*2951 A partnership was formed under an agreement which provided, among other things, that upon the death of any one of the partners there should be paid to his estate for a period of years the share of partnership earnings to which the deceased partner would have been otherwise entitled, and that upon the completion of such payments the business should become the sole property of the surviving purtners. Held, that the partnership agreement provided for the sale of the interest of a deceased partner to the surviving partners. Held, further, 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.
*572 These proceedings are for the redetermination of deficiencies in income tax as follows:
| Year | Willard C. Hill | William H. Plumer |
| 1920 | $4,114.35 | $6,559.79 |
| 1921 | 2,612.74 | 4,343.67 |
*573 The appeals were consolidated for hearing and*2952 decision. The only question involved in both cases is whether certain payments made to the estate of a deceased partner out of the profits of a business, the operation of which was continued by the surviving partners, constituted income to the surviving partners.
FINDINGS OF FACT.
The petitioners are partners in the firm of Elmer A. Loard & Co., which has conducted an insurance agency and brokerage business in Boston, Mass., since prior to 1912. On May 28, 1912, certain articles of agreement were signed by Elmer A. Lord, Horace H. Soule, William H. Plumer, and Willard C. Hill. the paragraphs material to a consideration of the question here in issue reading as follows:
ARTICLES OF AGREEMENT, made this twenty-eighth day of May, in the year one thousand, nine hundred and twelve, but operative from the first day of May, one thousand, nine hundred and twelve, by and between Elmer A. Lord, of Brookline, in the County of Norfolk and Commonwealth of Massachusetts, Horace H. Soule of said Brookline, William H. Plumber, of Newton, in the County of Middlesex and said Commonwealth, and Willard C. Hill, of Lexington in said County of Middlesex, for the conduct of an insurance business*2953 as a copartnership and the purchase by said Soule, Plumber and Hill of said Lord's interest in said business from said Lord, it being understood and agreed that this instrument takes the place of, and is substituted for, the copartnership agreement executed by said Lord, Soule, Plumer and Hill on the fourteenth day of April, in the year one thousand, nine hundred and ten, and the aforesaid latter agreement is null and void, except so far as it controls past and vested rights of the parties.
I. The parties above named hereby agree to associate themselves together as co-partners under the firm of Elmer A. Lord and Company, for the purpose of carrying on a general insurance business, the said co-partnership to continue for an indefinite term according to the pleasure of the aforesaid parties, but terminable according to the terms and conditions herein contained.II. At the time of the execution of this instrument the respective partnership interests of the various co-partners were as follows: said Lord, thirty-seven (37) per cent; said Soule, thirty (30) per cent; said Plumer, eighteen (18) per cent; said Hill, fifteen (15) per cent. It is intended by this instrument by sale*2954 by said Lord to said Soule and said Plumer and to said Hill of said Lord's interest to re-adjust the proportion of the respective partnership interests and otherwise to alter to some extent the relations of the various parties to each other and one to all the others as established by the agreement of April 14th, 1910.
III. And it is further understood and agreed that said Lord has sold to said Soule, Plumer and Hill one (1) share, or one per cent (1%) of the interest *574 in said business, said share to be held jointly by said Soule, Plumer and Hill in trust for such purposes as said Soule, Plumer and Hill see fit to apply it, and to be paid for by said Soule, Plumer and Hill monthly to said Lord out of the balance of the profits which said Soule, Plumer and Hill are jointly entitled to draw from the firm after allowing said Lord five per cent (5%) interest annually, payable quarterly on the respective indebtedness.
IV. And it is further understood and agreed that said Lord has sold to said Soule twenty-one (21) shares, or twenty-one per cent (21%) of the interest in said business, ten per cent (10%) of which has been paid for by said Soule in cash to said Lord, and*2955 eleven per cent (11%) of which is to be paid for by said Soule monthly to said Lord out of the entire balance of the profits which said Soule is entitled to draw out from the firm after allowing said Lord five per cent (5%) interest annually, payable quarterly, on the respective indebtedness until the total amount of the purchase price is paid.
V. And it is further understood and agreed that the said Lord has sold to the said Plumer ten (10) shares, or ten per cent (10%) of the interest in said business, and to the said Hill five (5) shares, or five per cent (5%) of the interest in said business, payment for which by said Plumer and said Hill to said Lord is to be made by said Plumer and said Hill monthly to said Lord out of the entire balance of the profits which said Plumer and said Hill are entitled to draw out from the firm after allowing said Lord five per cent (5%) interest annually, payable quarterly, on their respective indebtedness until the total amount of the purchase price is paid.VI. And it is further understood and agreed that the price of the purchase of the said interests by the said Soule, Plumer and Hill from the said Lord is based on an amount equal to twice*2956 the gross profits for the twelve calendar months ending April thirtieth, one thousand nine hundred and twelve, as determined by the profit ledger of the firm as verified by the auditor's report to be one hundred sixty-five thousand five hundred ninety-one dollars and twelve cents ($165,591.12), plus ten thousand, five hundred dollars ($10,500), for furniture, fixtures and supplies.
* * *
XIII. And it is further understood and agreed that in the case of voluntary retirement of any member of the firm the remaining members shall have the first opportunity of purchasing the interest of said retiring partner for a sum based on not exceeding twice the gross profits for the twelve (12) calendar months preceding such retirement plus the furniture and fixture account, each remaining partner to have the privilege of purchasing that proportion of such retiring partner's interest that such remaining partner's interest bears to the total interest of all the remaining partners, the payments to said retiring partner to be made - one-third (1/3) at the expiration of two (2) months from the date of such retirement, one-third (1/3) at the expiration of twelve (12) months from such retirement, *2957 and one-third (1/3) at the expiration of eighteen (18) months from such retirement.
XIV. And it is further understood and agreed that in the event of the death of any one of the aforesaid partners that the surviving partners will pay to the estate of the deceased partner, providing his interest is fully paid up at the time of his decease, three (3) annual payments for the three (3) entire years next succeeding the time of his death, sums equal to the full amount of his net profits for each of said three years, and for the entire fourth and fifth years next succeeding such death sums equal to five per cent (5%) of the full amount of his net profits for each of the said fourth and fifth, years, such payments to be made monthly, provided, however, if the interests of said Soule, Plumer *575 and Hill have not been fully paid for, that the estate of the said deceased shall receive that proportion which his interest already paid up, including accrued profits, bears to the agreed purchase price named in this instrument, and the completion of these payments shall be in full settlement of the said deceased partner's interest, and the business shall then become the sole property of*2958 the surviving partners.
XV. And it is still further understood and agreed that one of the principal purposes for executing this new partnership agreement is to carry out an often expressed wish of said Lord to retire from active interest in the insurance business in which he has been engaged for many years, and accordingly this sale of all of Lord's ownership in the shares, or percentages, as well as of good will and name of the business, including furniture and fixtures is madeHorace H. Soule died on March 18, 1920, and at the time of his death his interest in the partnership was fully paid up. After his death the share in the profits of the business to which he would have been entitled had he lived was paid to his estate over a period of years in accordance with the terms of the agreement signed May 28, 1912. The profits of the firm were divided month by month the same as before his death and a check was sent to his estate just as if it were a member of the partnership. The share paid to the estate was set up in the books of the firm in the same manner as it had been during the lifetime of Soule and in the same manner as the shares of the partners. The sum of $43,547.81*2959 was distributed to Soule's estate during the year 1920. For the year 1921 there was distributed to his estate the sum of $34,823.24.
On June 5, 1920, William H. Plumer, Willard C. Hill, and Hervey Mason entered into an agreement of partnership reading in part as follows:
AGREEMENT OF PARTNERSHIP made this 5th day of June, 1920, but operative from the first day of April, 1920 by and between William H. Plumer of Newton, Willard C. Hill of Lexington and Hervey Mason of Melrose:
WHEREAS an agreement of partnership was entered into on May 28, 1912 by Elmer A. Lord of Brookline, Horace H. Soule of said Brookline, the said Plumer and the said Hill for the purpose of carrying on an insurance business under the firm name of Elmer A. Lord & Company, and the said business has accordingly been carried on, and
WHEREAS in accordance with the provisions of said partnership agreement the entire interest of said Lord in said firm has been purchased by said Soule, Plumer and Hill and paid for by them in full, and
WHEREAS by the death of said Soule on March 18, 1920, subsequent to said purchase and payment, the partnership was been dissolved and the said Plumer and the said Hill have become*2960 entitled, (subject to the rights of the estate of said Soule under paragraph XIV. of said agreement) to fifty-eight and one-third (58-1/3) and forty-one and two-thirds (41-2/3) shares respectively of the business and assets of said firm, and
WHEREAS said Plumer desires to sell three of his shares to said Mason and the said Hill desires to sell two of his shares to the said Mason and certain other arrangements are to be made between them and the said three parties propose to form a new partnership to continue the business under the same name as heretofore.
*576 Now THEREFORE it is mutually agreed as follows:
1. The parties hereto agree to associate themselves together as co-partners under the firm name of Elmer A. Lord & Company, for the purpose of carrying on a general insurance business.
2. Plumer hereby sells to Hill two shares (of those owned by him before the death of Soule) or two per cent of the interest in said business payment for which shares is to be made by Hill to Plumer monthly out of the net profits of the business accruing upon the two shares thus sold, after allowing Plumer from said profits interest at the rate of five per cent per annum, payable*2961 quarterly, on the indebtedness for the time being of Hill to him arising from the purchase of said shares.
3. Plumer hereby sells to Mason three shares or three per cent of the interest in said business and Hill hereby sells to Mason two shares or two per cent of the interest in said business, (the said shares being of those owned by Plumer and Hill respectively before the death of Soule) payment for which shares is to be made by Mason to Plumer and Hill monthly in the proportion of three and two out of the net profits of the business accruing upon the five shares thus sold, after allowing Plumer and Hill from said profits interest at the rate of five per cent per annum, payable quarterly, on the indebtedness for the time being of Mason to them respectively arising from the purchase of said shares.
4. The purchase price to be paid by Hill and Mason for the shares described in paragraphs 2 and 3 hereof is based upon an amount equivalent to twice the gross profits of the former firm of Elmer A. Lord & Company for the twelve calendar months ending March 31, 1920, as determined by the profit ledger of said firm as verified by the auditor's report to be three hundred and two thousand*2962 six hundred sixty-six dollars and forty-four cents ($302,666.44), plus ten thousand five hundred dollars ($10,500) for furniture, fixtures and supplies, so that the sum payable to Plumer under the provisions of paragraph 2 hereof is six thousand two hunded sixty-three dollars and thirty-three cents ($6,263.33), and the sums payable to Plumer and Hill under the provisions of paragraph 3 hereof are nine thousand three hundred ninety-five dollars ($9,395) and six thousand two hundred sixty-three dollars and thirty-three cents ($6,263.33) respectively, with interest at five per cent as aforesaid on all of said sums.
5. Until Mason has fully paid for said five shares he shall continue to receive his present salary of four thousand dollars ($4,000) per year, unless the same shall be changed by mutual agreement or unless this partnership shall be terminated in the manner provided in paragraph 10 hereof or otherwise.
6. The payments to which the estate of said Soule is entitled under the provisions of paragraph XIV of the partnership agreement of May 28, 1912, shall continue to be made, that is to say, there shall be paid to said estate for the remainder of the three years next succeeding*2963 the death of Soule fifty-one and fifty-one ninety-ninths (51-51/99ths) per cent of the net profits of the business and for the two years next succeeding said three years one-twentieth of fifty-one and fifty-one ninety-ninths (51-51/99ths) per cent of said net profits, said payments to be made monthly.
7. During the remainder of the three years next succeeding the death of Soule, Plumer shall be entitled to twenty-three and twenty-eight nintey-ninths (23-28/99ths) per cent of the net profits of the business, Hill to twenty and twenty ninety-ninths (20-20/99ths) per cent (subject to the obligation to apply so much thereof as represents two (2) per cent of the net profits as provided in paragraph 2 hereof until the payment of his indebtedness to Plumer) and Mason to five (5) per cent (subject to the obligation to apply it as provided to paragraph 3 hereof until the payment of his indebtedness to *577 Plumer and Hill) and thereafter subject to the payment required to be made to the estate of Soule as aforesaid for the two years next succeeding they shall be entitled (if the options given in paragraph 11 hereof are exercised and subject to the performance of the terms of said*2964 options) to forty-five (45) per cent, forty-five (45) per cent and ten (10) per cent respectively of said net profits and to corresponding shares of the assets and business of the partnership.
Each of the signers of the agreement of May 28, 1912, was a man of large experience in the insurance field and each had built up an individual clientele. The value of an insurance agency and brokerage business consists largely of the probability that insurance originally written as a result of the efforts of the agency will be renewed from year to year through the same agency, and the net value of the tangible assets of the old partnership was very small in comparison with the value of its good will. After his death Soule's clientele was solicited by the new partnership and the business was conducted as intensively and in the same manner as it had been during his lifetime.
OPINION.
SMITH: In filing their income-tax returns for the years 1920 and 1921 each of the petitioners excluded the payments made to the estate of Horace H. Soule in computing the amount of partnership income available for distribution to themselves, whereas the respondent for each of those years added to the amount*2965 of net income reported by the partnership the amount paid to Soule's estate and included in the gross income of each of the petitioners his distributive share of the latter amount.
The petitioners contend that the effect of the partnership agreement of May 28, 1912, was to obligate the surviving partners to pay to the estate of the deceased partner the share to which the deceased partner would have been otherwise entitled and not that it provided for the sale of the deceased partner's interest to the surviving partners. Counsel for the petitioners cite ; , and ; , as standing for the proposition that in Massachusetts a sale of the good will and other assets of a partnership at the request of the representatives of a deceased partner leaves the survivors free to compete with the purchaser and to solicit business from former customers. From this they argue that since the value of the net assets of the partnership of Elmer A. Lord & Co. was so very small in comparison to the value of its good will that the agreed payments to be*2966 made to the Soule estate indicated that the petitioners were not purchasing anything from the estate, but rather that the agreement of May 28, 1912, placed an obligation in the nature of an expense upon the surviving partnership.
*578 Counsel for the respondent in his brief maintains that the payments made to the estate of Horace H. Soule constituted taxable income to the petitioners as part of their distributive shares of partnership profits, on the ground that such payments to the estate constituted a part of the purchase price to the surviving partners of Soule's interest in the partnership.
Section 218(d) of the Revenue Act of 1918 and section 218(c) of the Revenue Act of 1921 provide as follows:
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 (11) of subdivision (a) of section 214 shall not be allowed.
The respondent points out that the payments to Soule's estate must be included in the net income of the new partnership unless such payments could be held to constitute a deductible expense under the provisions of section 214(a)(1) of the Revenue*2967 Acts of 1918 and 1921, which reads in part as follows:
(a) That in computing net income there shall be allowed as deductions:
(1) 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; * * *
The petitioners admit that the estate of Horace H. Soule was not at any time a member of the partnership of Elmer A. Lord & Co. and that the amounts paid to such estate were part of the gross income of the new partnership. We think it clear that the payments made to the estate of Soule by the new partnership were not ordinary and necessary expenses deductible from gross income, and that, therefore, they must be included in the net income of the partnership. The question is as to whether the new partners should be liable to income tax in respect of the total profits of the partnership. The petitioners claim that by reason of the fact that under the agreements entered into they were obligated to pay a portion of these profits to the estate of Soule they should not be held a part of their distributive income of the partnership.
*2968 The evidence of record shows that at the time of the formation of the partnership of which Soule was a member it was recognized that his interest in the partnership had a large monetary value; further, that if the partnership assets were sold to any individuals only a part of that value could be realized. It was therefore provided that, if the surviving partners wished to carry on the business theretofore carried on under the name of Elmer A. Lord & Co., they should pay to the estate of the deceased partner a reasonable amount as the purchase price of the deceased partner's share in the partnership assets. This could have been paid in cash, in which event there *579 could be no question but that the petitioners were liable to income tax in the manner determined by the respondent. It is contended, however, that, by reason of the fact that the petitioners chose to pay to the estate of the deceased partner a portion of the profits of the partnership over a period of years, they should not be held liable to income tax in respect to the proportion paid. We think, however, there is no merit in this contention. The profits of a partnership belong to the partners. They may*2969 chose 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.
In view of the direct affirmative evidence to the effect that article XIV of the agreement of May 12, 1928, was inserted to overcome the condition existing in the Commonwealth of Massachusetts whereby surviving partners may compete against the purchaser of a deceased partner's interest, such agreement must be construed to have provided for the sale of the interest of a deceased partner to the surviving partners.
The evidence also indicates that*2970 during the year 1920 the business was operated by three partnerships as follows:
From January 1, 1920, to March 18, 1920, by a partnership composed of Hill, Plumber, and Soule.
From March 19, 1920, to March 31, 1920, by a partnership composed of Hill and Plumer.
From April 1, 1920, to December 31, 1920, by a partnership composed of Hill, Plumer, and Mason.
Consequently, the distributive share of each of the petitioners will be measured by his interest in each of these successive partnerships, including in the computation of the distributable net income of the partnerships composed of Hill and Plumer and of Hill, Plumer, and Mason, respectively, payments made to the estate of Horace H. Soule.
Reviewed by the Board.
Judgment will be entered under Rule 50.
TRUSSELL dissents.