Cobb v. Commissioner

L. S. COBB, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Cobb v. Commissioner
Docket No. 7136.
United States Board of Tax Appeals
9 B.T.A. 547; 1927 BTA LEXIS 2573;
December 9, 1927, Promulgated

*2573 During the taxable years petitioner's wife was a member of a partnership and her one-sixth share of the partnership profits was not taxable to him.

Theodore B. Benson, Esq., for the petitioner.
Joseph K. Moyer, Esq., for the respondent.

LITTLETON

*547 The Commissioner determined deficiencies of $135.18 for 1920 and $23.69 for 1921. It is claimed that the Commissioner erred in taxing petitioner upon one-third of the profits of a partnership upon the ground that petitioner's wife was not a partner and had no interest in the partnership profits.

*548 FINDINGS OF FACT.

Petitioner is a citizen of California. Prior to and during the taxable years he was married and living with his wife, Mercedes M. Cobb. In 1919 L. S. Cobb & Co. was a corporation. Its outstanding capital stock of $15,000 par value was owned equally by petitioner, his father, C. H. Cobb, and his uncle, A. J. Cobb. C. H. and A. J. Cobb had been married for more than 35 years and their wives had been to a considerable degree instrumental in their success. Petitioner's father had made him a gift of certain real estate and had loaned him $7,200. Petitioner married*2574 a short time prior to October, 1920. A short time after the corporation was organized it was dissolved and the three stockholders formed a partnership under the same name. Shortly prior to October, 1920, it was decided to form a new partnership making the wives of the three members equal partners therein. The father and uncle of petitioner were fearful that he might have domestic troubles. They were desirous therefore of having some provision inserted in the partnership agreement limiting the right of the petitioner's wife in the property and profits of the partnership in the event of separation of petitioner and his wife, death, or attempted alienation by the wife of her interest in the capital or profits of the partnership. In order that there might be no distinction they concluded to make the same provision in respect of the interest of their wives. Accordingly, on October 1, 1920, an agreement creating a new partnership composed of the three individuals mentioned and their wives was entered into. This partnership agreement, so far as material here, provided -

THIS AGREEMENT, Made and entered into this 1st day of October, 1920, by and between C. H. Cobb and Anna D. Cobb, *2575 his wife, A. J. Cobb and Katie E. Cobb, his wife, and L. S. Cobb and Mercedes M. Cobb, his wife.

WITNESSETH: 1. THAT, WHEREAS, C. H. Cobb, A. J. Cobb and L. S. Cobb are now, and have heretofore been, conducting as co-partners the business of buying, selling and dealing in automobiles, automobile accessories and supplies, and operating a garage in the City of Fresno, County of Fresno, State of California, under the firm name of L. S. Cobb & Co., and,

2. WHEREAS, they, for the purpose of familiarizing their respective wives with business affairs, and particularly with their respective business, and to provide them with an independent income of their own, and take their said wives into co-partnership with them, and to give to them an equal interest in said co-partnership property and business;

* * *

5. And the said L. S. Cobb does hereby give and grant unto the said Mercedes M. Cobb an undivided one-half (1/2) interest in his share and interest in said co-partnership property and business; provided, however, that should the said Mercedes M. Cobb at any time cease to be the wife of the said L. S. Cobb during his lifetime or die before him, all the interest in said co-partnership*2576 hereby given to her and in the property owned or hereafter acquired by it, together with all the undistributed profits thereof, shall immediately revert *549 to and be vested in the said L. S. Cobb, and all her interest shall be divested, and the said Mercedes M. Cobb, her heirs, legatees, devisees, executors or administrators, shall have no interest therein, and provided further that any grant, sale, transfer, encumbrance, gift or assignment by the said Mercedes M. Cobb during the lifetime of said L. S. Cobb of her interest, or any part thereof, in said co-partnership, or of the profits thereof, or any part thereof, whether voluntary or involuntary, or by operation of law, to any person, except said L. S. Cobb, shall be void, and upon the making by the said Mercedes M. Cobb of any grant, sale, transfer, encumbrance, gift or assignment of her interest therein, or any part thereof, to any other person during the lifetime of said L. S. Cobb, voluntary or involuntary, or any assignment or transfer by operation of law during his lifetime, will work a forfeiture to said L. S. Cobb of her interest therein and all her interest in all property now owned or hereafter acquired by said*2577 co-partnership, and all profits accrued shall revert to and vest in the said L. S. Cobb.

6. In consideration of the premises, the said parties hereto do agree to and do hereby enter into a co-partnership under the firm name and style of L. S. Cobb & Co., for the purpose of engaging in the business of buying, selling and dealing in automobiles, automobile accessories and supplies, and operating a garage for the repair of automobiles in the City of Fresno, on the following terms and conditions:

1. Each of the parties hereto shall own an undivided one-sixth (1/6) interest in said co-partnership and property, subject to the conditions hereinabove set forth, and shall share equally in the profits and losses of said business.

2. The capital invested in said business shall be such as is now or may be hereafter by agreement invested in said business; each partner agrees to contribute his or her proportion to the increased capital, should a majority of the co-partners decide to increase the invested capital.

3. None of the co-partners shall withdraw any of the capital from the co-partnership, or any of its profits, except by a consent of a majority of the co-partners.

4. The*2578 term of this co-partnership shall continue so long as it is agreeable to a majority of said co-partners, and said co-partnership cannot be dissolved without the consent of a majority of said co-partners. The death of one or more of said co-partners shall not dissolve said co-partnership, so long as a majority of them survive. One or more co-partners acquiring the interest of another co-partner or co-partners will not dissolve this partnership.

5. Should there be a disagreement as to the management of the business, the will of a majority of the co-partners shall control. No profits shall be withdrawn from the business except by consent of the majority of the co-partners.

6. The members of the co-partnership of the predecessor of the co-partnership which is hereby formed shall continue to draw the same salaries that they now receive; such salaries may be either increased or decreased by agreement, but none of the co-partners shall draw or be entitled to draw any salary or compensation from said co-partnership, except by agreement of a majority of the co-partners.

7. A full and complete set of books of the business of said co-partnership shall be kept, and free acess thereto*2579 shall be allowed to the several members thereof, and annual or semi-annual accounts shall be made and rendered to the co-partners.

8. No money shall be borrowed on the credit of said co-partnership, except for co-partnership purposes; nor shall co-partnership funds be used for the private business of any of the co-partners, except by unanimous consent.

*550 9. The members of the co-partnership may designate some of their members to have the active management and control of said co-partnership business, by whom checks shall be drawn and money borrowed for account of the co-partnership, but all moneys belonging to the co-partnership shall be deposited in such bank or banks as the co-partners may agree upon, in the co-partnership name. Until others are designated, the members now having the management shall continue.

10. It is further understood and agreed that some of the members of this co-partnership are now engaged in the City of Fresno individually, or in co-partnership with others, in the same or a similar business to that for which this co-partnership is organized, and it is agreed that they may continue to engage in and carry on said other business, or engage*2580 in other and additional business of the same kind, though they may be to some extent in competition with the business to be conducted pursuant to this agreement; and it is further agreed that this co-partnership shall not, nor shall any of its members by virtue thereof, be entitled to any of the profits of any other business now or hereafter carried on or conducted by any of the co-partners individually or in conjunction with others, even if it be the same or of the same character as the business hereby agreed to be conducted, and the co-partners shall only be required to devote such of their time to the business of this co-partnership as shall be agreed on.

The partnership agreement was duly executed by the three men and their wives. Its provisions concerning the wives of C. H. and A. J. Cobb were the same as above quoted. A "certificate of conducting business under a fictitious name" was forthwith executed and filed with the clerk of the Superior Court of Fresno County, California, in which the names of the six owners or members of the partnership aforementioned in the articles of agreement appeared, and in which a declaration was made that they were transacting business as*2581 partners under the name of L. S. Cobb & Co. During the taxable years the partnership paid petitioner a salary of $500 a month, and C. H. Cobb a salary of $250 a month. None of the other members were paid a salary.

In 1923 the wives of C. H and A. J. Cobb withdrew from the partnership and their husbands paid them $12,500 for their interest. Matrimonial difficulties arose between petitioner and his wife. They separated and in January, 1924, petitioner paid his wife $10,000 "in consideration of all her right in all community property owned by them and her interest in the firm of L. S. Cobb & Company, a copartnership, of which she is a member."

During the taxable years the business of L. S. Cobb & Co. was rapidly expanding and for that reason all profits were left and used in the business. In computing petitioner's net income the Commissioner included therein one-third of the profits of L. S. Cobb & Co. for the taxable years upon the ground that "the agreement discloses that the wives had apparently no control over the assets of the partnership; that they can not draw any amount from the partnership or dispose of their interest therein without the consent of the other members*2582 *551 and, further, that in case of separation the undistributed profits would become the profits of the husbands in each case."

OPINION.

LITTLETON: Petitioner contends that his wife was a member of the valid partnership and owned a one-sixth share of the capital and profits of the business. The Commissioner seizes upon certain provisions of the partnership agreement and insists that the petitioner's wife "had no interest in or control over the assets of L. S. Cobb & Co. whatsoever, either as to her share of the taxpayer's capital investment in the firm or the distributable net profits thereof; she in fact was not a partner in the firm." We find no support of this claim in the partnership agreement. The parties to the agreement were competent to enter into a valid partnership. The bona fides of the transaction is not questioned. The Civil Code of California provides -

Section 158. Husband and wife may make contracts. Either husband or wife may enter into any engagement or transaction with the other, or with any other person, respecting property, which either might if unmarried; subject, in transactions between themselves, to the general rules which control*2583 the actions of persons occupying confidential relations with each other, as defined by the title on trusts.

Section 2395. Partnership, what. Partnership is the association of two or more persons, for the purpose of carrying on business together, and dividing its profits between them.

Section 2404. When division of losses implied. An agreement to divide the profits of a business implies an agreement for a corresponding division of its losses, unless it is otherwise expressly stipulated.

Section 2428. Power of majority of partners. Unless otherwise expressly stipulated, the decision of the majority of the members of a general partnership binds it in the conduct of its business.

Section 2444. Liability of one held out as partner. Any one permitting himself to be represented as a partner, general or special, is liable, as such, to third persons to whom such representation is communicated, and who, on the faith thereof, give credit to the partnership.

Section 2450. Total dissolution of partnership. A general partnership is dissolved as to all the partners:

* * *

By the transfer to a person, not a partner, of the interest of any partner in*2584 the partnership property.

Outside the provisions in the partnership agreement attempting to limit the rights of the wife in the event of separation or death and in respect of her right to alienate her interests, the wife had equal rights and authority with her husband. The provisions relating to the power of alienation by the wife were conditions subsequent, were repugnant to the interest created, and were ineffective to prevent the vesting of the one-half interest in the wife. ; *552 ; ; ; ; ; . The conditions in the partnership agreement restraining alienation by the wife were void under the provisions of section 711 of the California code. This section has general application and provides that "Conditions restraining alienation, when repugnant to the interest created, are void."

It was not necessary that the partners make a distribution of profits in order for them to be taxable to the members*2585 of the partnership under the revenue statute. The Commissioner is reversed.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.