*9 Decision will be entered under Rule 50.
In the taxable years petitioner was one of two managing partners in a Washington partnership, of which his mother, his two brothers, and another were members. Petitioner's partnership interest was derived from his stockholdings in a predecessor corporation and was in the same percentage, to wit, 29 per cent. Part of his capital investment in the corporation was his separate property and the rest was the community property of himself and wife. Pursuant to the partnership agreement, petitioner and the other managing partner drew salaries, and after deduction of such salaries the net profits of the partnership were distributable to all the partners in proportion to their capital interests. Held, that there has been no such commingling of separate property with community property as to make petitioner's entire capital interest in the partnership the community property of himself and wife; that petitioner's capital investment in the partnership is part separate and part community; that petitioner's salary is community income; and that the rest of his distributive share of partnership income represents a return on invested capital and *10 is part separate and part community income in the ratio of separate invested capital to community invested capital.
*1394 This case involves an income tax deficiency for 1943 in the amount of $ 13,034.77. The year 1942 is involved to the extent of the unforgiven portion of the tax liability for that year pursuant to the Current Tax Payment Act of 1943. Petitioner claims an overpayment of $ 2,686.14.
Petitioner was a member of a partnership during 1942 and 1943, and the question for decision is the proper allocation of his partnership income between separate and community income.
FINDINGS OF FACT.
Petitioner is an individual, who for many years has been domiciled in the State of Washington. His income tax returns were filed with the collector for the district of Washington.
In 1928 petitioner graduated from Washington State College with a degree in electrical engineering, at which time he became an employee of an electrical supply and engineering business which was operated as a partnership by his father and D. W. Powell.
Shortly thereafter petitioner's*11 father died and the business was incorporated under the name of Tinling & Powell Co., at which time petitioner acquired a stock interest by gift from his mother and became general manager and secretary-treasurer of the corporation.
In August 1934 a second corporation was organized, under the name of Tinling & Powell, Inc., as successor to Tinling & Powell Co. It engaged in electrical engineering and construction, machinery repairing, sales of merchandise, machinery, and equipment, and designing of electrical installations. D. W. Powell was president and superintendent in charge of the shop operations. Petitioner continued in the capacity of general manager and secretary-treasurer. Petitioner's mother, F. R. Tinling, was vice president. The capital stock of the corporation then consisted of 12,500 shares of $ 1 par common and 12,500 shares of $ 1 par preferred.
On May 2, 1935, petitioner was married to his present wife, Helen E. Tinling. At the date of his marriage he owned 3,525 shares of common stock in Tinling & Powell, Inc., and none of the preferred. The 3,525 shares of common stock were his separate property.
Petitioner's salary from the corporation was $ 11,980 in 1935*12 and 1936 and $ 8,000 in 1937, 1938, 1939, and 1940. Petitioner ordinarily did not draw over $ 3,000 or $ 3,200 a year, and the undrawn balances, together with accrued and undrawn amounts representing salaries *1395 of other corporate officers, were credited, usually at the end of the year, to an account on the corporate books called "Officers Salaries Payable."
At the beginning of 1935 accrued salary payable to petitioner recorded in the "Officers Salaries Payable" account amounted to $ 1,990. Petitioner withdrew $ 1,310 on April 30, 1935, leaving a balance of $ 680, his separate property. In addition, of the amount of $ 10,000 credited to that account in 1935 as payable to petitioner, one-third, or $ 3,333.33, was earned prior to petitioner's marriage. Thus, $ 4,013.33 of earned but unpaid salary constituted the separate property of petitioner.
At the date of his marriage petitioner had one or two bank accounts, but his bank balances were nominal in amount. After marriage, petitioner's wife continued to work through 1938. She earned about $ 150 to $ 200 a month. She and petitioner maintained only one bank account, in which both deposited their earnings. With funds from*13 this account petitioner purchased from his mother 3,670 shares of preferred stock in the corporation on December 14, 1935. These shares were community property of petitioner and his wife.
In the early part of 1939, the capitalization of the corporation was increased, and on February 15, 1939, stock was issued to corporate officers in satisfaction of loans made by them and accrued salaries owing to them. The journal entry recording the transaction on the corporate books was as follows:
| 1939 | ||||||||
| Feb. 15 | Salaries Payable | $ 40,346.89 | ||||||
| Notes Payable | 4,209.00 | |||||||
| Loan a/c H. B. T. | 7,700.00 | |||||||
| Notes Rec. -- H. B. T. | $ 70.00 | |||||||
| Loan a/c -- F. R. T. | 250.00 | |||||||
| Treasury Stock -- Common | 12,500.00 | |||||||
| Treasury Stock -- Preferred | 12,500.00 | |||||||
| Paid in Surplus | 26,935.89 | |||||||
| Treasury Capital Stock taken in payment | ||||||||
| of Indebtedness: | ||||||||
| F. R. Tinling | 4,850 | shares | each | class | ||||
| H. B. Tinling | 6,737 | " | " | " | ||||
| D. W. Powell | 525 | " | " | " | ||||
| D. L. Tinling | 388 | " | " | " |
The "Loan a/c H. B. T., $ 7,700" appearing in the above entry represented a loan made by petitioner to the corporation in 1937 with the community funds*14 of himself and wife.
By February 15, 1939, accrued salary payable to petitioner, which was canceled by the above transaction, amounted to $ 19,566.47. The *1396 total of the salaries and loans payable to petitioner and canceled by the issuance of 13,474 shares of capital stock to him was $ 27,196.47, of which $ 4,013.33, or 14.75 per cent, was the separate property of petitioner, and the rest was community property. Of the 13,474 shares so issued, 1987 shares (14.75 per cent) constituted the separate property of petitioner and the remainder the community property of petitioner and his wife.
In September 1939 petitioner acquired 75 additional shares of common stock in the corporation, without payment. Altogether during the existence of the corporation, from August 1934 to December 31, 1940, petitioner acquired 10,337 shares of common stock and 10,407 shares of preferred stock. Some of these shares were disposed of during that period, the source of such shares as between separate and community property not being shown, with the result that at the date of dissolution on December 31, 1940, petitioner held 7,200 shares of common stock and 7,340 shares of preferred -- a total of*15 14,540 shares, or 29.08 per cent of the 50,000 shares then outstanding. Of these 14,540 shares, 5,512, or 37.91 per cent, constituted the separate property of petitioner and the rest constituted the community property of petitioner and his wife.
As of December 31, 1940, the corporation was dissolved and its net assets were distributed to the three stockholders, petitioner, his mother, and Powell, in exchange for their stock. As an incident to the dissolution, there were eliminated from the accounts of the business the "Officers Salaries Payable" account in the sum of $ 7,009.60, of which $ 3,820.22 was owing to petitioner for the period from February 15, 1939, to December 31, 1940; "Good Will" in the amount of $ 11,592.87; "Paid in Surplus" in the amount of $ 26,935.89; and an operating deficit of $ 10,826.09. After these adjustments the net assets of the corporation were $ 61,526.53. With these petitioner, his mother, and Powell commenced doing business as a partnership under the name of Tinling & Powell, on January 1, 1941.
Articles of copartnership were executed in which it was agreed that petitioner's partnership interest should be 29 per cent (the same as his proprietary *16 stock interest in the corporation at its dissolution) and that petitioner and Powell should each be entitled to draw $ 3,120 a year, "as salary due them." Petitioner's mother was not active in the business, and no salary was provided for her. Powell's partnership interest was 12 per cent and that of petitioner's mother was 59 per cent.
As of January 1, 1942, petitioner's mother gave a portion of her partnership interest to each of her two other sons, and on that date a new partnership agreement was executed by the five partners: petitioner, *1397 whose 29 per cent interest remained unchanged; D. W. Powell, 12 per cent; F. R. Tinling, 21 per cent; D. R. Tinling, 19 per cent; D. L. Tinling, 19 per cent. The new agreement was substantially identical, except for the new partners, with the original agreement. Petitioner and Powell were the active partners and managed the business. The provision that they should draw salary of $ 3,120 a year each was continued. No provision was made for salary to the other three partners, who rendered no services.
During the period in question the partnership was engaged in extensive electrical construction work and other operations in connection*17 with war activities. According to the partnership books, operations during the years 1941 to 1943 were as follows:
| 1941 | 1942 | 1943 | |
| Gross receipts | $ 147,054.18 | $ 801,611.42 | $ 442,659.95 |
| Gross profit | 54,679.94 | 185,663.91 | 172,481.71 |
| Net profit | 29,206.03 | 146,273.65 | 131,790.16 |
Cost of merchandise sold, as reported in the partnership returns, was $ 64,905.24 in 1941, $ 549,336.98 in 1942, and $ 216,197.76 in 1943.
The partnership net worth increased from the original investment of $ 61,526.53 to $ 83,862.86 at the close of 1941, and to $ 220,896.51 as of the end of 1942. On December 31, 1943, it was $ 104,726.36, substantial withdrawals having been made by the partners in 1943. All withdrawals by the partners were in proportion to their partnership interests, so that their relative capital investments remained in the same proportion.
The net profits of the partnership, after deduction of salaries to petitioner and Powell in the amount of $ 3,120 each, were divided among the partners in proportion to their partnership interests and capital investments. Petitioner's distributive shares of partnership net income as reported in the partnership returns for 1941, 1942, *18 and 1943 were $ 9,974.05, $ 43,751.51, and $ 39,161.06, respectively. These amounts included salary of $ 3,120 each year.
During the last half of 1942 and in 1943 petitioner was employed as chief engineer and general manager of Wayne-Burnaby, Inc., a considerable part of whose stock was owned by the partners or by Tinling & Powell partnership. That company had war contracts in large volume. Petitioner was paid salary of $ 1,000 a month by Wayne-Burnaby, Inc. He devoted about eight hours of his working day to that employment and about six hours a day to the management of the business and affairs of Tinling & Powell.
Petitioner's investment account on the partnership books for the period January 1, 1941, to December 31, 1943, was as follows: *1398
| Date | Debits | Date | Credits | ||
| 1941 | 1941 | ||||
| June 30 | $ 182.61 | Jan. 1 | $ 17,842.70 | ||
| To Bal | 24,320.24 | Dec. 31 | 6,660.15 | ||
| $ 24,502.85 | $ 24,502.85 | ||||
| 1942 | 1942 | ||||
| Dec. 31 | $ 870.00 | Jan. 1 | Balance | $ 24,320.24 | |
| Dec. 31 | 3,120.00 | Dec. 31 | 40,609.76 | ||
| To Bal | 64,060.00 | Dec. 31 | 3,120.00 | ||
| $ 68,050.00 | $ 68,050.00 | ||||
| 1943 | 1943 | ||||
| Feb. 28 | $ 29,000.00 | Jan. 1 | Balance | $ 64,060.00 | |
| Feb. 28 | Corp. Tax | 489.13 | Dec. 31 | 36,409.55 | |
| Mar. 31 | 10,718.06 | Dec. 31 | 3,120.00 | ||
| Apr. 30 | 891.70 | ||||
| Oct. 31 | 29,000.00 | ||||
| Dec. 31 | 3,120.00 | ||||
| To Bal | 30,370.66 | ||||
| $ 103,589.55 | $ 103,589.55 |
*19 In their individual returns for 1942 petitioner and his wife each reported one-half of his distributive share of partnership income. Respondent has determined that petitioner's distributive share of partnership income, including salary, was $ 44,172.36; that one-half the salary, or $ 1,560, was taxable to his wife as community income; and that the remainder was the separate income of petitioner.
In his return for 1943 petitioner reported $ 22,554.63 as the portion of his distributive share of partnership income taxable to him, and his wife reported in her return $ 16,623.83 as the portion taxable to her. The allocation in the returns was made on the basis of a formula set out in G. C. M. 9825, X-2 C. B. 146. Respondent determined that one-half of petitioner's salary of $ 3,120, or $ 1,560, was the only portion taxable to the wife as community income, and that the remainder of $ 37,618.46 was petitioner's separate income.
OPINION.
Petitioner now contends that his entire capital interest in the partnership of Tinling & Powell in the taxable years was community property, and that consequently all of his distributive share of partnership income was community*20 income, taxable one-half to himself and one-half to his wife. Respondent, on the other hand, has determined and still contends that the only portion of the distributive share of partnership income constituting community income was petitioner's salary of $ 3,120 in each of the taxable years, and that the remainder was petitioner's separate income.
Petitioner rests his case upon the argument that, although he at one time had some separate property invested in the corporation, Tinling & Powell, Inc., that property has since been so commingled with community property that it is impossible to trace any part, and the whole *1399 must, under Washington law, be regarded as belonging to the community.
This contention was raised for the first time at the hearing. Few facts were alleged in the original petition, and counsel for petitioner explains that information regarding the sources of petitioner's capital investment in the partnership was first made available to him shortly before the hearing. An amended petition was therefore filed at the hearing, and respondent subsequently filed his answer thereto. Respondent was thus placed in a somewhat disadvantageous position, but, in view*21 of the circumstance that the facts were not made available to petitioner's counsel at an earlier time, respondent raised no objection to the introduction of evidence on the theory of the amended petition, and the hearing proceeded accordingly.
In support of his argument petitioner relies principally upon In re Buchanan's Estate, 89 Wash. 172">89 Wash. 172; 154 P. 129">154 P. 129. In that case a husband and wife were married in 1901, at which time a corporation was organized by the husband and a third person. Of the husband's original capital investment in the amount of $ 900, $ 400 was from his separate funds and $ 500 from his wife's separate funds. The wife died in 1911, and her son by a former marriage contended that she had a community half interest in the stock of the corporation. By the time of the wife's death the value of the stock had increased twentyfold. The court found that the enhancement in value was due chiefly to the husband's services. Since dividends on the stock had been credited to the same account as the husband's salary on the corporate books, from which account living expenses had been paid, the court held there had been*22 such a commingling that the identity of the separate property was lost and all the stock was community. In so deciding, it stressed the fact that the original contribution of separate funds was very small by comparison with the value of the stock at the wife's death.
We think the facts in the instant case are sufficiently different from those in the Buchanan case to make inapplicable the ruling in that case. Moreover, we find from an analysis of other decisions of the Washington courts that the Buchanan case has often been distinguished and, in effect, limited to its own facts. Among cases in which the Supreme Court of Washington went to considerable lengths to trace separate investments through corporate books and records and through exchanges of property and business transactions covering a period of years, in order to determine the respective portions of stockholdings or exchanged property constituting separate and community property are: Jacobs v. Hoitt, 119 Wash. 283">119 Wash. 283; 205 P. 414">205 P. 414; In re Brown's Estate, 124 Wash. 273">124 Wash. 273; 214 P. 10">214 P. 10; In re Hebert's Estate, 169 Wash. 402">169 Wash. 402;*23 14 P.2d 6">14 P.2d 6; State ex rel Van Moss v. Sailors, 180 Wash. 269">180 Wash. 269; *1400 39 P.2d 397">39 P.2d 397; and In re Dewey's Estate, 13 Wn. 2d 220">13 Wn.2d 220; 124 P.2d 805">124 P.2d 805.
In the Brown case, supra, the court stated that the fundamental principles to be followed in determining the status of separate or community property are:
1. The presumption is that property acquired during coverture is community property.
2. The status of property is to be determined as of the date of its acquisition.
3. If property is once shown to have been separate property, the presumption continues that it is separate until overcome by evidence.
4. Separate property continues to be separate through all its changes and transitions, so long as it can be clearly traced and identified.
5. The rents, issues, and profits of separate property remain separate property.
6. Separate property may lose its identity as such by being consolidated with community property.
It thus appears that the presumption that property once separate continues to be so, even through transitions and*24 exchanges, is of no less importance than the presumptions with respect to community property. The right of spouses in their separate property is as sacred as is the right in their community property. In re Dewey's Estate, supra;Guye v. Guye, 63 Wash. 340">63 Wash. 340; 115 P. 731">115 P. 731.
In Julius Shafer, 2 B.T.A. 640">2 B.T.A. 640, after discussing the Brown, Buchanan, and Hoitt cases, we stated that the decisions of the Supreme Court of Washington:
* * * lay down the rule that where business income was produced in part by the separate property and in part by the efforts of the community, and each of these two factors was substantial, the court will attempt to allocate such earnings; but if it appears that the income is to be attributed primarily to one element, the other element may be disregarded.
With the foregoing principles in mind, we find that the evidence adduced by petitioner in the instant case demonstrates that respondent's determination is in part erroneous. That is to say, petitioner has proved that at least some part of his capital investment in the partnership is community*25 property. On the other hand, his evidence falls short of establishing that there has been such a commingling of separate and community funds as to bring him within the ambit of the Buchanan case and require a holding that all his capital investment is community property. Factually, we think that the instant case is more nearly like the Hoitt, Sailors, Brown, and Hebert cases, all supra, and that petitioner's investment of separate funds is susceptible of being traced through the corporation into the partnership, which took over the net assets of the corporation. Although an exact determination is difficult, a reasonable approximation, as in the Hoitt case, may be made from the facts of record.
Petitioner held some stock in the corporation at the date of his marriage. Admittedly this was his separate property. Of the additional *1401 stock acquired on February 15, 1939, through the cancellation of accrued salary owing to petitioner and loans made by him to the corporation, a part was community and a part separate. This is so because a part of the accrued salary account represented salary earned by petitioner before marriage. We have determined the amount*26 of accrued salary which represented his separate property, and the ratio of that to the total credits canceled on February 15, 1939, affords the measure of the separate property portion of the stock issued to petitioner on that date.
Although petitioner disposed of some of his stockholdings prior to dissolution of the corporation, he has not shown the source of such shares. Therefore, bearing most heavily against him because of his neglect in that regard, we have assumed that he retained the stock which constituted his separate property. The result is that at dissolution, 37.91 per cent of petitioner's proprietary interest in the net assets, based upon his stockholdings, represented his separate property. We find no merit in petitioner's contention that so-called contributions to capital, consisting of the excess of the credits canceled on February 15, 1939, over par value of the stock received, and accrued salary owing to him as of December 31, 1940, so tainted all the stockholdings with a community interest that all must be held to be community property. We think it is sufficient answer that petitioner's proportionate proprietary interest in the net assets was not thereby increased, *27 for his partnership interest was fixed at 29 per cent -- the same percentage as his stockholdings in the corporation. If his relative contributions to capital were greater than those of the other stockholders, the excess might well have amounted to a gift or gifts.
The partnership took over the assets and liabilities of the corporation and continued in the same kind of business. We hold, therefore, that at the date the partnership was organized petitioner's capital investment of $ 17,842.70 was his separate property to the extent of 37.91 per cent, and the remainder was community property.
We must next consider the question as to how much of petitioner's share of partnership income is to be treated as attributable to personal services and how much to a return on capital investment. Petitioner suggests that if it is held that not all of his capital investment is community property, an allocation based on the formula contained in G. C. M. 9825, X-2 C. B. 146, would be more equitable.
Allocations based upon that formula, that is, in the ratio of an assumed reasonable salary allowance to a fair return on capital, have been approved by this Court in Clara B. Parker, Executrix, 31 B.T.A. 644">31 B.T.A. 644,*28 and J. Z. Todd, 3 T.C. 643">3 T.C. 643; affirmed and remanded, 153 F.2d 553">153 F.2d 553; decision on remand, 7 T.C. 399">7 T.C. 399. In the instant case, however, *1402 the partners provided specifically in their partnership agreement that petitioner and Powell should draw $ 3,120 each year "as salary due them." They were the only two partners who rendered services and managed the business. According to the practice of the partners, the salaries of petitioner and Powell were first deducted, and the remaining partnership profits were divided among all the partners in proportion to their capital investments. With the exception of $ 3,120 salary, the partners who performed no services received the same relative return on their capital investment as did the petitioner. No additional sums were accrued on the books as salary owing to petitioner.
In the light of these circumstances, we can do no more than hold that the salary of $ 3,120 agreed to by all the partners represents the measure of petitioner's compensation for services rendered, and that the remainder of his share of partnership income is to be treated as a return*29 on capital. Such was our holding in George W. Van Vorst, 7 T.C. 826">7 T.C. 826, in which we stated that any resort to the formula outlined in G. C. M. 9825 is unnecessary where the partners have agreed among themselves upon amounts which are to be allowed the managing partners as compensation for services and upon the portion of profits to be allocated to all the partners as a return on invested capital. Cf. In re Hebert's Estate, supra.
Since not all of the profits were withdrawn by petitioner in the year earned, his capital investment was greater in 1942 and 1943 than it was in 1941, and the relative separate and community portions of the capital investment were different. These portions can be determined in the recomputation. We have held that petitioner's original investment of $ 17,842.70 in the partnership was separate property to the extent of 37.91 per cent. We have shown in our findings petitioner's shares of partnership income for 1941, 1942, and 1943. In 1941, $ 3,120 thereof constituted community income attributable to services; 37.91 per cent of the remainder constituted separate income*30 attributable to separate capital investment; and 62.09 per cent constituted community income attributable to the community capital investment. We have also shown in our findings the debits and credits to, as well as the year end balances in, petitioner's investment account on the partnership books. There being no showing to the contrary, the withdrawals will be treated as having been made first from community funds. Lawrence Oliver, 4 T.C. 684">4 T.C. 684. The effect is that when community profits were withdrawn and separate profits were left in the business, the separate property part of petitioner's capital investment increased. Cf. George W. Van Vorst, supra.
From the foregoing, the relative proportions of petitioner's separate and community capital investment can be determined for 1942 and *1403 1943, and these in turn will determine what proportion of the distributive shares of partnership income other than the salary of $ 3,120 represented return on separate capital investment and what proportion represented return on community capital investment. See George W. Van Vorst, supra.
Decision*31 will be entered under Rule 50.