*3827 1. A partnership, of which the petitioners are members, is engaged in general shorthand reporting and does reporting for the Public Service Commission of Pennsylvania and for the Board of Viewers of Philadelphia County. The reporting is done by members of the partnership and by hired employees. Held, that no part of the income received is exempt from income tax.
2. Several of the petitioners received both tax-exempt and taxable income and had expenses connected with the earning of such income which, for the years 1919 to 1923, were deducted from the taxable income alone in their individual returns. The Commissioner disallowed such portion of the total expenses as the gross tax-exempt income bore to the gross taxable income. Held, that the expenses incurred in the earning of the tax-exempt income are not deductible from the gross taxable income and in the absence of evidence of a better allocation of expenses to the tax-exempt income and to the taxable income than that made by the respondent, has disallowance of the deduction of a portion of the total expenses is sustained.
*335 These proceedings, duly consolidated for disposition, involve deficiencies in income tax as follows:
| Year | Victor G. Marquissee (Docket No. 7391) | Walter H. Lewis (Docket No. 7392) | Martin F. Moore (Docket No. 7393) | T. Roy Phillips (Docket No. 7394) | Charles F. Phillips (Docket No. 7395) |
| 1919 | $92.79 | ||||
| 1920 | 217.66 | $11.51 | $9.25 | ||
| 1921 | 208.84 | 8.61 | 38.54 | ||
| 1922 | $9.82 | 70.27 | $9.82 | 9.82 | 15.09 |
| 1923 | 17.63 | 39.61 | 55.14 |
This proceeding was first heard upon a stipulation filed by counsel for the petitioners and the respondent, which admitted that certain income of the partnership was exempt from tax. This stipulation not being acceptable to the Board, the proceedings were restored to the Day Calendar for the taking of further evidence to enable the Board to decide the questions involved. The issue presented is whether the net income of the petitioners was correctly computed. At the hearing counsel for the respondent moved to increase the deficiencies determined by the Commissioner in accordance with the evidence adduced.
FINDINGS OF FACT.
1. The petitioners are members of the partnership*3829 of Guilbert & Lewis, which is engaged in the business of general shorthand reporting, in Philadelphia, Pa.
2. During the years 1920, 1921, and 1922 the partnership of Guilbert & Lewis was composed of the petitioners and C. H. Guilbert. Guilbert deceased in October, 1923, and his estate received his pro rata share of the earnings of the partnership for the balance of the year 1923. In the conduct of its business the partnership maintained a central office with a force of clerks, stenographers and assistant shorthand reporters, rented a common suite of offices, purchased materials, supplies and paraphernalia for the entire force, and in general was subject to overhead expenses. These expenses were incurred in part from stenographic services performed for certain State commissions and boards, and in part from the stenographic services performed for the United States and business concerns.
3. Victor G. Marquissee, a member of the firm from 1920, first performed services for the Public Service Commission of Pennsylvania. On September 29, 1923, he was appointed an official stenographer of the Court of Common Pleas, Number Four, of Philadelphia County, his term of office beginning*3830 October 1, 1923. He was appointed to this position by the presiding judge of the court at a *336 salary of $4,000 per annum, payable semimonthly, and took an oath of office to the effect that he had not spent any money in acquiring the office and that he would carry out the duties prescribed by the court with fidelity and accuracy. His duties as such official stenographer were to take notes of the evidence given during the trial of cases in court, to transcribe the same, to certify one copy, and file it as an official record, and such other duties as the judges from time to time prescribed, such as writing the decisions of the judges and the reporting of divorce cases which were referred by the court to masters. The duties were in nowise discretionary. For such services he received a salary and in addition transcript fees for the transcripts which were filed as official records and also from the sale of copies to litigants. The amount of his salary was certified by the judge of the court and the county commissioners. The latter issued an order on the city treasurer, who then issued a warrant which was cashed by him. This salary was received by Marquissee individually; *3831 it never went into the firm income and was not returned as taxable income by Marquissee in his individual return. The fees received were claimed as exempt income. The money received from the sale of copies to litigants was returned as taxable income of the partnership.
In the collection of fees there was no appropriation made for same in advance, but bills were presented to the court which were audited by the court's clerk and approved by the judge on an order which was signed by the judge, and which directed the county to pay those charges in accordance with the provisions of an Act of Assembly, approved May 1, 1907.
After Marquissee's appointment as official stenographer of the Court of Common Pleas, Number Four, he continued as a member of the firm of Guilbert & Lewis. He employed a typist who transcribed his notes. This typist was not paid by the firm of Guilbert & Lewis, but was paid by Marquissee out of his own funds. The typist occupied an office in the suite of offices rented by the firm. The typist transcribed all of Marquissee's notes, not only those connected with his work before the Court of Common Pleas, but before other bodies as well; for his work as official*3832 stenographer did not occupy all his time. Marquissee received 10 per cent of the net income of the partnership.
4. Walter H. Lewis was official stenographer of the Court of Common Pleas, Number Four, and of Common Pleas Courts of Chester County, Delaware County, and Montgomery County. Charles F. Phillips was official stenographer of the Court of Common Pleas, Number Four, of Philadelphia County, and was appointed at the same time as Marquissee. The facts with respect to their incomes *337 and employment were the same or substantially the same as those above stated of Marquissee.
5. The firm of Guilbert & Lewis had, prior to the beginning of the taxable years herein involved, been appointed or engaged to act as official stenographers of the Public Service Commission of Pennsylvania and of the Board of Viewers of Philadelphia County.
6. T. Roy Phillips performed most of his services for the Public Service Commission and Martin F. Moore for the Board of Viewers of Philadelphia County. Creation, powers and duties of the former were provided for in the Act of 1913, P.L., 1374, West Co. Pa. Stats., Secs. 18057-18214. The Commission was created as an "administrative*3833 body" with an official name and seal, its members were to be appointed by the governor with the advice and consent of the senate, and its powers were very comprehensive, having to do with the supervision and regulation of public service companies in the Commonwealth of Pennsylvania. By the ninth section of article IV of the act, the Commission was given "power to employ during its pleasure, and at such rates of compensation as it may determine, such officers, experts, engineers, statisticians, accountants, inspectors, clerks, and employees as it may deem necessary to carry out the provisions of this act." The act further provides, "the testimony shall be taken down by the stenographer appointed by the Commission." (Article 6, section 7.) The firm of Guilbert & Lewis was appointed official stenographers of the Commission for the eastern half of Pennsylvania; the rates of compensation were fixed by the Commission; the stenographers so appointed exercised no discretionary authority but gave their services under the immediate direction of the Commission; the tenure of office was not fixed by contract and the firm was employed at the pleasure of the Commission; compensation was paid to*3834 the firm directly by the Treasurer of the Commonwealth of Pennsylvania out of public funds upon orders of the Commission, approved by an auditor general of the Commonwealth.
7. The firm of Guilbert & Lewis was also appointed as official stenographers by the Board of Viewers of Philadelphia County. The county boards of viewers were created and their powers prescribed by the Act of 1911, P.L. 1123, West Co. Pa. Stats., sec. 6575, et seq. These boards were created as arms of the courts of common pleas, their members being appointed by the judges of the latter. They are quasi-judicial bodies with jurisdiction over condemnation questions involving the right of eminent domain, etc. By section 8 of the act it is provided that, "the said Board of Viewers shall employ such stenographers and clerical assistants * * * as the County Commissioners, or the legislative body of the county shall authorize * * *. The salaries or compensation of such stenographers and *338 clerical assistants shall be fixed by the said County Commissioners or the legislative body of the county * * * and shall be paid out of the treasury of the proper county." The tenure of the appointment of the partnership*3835 was at the pleasure of the Board of Viewers; it had been continuous for a number of years prior to 1920 and continued from 1920 to 1923, inclusive.
8. The income of the partnership from the performance of services for the Public Service Commission and the Board of Viewers of Philadelphia County was returned as nontaxable income upon the returns of the partnership, filed for the taxable years under review. These services were performed principally by members of the partnership, but in some cases by employees of the partnership. The employees performing these services received compensation at a stipulated rate per quantity of work done.
9. The firm of Guilbert & Lewis filed annually with the collector of internal revenue at Philadelphia a partnership return on Form 1065, in which the net income of the partnership was computed by deducting from "taxable income" all the ordinary and necessary expenses of the partnership incurred in carrying on its business, the result being an annual net loss which was set up in red ink as "net income" and, under the schedule entitled "partner's shares of income and credits," the said net loss was distributed to each partner in proportion to*3836 his interest in the partnership. On the face of each return, under the heading "income" the firm made disclosure by rider or notation of its "exempt income" in substantially the following language:
The firm also received from the State of Pennsylvania and governmental instrumentalities thereof salaries amounting to which counsel advises is exempt from tax.
A copy of the partnership's return for 1923 shows as follows:
| Total income from business or profession (excluding | ||
| tax-exempt income) | $43,212.83 | |
| Salaries & Wages not reported as labor | $4,023.50 | |
| Rent | 2,682.20 | |
| Telephone | 567.73 | |
| Supplies | 2,146.12 | |
| Miscellaneous | 1,472.18 | |
| Cost of work billed (wages, etc.) | 39,807.32 | |
| Cost of work U.S.A. (wages, etc.) | 1,239.95 | |
| Lighting | 318.21 | |
| Janitor service | 522.00 | |
| Coal | 153.99 | |
| 52,933.20 | ||
| Net loss | $9,720.37 |
*339 The firm also received from the State of Pennsylvania and governmental instrumentalities thereof salaries amounting to $22,643.70 which counsel advises is exempt from tax.
The above return for 1923 is accepted as a correct illustration of the returns filed.
10. The Commissioner disallowed a part of the deductions for total expenses*3837 as outlined in paragraph 9, supra, and being unable to separate the expense of earning the "taxable income" from the expense of earning the "exempt income," the Commissioner took a percentage of the total expenses using the same percentage rate as the firm's taxable income bore to its total income and allowed the resultant portion of the firm's total expenses as a deduction.
11. Each of the aforesaid members of the firm of Guilbert & Lewis on his individual income-tax returns for the years in controversy set up under the heading "income" as Item 4, "income from partnerships, fiduciaries, etc.," the amount of his distributive share of the partnership's net loss, as computed in paragraph 9 supra. No return was made of his distributive share of the partnership's "exempt income." A copy of Victor G. Marquissee's return for 1923, which is accepted as a correct illustration of the several individual returns filed by the petitioners, shows his income from taxable sources and then the deduction from gross income of $972.03, representing his proportionate part of the net loss of the partnership for the year 1923, the total net loss of the partnership amounting, as above stated, *3838 to $9,720.37. In determining the deficiencies of each of the partners, the Commissioner disallowed the deduction of any amount representing partnership loss and added to net income his proportionate part of the adjusted net income of the partnership.
12. The individual partners also earned separate "taxable income" which accrued to them individually as personal income. Likewise, separate expenses which were incurred in the earning of the separate income were individually assumed by the several partners. In making return of this separate income on their personal returns, the petitioners followed the aforesaid firm procedure of deducting all their separate expenses from their separate "taxable income." In each case the Commissioner, following his treatment of the partnership return, allowed a deduction only of a percentage of the expenses prorated in ratio of the taxpayer's separate "taxable income" to his total separate income.
13. The method followed by the respondent in computing the net income of the partnership for 1923 and of the net income of Victor G. Marquissee for the year 1923 is shown by the following "schedule-11" and "schedule-7," filed as a part of the stipulation*3839 in this case:
| SCHEDULE 11 | ||
| Gross taxable income 1923 | $43,212.83 | |
| Deductions | ||
| Salaries wages to employes | $4,023.50 | |
| Rent | 2,682.20 | |
| Phone | 567.73 | |
| Supplies | 2,146.12 | |
| Miscellaneous expenses | 1,472.18 | |
| Cost of work billed | 41,047.27 | |
| Lighting | 318.21 | |
| Janitor service | 522.00 | |
| Coal | 153.99 | |
| 52,933.20 | ||
| 0.6561% of $52,933.20 = deductible expense of | 34,729.47 | |
| Net income | 8,483.36 |
| Taxable. | |
| Non taxable income | $22,643.70 |
| Taxable income | 43,212.83 |
| 65,856.53) $43,212.83 (0.6561 per cent. |
| SCHEDULE 12. - DISTRIBUTION OF INCOME | ||
| Name and address | Per cent | Year ended 1923, other income |
| C. H. Guilbert, dec'd 9/12 | $1,908.75 | |
| C. H. Guilbert estate 30 3/12 | 636.25 | |
| W. H. Lewis | 30 | 2,545.01 |
| C. T. Phillips | 10 | 848.34 |
| T. Roy Phillips | 10 | 848.34 |
| M. F. Moore | 10 | 848.34 |
| V. G. Marquissee | 10 | 848.34 |
| 8.483.36 | ||
| 12-31-23 |
| SCHEDULE 7 | ||||
| Block adjustments | ||||
| Block | Return | Additions | Deductions | Corrected |
| 2 | $3,185.20 | $398.05 | $3,583.25 | |
| 4 | (972.03) | 1,820.36 | 848.33 | |
| 2,313.17 | 2,218.41 | 4,431.58 | ||
| 17 | 544.00 | 544.00 | ||
| Total | 1,669.17 | 2,218.41 | 3,887.58 |
| SCHEDULE 7-A | ||
| Explanation of items | ||
| Item 2. | ||
| Income from business or profession | $5,165.56 | |
| Wages to stenographers | 1,911.02 | |
| Expenses | 68.84 | |
| 1,980.36 | ||
| 0.799 per cent of $1,980.36 - Deductible expense | 1,582.31 | |
| Net income from profession | 3,583.25 |
*3840 This is the only year taxpayer received exempt income.
| Exempt income | $1,300.00 |
| Taxable income | 5,165.56 |
| Total income | 6,465.56/$5,165.56/0.7999 per cent |
Item 4.
| Guilbert & Lewis | $848.33 |
Item 17.
| Taxes, $150.00; mortgage interest, $334.00; contributions, $60.00 | $544.00 |
| SCHEDULE 8 | ||
| 12/31/23 | ||
| Computation of tax | ||
| Total net income | $3,887.58 | |
| Less exemption | $3,300.00 | |
| 3,300.00 | ||
| Income subject to normal tax | 587.58 | |
| Tax 4 per cent on $587.58 | $23.50 | |
| Total tax | 23.50 | |
| Tax previously assessed | None. | |
| Additional tax to be assessed | 23.50 | |
| Less 25 per cent reduction act 1924 | 5.87 | |
| Additional tax to be assessed | 17.63 |
*341 14. The method of computing the taxable income of the partnership and of the petitioners for years other than 1923 was as indicated in the aforegoing.
OPINION.
SMITH: The first question presented by these proceedings is whether any part of the gross income of the partnership is exempt from income tax. In the filing of its returns the partnership claimed that such portion of its income as came from charges to the State of Pennsylvania or*3841 from political subdivisions of the State for work done was exempt from tax and deficiencies were determined by the respondent upon the basis that such income of the partnership was exempt income. The respondent disallowed such portion of the total expenses shown as a deduction on the partnership returns as the reported tax-exempt income bore to the total income and determined the net income of the partnership accordingly. The petitioners appealed to this Board from such disallowances. The Board refused to accept a stipulation of the parties litigant to the effect that certain income of the partnership was exempt from income tax and upon its own motion ordered a rehearing of the proceedings for the purpose of enabling it to determine the true deficiencies.
At the rehearing of this case it was testified to on behalf of the petitioners that the firm of Guilbert & Lewis had been "appointed" *342 prior to the taxable years herein involved, as official stenographers of the Public Service Commission of Pennsylvania and of the Board of Viewers of Philadelphia County, and it was argued that by virtue of such appointment the members and employees of the firm who performed the services*3842 for the Commission and Board were employees of the State of Pennsylvania or of a subdivision of the State and that their compensation was exempt from income tax under section 1211 of the Revenue Act of 1926.
The method of "appointment" of Guilbert & Lewis as official stenographers of the Public Service Commission and of the Board of Viewers is not clear. There was no written contract executed. The firm was engaged for an indefinite period. That period might be terminated any time by the Commission or Board. The compensation received by the firm was a given amount per one hundred words of testimony taken or transcribed. Under the arrangement the stenographic services were furnished either by members of the firm or by hired employees.
Upon this state of facts we are asked to find that the members of the partnership and its employees who performed services for the Commission and Board were employees of a State, within the purview of section 1211 of the Revenue Act of 1926. This we can not do. Even though the appointment of the partnership was not evidenced by any written contract it does not follow that the members of the partnership were employees of the State of Pennsylvania*3843 in the performance of their work or that a contract for the performance of the services did not exist. The partnership was engaged to do the work and not an individual member or employee. We think that the status of the partnership with respect to its engagement by the Commission and Board was that of an independent contractor within the rule laid down by . See also ; ; R. Clipston Sturgis, 10, B.T.A. 1394. We are, therefore, of the opinion that the entire income of the partnership was taxable. Since this is true, there is no occasion for the disallowance of the deduction from the gross income of the partnership of any part of the expenses paid in carrying on the partnership business.
The second question is whether certain of the petitioners are entitled to deduct from gross income included in their individual tax returns the entire amounts paid by them for services of typists, materials, etc. As official stenographers of the courts of common pleas, they received salaries and fees which they have claimed as tax-exempt*3844 income and the status of such income is not questioned by the respondent. These same petitioners, however, received admittedly taxable income and they claimed the right to deduct from such taxable income the total expenses paid by them for typists, etc. The *343 respondent has disallowed such portion of the expenses as the taxable income bore to the total income received directly for stenographic services. The petitioners have appealed to the Board from such disallowances and submit that under section 214(a)(1) of the Revenue Acts of 1918 and 1921 they are entitled to deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *."
At this point it is pertinent to inquire the extent of the exemption from income tax of compensation received for the performance of services to a State or a political subdivision of a State. In the , it is stated:
The Revenue Act of 1921, which was in effect during the taxable year involved, did not by its terms exempt the salaries of officers and employees of a State from the income tax, but section 1211 of the Revenue Act*3845 of 1926, which is retroactive and effective as to all prior revenue acts, provides as follows:
"Any taxes imposed by the Revenue Act of 1924 or prior revenue Acts upon any individual in respect of amounts received by him as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded."
The above section is the only provision of the statute with respect to the compensation received by State officers or employees. That section does not expressly exempt the compensation of officers or employees of the State from the Federal income tax. It, however, clearly indicates that it was not the intention of Congress to tax compensation for personal services rendered by an officer or employee of a State. In effect, it merely incorporates into the statute the principle that had long been established by judicial construction and may fairly be considered as an interpretation of the different revenue acts. The United States*3846 Supreme Court had long prior to the enactment of the Revenue Act of 1926 held that the Federal Government had no power to levy or collect a tax upon the compensation of officers and employees of States. * * *
Section 1211 of the Revenue Act of 1926 is entitled "Salaries of State and Municipal Officers." It is evident from this section that Congress intended to exempt from tax only the salaries or compensation paid for personal services. In the proceedings at bar the petitioners have excluded from gross income the total compensation received directly from the State and then in addition have claimed the deduction from admittedly taxable income of expenses incurred in connection with the earning of tax-exempt income. We think that this goes beyond the statute. Although under section 214(a)(1) of the Revenue Acts of 1918 and 1921 an individual is entitled to deduct all ordinary and necessary expenses incurred in the carrying on of any trade or business, we apprehend that this should not be extended to include expenses incident to the earning by an employee of a State of compensation for personal services. To the extent that such expenses are incident to the occupation of the*3847 State employee they are not ordinary and necessary expenses of any trade or business *344 from which any taxable income is derived. We think that it was incumbent upon the petitioners to segregate expenses connected with their business from which taxable income was derived from expenses incident to the earning of claimed nontaxable income. The petitioners have not done this. The allocation of expenses made by the respondent is reasonable and appears to have been a proper allocation in the circumstances. . The disallowance made by the respondent is sustained.
Motion of the respondent to increase the deficiencies in accordance with the evidence adduced at the second hearing is granted.
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
LOVE, dissenting: I dissent in these cases on two phases.
First, I am opposed to the policy adopted by the Board in refusing to accept a stipulation of fact signed by petitioner and respondent and filed prior to the first hearing in this case. That stipulation was a stipulation of facts, notwithstanding it did involve a*3848 legal conclusion based on facts known to the Commissioner, but not set out in the stipulation. I believe the case should have been decided on those stipulations. I do not believe that Congress designed to constitute this Board a guardian of the Commissioner of Internal Revenue or a guardian of the rights of taxpayers. The Commissioner's office is supplies with competent counsel and experts who are qualified to take care of its interests and who should be held responsible for the conduct of its affairs. Taxpayers are presumed to procure and be guided by competent counsel. When both parties come before the Board, as they may do before a district court, with a signed stipulation of facts, my inclination is to accept such stipulation and, applying the law, decide the issues involved.
Second, since a rehearing was ordered and in view of the evidence presented at that hearing, I agree with the decision reached as a result of that hearing in regard to income that is taxable and as to that which is exempt. I do not agree, however, with the decision wherein it refuses to allow a deduction of all expenses from the taxable part of the income and attempts to allocate, in a "reasonable"*3849 was such expenses to both taxable and exempt income. The statute is not ambiguous. The statutory method of determining net taxable income is laid down and expressed in plain English, and in order to reach the conclusion reached in this case, something must be read into the statute that can not, legitimately, be imputed to the words used therein.
Section 213 of the Revenue Acts of 1918 and 1921 defines gross income and prescribes what it shall include and what it shall not include. Income that is exempt is expressly excluded.
*345 Section 214 defines net income and prescribes that the amount of net income shall be obtained by deducting from gross income "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."
Because in a particular case the application of the mandate of the statute appears to result in an inequitable or incongruous situation, is not sufficient grounds for a court or this Board to disregard the statutory provisions. This Government is a government by law, and all judicial tribunals should decide cases according to the prescribed law, and not attempt to deal out substantial justice as*3850 the particular judge or court may believe such justice to be. When the statute blazes the road, the courts must follow that road.
I believe it may be truthfully and conservatively stated that there are hundreds of banks and trust companies in the United States that handle, regularly, in their business, millions of dollars worth of Government bonds, the interest on which is exempt, and also other securities the income on which is exempt. The expense of handling such matters is uniformly, so far as I know, included in the general expense account of such institutions and deducted from gross income which does not include exempt income. I believe these taxpayers' return should be handled in the same manner.