust agreement, then in such case Frederick H. Scott shall act as successor in trust, or in case of his death prior to said time, then in such case John W. Scott shall act as successor in trust hereunder.
On December 31, 1912, and while the trust instrument mentioned1927 BTA LEXIS 2482">*2491 was still in force, the partnership created by the agreement of August 1, 1907, expired, and on the same day a new partnership agreement was made and the petitioner, Frederick H. Scott, was admitted to the partnership. The interests of the petitioners in the new partnership were stated as follows:
| Per cent | |
| John W. Scott | 10 |
| Robert L. Scott | 17 1/2 |
| Frederick H. Scott | 7 1/2 |
9 B.T.A. 955">*959 Of the 17 1/2 per cent interest standing in the name of Robert L. Scott, 7 1/2 per cent was held by him in his own right and 10 per cent was the interest theretofore conveyed by his father to him in trust. The terms of the partnership agreement of December 31, 1912, were in general the same as those of the agreement of August 1, 1907. The drawing accounts under the new agreement were as follows:
| Per month | |
| John W. Scott | $3,500 |
| Robert L. Scott | 6,000 |
| Frederick H. Scott | 2,816 |
John E. Scott's drawings were included in those of Robert L. Scott. The drawings of John E. Scott in each of the years 1911, 1912, and 1913, were between $30,000 and $35,000. His share of the profits of the partnership, if distributed, would have been several times $30,000 in each1927 BTA LEXIS 2482">*2492 of those years.
When the Revenue Act of 1913 was passed, the questions arose as to whether the father, john E. Scott, should report as income, the net profits accruing upon the interest in the partnership covered by the trust agreement of January 10, 1911, and who should pay the tax thereon. In consequence of these questions John E. Scott and his three sons, the petitioners herein, executed the following agreement on March 21, 1914.
THIS AGREEMENT, made this 21st day of March, 1914, by and between John E. Scott, of the City of Pasadena, State of California, party of the first part, and John W. Scott, of the Village of Glencoe, County of Cook, and State of Illinois, Robert L. Scott of the City of Evanston, County of Cook, and State of Illinois, and Frederick H. Scott of the Village of Winnetka, County of Cook, and State of Illinois, parties of the second part, WITNESSETH:
WHEREAS, heretofore, on the 10th day of January, 1911, the party of the first part transferred and conveyed to Robert L. Scott, all of the capital and surplus owned by the party of the first part and theretofore invested by Robert L. Scott in the copartnership of Carson, Pirie, Scott & Company; and whereas, 1927 BTA LEXIS 2482">*2493 a question has arisen as to whom the accumulated income arising from such capital and surplus belongs, and as to who should report said income to the Federal Government, and pay the income tax thereon; and whereas the parties wish to remove all uncertainty upon such questions; and whereas, furthermore, the party of the first part wishes a definite, fixed income which shall not in any manner depend upon the earnings of said copartnership, and wishes to transfer absolutely to the parties of the second part any and all interest, legal and equitable, which he has in the property heretofore conveyed by him to Robert L. Scott as trustee under the agreement on the 10th day of January, 1911, and any and all income which has accumulated upon said capital and surplus;
NOW, THEREFORE, the party of the first part does hereby revoke the trust created under and by virtue of the said agreement on the 10th day of January, 1911, and does hereby transfer, assign and deliver all of the property included in such trust and conveyed to Robert L. Scott under the terms of such trust, and all income which has accumulated upon said capital and surplus of trust fund, in equal portions, to each of the parties1927 BTA LEXIS 2482">*2494 of the second part; that is, one-third 9 B.T.A. 955">*960 to John W. Scott, one-third to Robert L. Scott, and one-third to Frederick H. Scott, to be the absolute property of each of such persons and their heirs, free from any trust.
And for and in consideration of the transfer and conveyance by the party of the first part to the parties of the second part of said property, the parties of the second part do hereby jointly and severally agree on the part of themselves, their heirs, executors, administrators and assigns, to pay to the said party of the first part, during his life, the sum of Thirty-six Thousand ($36,000) Dollars per annum, said sum to be payable monthly in twelve equal installments, on the first day of each and every month, beginning on the first day of April, 1914.
And if said party of the first part shall die before his wife, Harriet Emma Scott, then the parties of the second part further jointly and severally agree on the part of themselves, their heirs, executors, administrators and assigns, to pay to Harriet Emma Scott, from and after the death of party of the first part, during her life, the sum of Twenty-five Thousand ($25,000) Dollars per annum, payable monthly1927 BTA LEXIS 2482">*2495 as aforesaid during her life.
During the five years subsequent to March 21, 1914, the annual earnings on the interest in the partnership covered by the trust agreement mentioned and the agreement of March 21, 1914, were from eight to ten times the amount of the annual payment of $36,000 specified in the agreement of March 21, 1914.
John E. Scott, the father, died in 1918, having received under the terms of the agreement of March 21, 1914, forty-seven monthly payments of $3,000 each. The sons thereafter paid to their mother, $2,083 per month, and have continued to do so until the present time. The payments so made to the father and to the mother have been borne in equal shares by the three sons.
The petitioners in each of the years 1921 and 1922, included in their own income-tax returns, as gross income, the entire income from the property turned over to them by their father under the agreement of March 21, 1914, and deducted from gross income the amount of their respective payments to their mother. The respondent, upon audit of the petitioners' returns for the years 1921 and 1922, disallowed the deductions so taken and determined deficiencies in tax as above set forth.
1927 BTA LEXIS 2482">*2496 OPINION.
MARQUETTE: It is the contention of the petitioners that the contract of March 21, 1914, was in substance either a sale of John E. Scott's life estate in the 10 per cent interest in Carson, Pirie, Scott & Co. which he reserved to himself by the trust agreement of January, 1911, or a reservation at law to himself and wife of part of the income from such interest, and that in either event the payments made by the petitioners to their mother in 1921 and 1922, pursuant to the contract, were properly deductible from the total income 9 B.T.A. 955">*961 received by them. The respondent, on the other hand, urges that the contract of March, 1914, was what it purported to be on its face, a sale by the father to the sons of the father's interest in the partnership in consideration of certain annual payments to be made to the father and mother during their lives, and that the payments involved herein are capital expenditures and therefore not deductible in computing the petitioners' net income.
We will first discuss the petitioners' second contention, that the contract of March 21, 1914, was in substance a reservation of income by John E. Scott. We can not, however, agree with that1927 BTA LEXIS 2482">*2497 contention. It is true that so long as the sons performed their part of the contract and paid to the father annually the amount of $36.000, he was, in so far as his annual income was concerned, in exactly the same position as he would have been in if he had expressly reserved to himself $36,000 of the annual income of the partnership, that is, his income in each year was $36,000. However, there was in law no reservation. Under the contract the interest in the partnership passed to the sons absolutely and they were free to dispose of it as they might see fit. The amounts to be paid to the father and to the mother were not charges on the partnership interest or the income thereof, and if the petitioners had, immediately after the contract was executed, sold the interest thereby conveyed to them, the purchaser would have taken a clear and unencumbered title and would have been entitled to the free and unrestricted enjoyment of the interest and the income therefrom. Upon the failure of the petitioners to make the annual payments provided by the contract, neither the father nor the mother would have had any interest in or charge upon the property or rights conveyed by the contract1927 BTA LEXIS 2482">*2498 of March 21, 1914, but they would have been limited to an action at law against the sons to collect the yearly payments if and when they accrued under the contract. We are of the opinion that there is no merit in this contention of the petitioners.
The petitioners argue that by the trust instrument of January, 1911, the father divested himself of title to the interest in the partnership, reserving to himself for life the income thereof, or in other words, what amounted to a life estate therein; that on March 21, 1914, he had nothing to convey to his sons except his life estate in, or the right to the income from, the interest in the partnership, and that by the contract of that date he intended to convey, and in fact did convey only the life estate, although in terms he revoked the trust and purported to make a new conveyance of the entire partnership interest.
It may be admitted for the sake of argument that John E. Scott, by the contract of March, 1914, intended to and did convey to his sons only the right to the income from the 10 per cent interest in 9 B.T.A. 955">*962 the partnership which he had theretofore reserved to himself under the trust agreement of January, 1911, but it1927 BTA LEXIS 2482">*2499 does not follow therefrom that the payments to the mother in 1921 and 1922 were a part of the consideration paid for the conveyance of such life estate or the right to receive income. By the trust agreement John L. Scott conveyed his interest in the partnership to Robert L. Scott and his two brothers, reserving to himself the right to the income during his life. Upon the death of John E. Scott the trust was to terminate and the corpus thereof was to be divided among the three sons. As a part of the consideration for the execution of the trust agreement the sons agreed to pay to their mother, after the termination of the trust, the amount of $20,000 annually during her life. These annual payments, which were not to begin until after the trust had terminated and the sons had received both the corpus and the right to the income therefrom, were obviously not in consideration of the father's life estate, for that was reserved, not passed, by the trust instrument. It is much more logical and reasonable to hold that they were intended as a consideration for the transfer of the corpus. The sons were, therefore, when the contract of March, 1914, was executed, already obligated to pay1927 BTA LEXIS 2482">*2500 to their mother after their father's death, $20,000 per year as a consideration for the transfer to them of the corpus of the trust property and such payments were not the consideration for the transfer to them of their father's life estate. There may be merit in the contention that the payments to the father of $36,000 per year under the contract of March, 1914, were made in consideration of his relinquishment of the right to the income from the partnership interest, but they ceased upon the father's death and are not involved herein. The payments which we are considering are those the sons made to their mother and which, except that they have been somewhat increased in amount, would have been required even if the contract of March, 1914, had never been executed. We attach no particular weight to the fact that by the contract of March, 1914, the payments to the mother were increased in amount, and we are of the opinion that considering the contract as merely a conveyance of the father's right to the income from the partnership interest, the payments to the mother, which are the only ones involved herein, were not made as a consideration therefor. For the reasons stated we approve1927 BTA LEXIS 2482">*2501 the respondent's action in disallowing them as deductions from petitioners' income.
Reviewed by the Board.
Judgment will be entered for the respondent.
TRUSSELL dissents.