*2441 1. Where the life tenant of a going business made an absolute conveyance of her interest in consideration of an agreement to pay her an annuity of $25,000, held that the amounts paid were capital expenditures.
2. Where an interest in property is purchased, terminable upon the death of the grantor, the grantee agreeing to pay an annuity of $25,000, held that the amount paid each year should be deducted, under section 214(a)(8) of the Revenue Act of 1921, for exhaustion of the terminable estate so acquired.
*1145 The respondent has asserted deficiencies in income taxes as follows:
| Docket No. | Year | Amount | |
| Floyd M. Shoemaker | 25639 | 1923 | $688.43 |
| 1922 | 9,097.84 | ||
| Flora H. Shoemaker | 25640 | 1923 | 213.55 |
| M. Holmes Shoemaker | 25886 | 1923 | 418.74 |
| Guy S. Shoemaker | 25887 | 1923 | 509.38 |
| Clayton S. Shoemaker | 25888 | 1923 | 623.64 |
| Lois Shoemaker Olcott | 25889 | 1923 | 262.30 |
Two questions are presented for determination in these proceedings, *2442 which were instituted for a redetermination of the deficiencies asserted: (1) Whether the $25,000 paid to Charlotte S. Holmes by the petitioner, Flora H. Shoemaker, in 1922 and by the partnership in 1923 is deductible as an expense in each of the taxable years; and (2) whether in the event the Board determines the payment to have *1146 been a capital expenditure, as contended by the respondent, they are entitled to deductions for exhaustion of the life estate so purchased.
At the hearing the appeals were consolidated, the issues involved being common to all.
FINDINGS OF FACT.
The petitioners are individuals residing at Elmira, N.Y. Flora H. Shoemaker is the daughter of Charlotte S. Holmes and the wife of Floyd M. Shoemaker. The petitioners Lois Shoemaker Olcott, Clayton S., Guy S., and M. Holmes Shoemaker are the children of Flora H. and Floyd M. Shoemaker.
On July 13, 1919, Clay W. Holmes, husband of Charlotte S. Holmes, died, leaving a last will and testament, which provides in part as follows:
Second. - I give and bequeath to my beloved wife, Charlotte Holmes, all real and personal property of which I may die possessed, for her sole use and benefit, during*2443 her life, the same to pass from her to her only daughter, Flora Lois Shoemaker, at her death, for the sole benefit of herself and her children. In case my wife should die before me then my daughter Flora Lois Shoemaker, shall in her stead receive all the property conveyed by this Will, or in case my wife should be of unsound mind then the property shall pass to the daughter aforesaid with the condition that so much of the property as may be needed shall be used without limit to make my said wife comfortable while she lives.
An order of the surrogate's court held in Chemung County, New York, on the 8th day of June, 1920, fixes the value of the estate to Charlotte S. Holmes and Flora L. Shoemaker as of the date of the death of Clay W. Holmes as follows:
ORDERED, That the cash value of all the legacies, estates, annuities, life estates, terms of years, property and interests, growing out of the estate of said deceased, and which are subject to tax under said Act, and the tax to which the same are liable, shall be and the same are hereby assessed and fixed as follows:
| Beneficiary | Present value | Tax |
| Charlotte Holmes | $80,741.60 | $1,264.83 |
| Flora L. Shoemaker | 376,575.39 | 11,613.02 |
*2444 The estate consisted largely of a going business, the Holmes Frostilla Co., which manufactured face lotions and cosmetics. The Holmes Frostilla Co. had been established about 1870 by Clay W. Holmes, then a pharmacist in the City of Wilkes-Barre. With a certain doctor he had observed the complications resulting to the skin of miners in that locality from climatic and occupational conditions and devised the formula for Frostilla, which they prepared in the drug store operated by Holmes. Demands increased and after a half *1147 century the formula for Frostilla became quite valuable, the article being widely distributed.
During the few years just preceding the death of Holmes he took an indifferent interest in developing the Frostilla business. Upon his death a modern sales system was instituted and a national advertising campaign conducted which Holmes had not thought worth while. The result was a large increase in sales and a better market position as the articles manufactured became internationally established.
The net earnings of the Holmes Frostilla Co. for the years 1916 to 1922, inclusive, were as follows: 1916, $38,647.01; 1917, $39,257.17; 1918, $21,454.66; *2445 1919, $52,852.16; 1920, $49,939.48; 1921, $46,606.19; 1922, $41,183.27.
As a result of the business methods employed and the resulting increase in net earnings, the Holmes Frostilla Co. had a value on December 8, 1921, greatly in excess of the value at the date of Holmes' death.
On December 8, 1921, the life interest of Charlotte S. Holmes in the estate of her husband had a value of at least $92,500.
On December 27, 1921, Charlotte S. Holmes was 82 years of age and according to accepted mortality tables her life expectancy, dating from January 1, 1922, was 3.7 years. She was quite unequal to the management and personal direction of her property, which included the Holmes Frostilla Co., and in order to relieve herself of the care and obligations attached thereto the following contract was entered into on December 8, 1921:
THIS AGREEMENT, made this 8th day of December, 1921, by and between Charlotte S. Holmes, of the City of Elmira, New York, party of the first part, and Flora Holmes Shoemaker, of the City of Elmira, New York, party of the second part, WITNESSETH:
THAT WHEREAS, Clay W. Holmes died on the 13th day of July, 1919, leaving a last Will and Testament wherein*2446 he left to the party of the first part a life estate in all his property, with the remainder to the party of the second part, and
WHEREAS, the party of the second part is desirous of continuing the business of said Clay W. Holmes, known as the Holmes Frostilla Company, and other business conducted by said Clay W. Holmes, and the party of the first consents thereto, and
WHEREAS, it is to the benefit of said business that certain expenditures be made other than the ordinary routine expenditures,
NOW THEREFORE, the party of the first part, in consideration of the sum of One Dollar, ($1.00), paid by the party of the second part, the receipt whereof is hereby acknowledged, and the promises of the party of the second part hereinafter contained, does hereby consent that the custody and control of the corpus of the estate of said Clay W. Holmes excepting the garage lot and the garage thereon which is now used by the first party, and excepting also the cemetery lot, may be transferred to the party of the second part to use and invest the same as said second party may desire absolutely as if it were her *1148 own, and pay the income thereof monthly during the life of said party*2447 of the first part as hereinafter provided.
1. The party of the first part hereby grants to the party of the second part power to grant and convey in her own name any of the assets of said estate, excepting the garage lot and the garage thereon which is now used by the first party, and excepting also the cemetery lot, and the party of the first part hereby grants, quitclaims and remises unto the party of the second part, her heirs and assigns forever, all the real estate which belonged to said Clay W. Holmes at the time of his death, excepting the garage lot and the garage thereon which is now used by the first party, and excepting also the cemetery lot, and agrees to execute such other instruments in writing as may be necessary or convenient to carry out the terms of this agreement.
2. The party of the second part agrees to pay monthly to the party of the first part, from the income of said estate, one-twelfth of Twenty-five thousand dollars, ($25,000) i.e. Two Thousand Eighty-Three Dollars and Thirty-Four cents, ($2,083.34) during the life of said party of the first part, and in case the income of said estate is not sufficient therefor the party of the second part agrees*2448 to pay the difference between the income of said estate and said figure to the party of the first part, with the following exception, that in case the Frostilla business is so destroyed or interrupted by fire, war, riot or any force or cause beyond the control of the second party so that it earns no income, during such period of time as it earns no income the party of the second part shall be compelled to pay to the party of the first part the actual income of said estate, and in case the income of said estate is not sufficient to pay monthly the sum of $520.84, the party of the second part agrees to pay the difference between the income of said estate and said $520.84.
3. The party of the first part grants, conveys and assigns unto the party of the second part all her right, title and interest to the income of said estate over and above said Twenty-five Thousand Dollars, ($25,000) per annum as hereinbefore mentioned.
4. The party of the second part agrees to deposit with the Second National Bank of Elmira, N.Y., U.S. Liberty Bonds of the par value of $100,000 to insure the faithful performance of this contract by said second party, and the party of the second part agrees that*2449 on default of any payment due from her to the first part hereunder for thirty days after demand by the first party therefor, that said Second National Bank may sell at the market sufficient of said Bonds to make such payment and may make such payment to said first party in behalf of said second party. The income on said bonds shall be collected by said Second National Bank and turned over to party of the second part after deducting its charges for carrying out its part of the agreement. Upon the termination of this agreement said Second National Bank shall surrender said bonds to the party of the second part.
5. It is further mutually agreed that the covenants hereof shall not become effective until the 1st day of January, 1922.
6. The parties hereto, being the widow and only heir at law and next of kin of Clay W. Holmes, deceased, do hereby agree, upon the transfer by Floyd M. Shoemaker, as Administrator with the Will annexed of Clay W. Holmes, deceased, of all the assets of said estate to the party of the second part, and upon the approval and confirmation of this agreement by the Surrogate of the County of Chemung, to release said Administrator of and from all claims against*2450 him, and consent that he be discharged as such Administrator and his accounts settled, and agree to sign any instrument releasing and discharging him from the duties of said office.
*1149 IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and seals the day and year first above written.
The business was conducted by Flora H. Shoemaker during the year 1922 and the $25,000 payment made by her to Charlotte S. Holmes. In the latter part of December, 1922, it was determined to operate the business for the next year as a partnership, and on December 26, 1922, the following agreement was entered into:
THIS AGREEMENT, made this 26th day of December, 1922, between Flora H. shoemaker of the City of Elmira, New York, and Floyd M. Shoemaker, M. Holmes Shoemaker, Guy S. Shoemaker and Clayton S. Shoemaker, all of the City of Elmira, N.Y. and Lois Shoemaker Olcott of Big Flats, New York.
WHEREIN IT IS MUTUALLY AGREED AS FOLLOWS:
I. That the parties hereto shall as partners engage in and conduct a business of manufacturing and selling Frostilla lotion and other Frostilla preparations.II. That the name of the partnership shall be The Frostilla Company.
*2451 III. That the term of the partnership shall begin January 1, 1923. IV. That the place of business of the partnership shall be located at 410 West Gray Street, Elmira, N.Y.V. That said Flora H. Shoemaker made an agreement under date of December 8, 1921, with her mother, Charlotte S. Holmes wherein and whereby said Flora H. Shoemaker agreed to pay to said Charlotte S. Holmes the sum of twenty-five thousand dollars, ($25,000) annually during the life time of said Charlotte S. Holmes. VI. That said Flora H. Shoemaker has heretofore been engaged in business at the address given above under the name and style of The Frostilla Company. That the partnership will engage in business at the same address and with all the assets of said Flora H. Shoemaker which have been devoted and invested in the manufacture and marketing of Frostilla lotion.VII. It is understood and agreed between the parties hereto that the investment of said Flora H. Shoemaker in said partnership shall be only the tangible and intangible assets including good-will which she employed as of January 1, 1923, in the manufacture, sale and marketing of Frostilla lotion and that said assets and income therefrom*2452 shall be burdened with the annual payment to said Charlotte S. Holmes as herein set out and it is understood and agreed between the parties hereto that said twenty-five thousand dollars, ($25,000) shall be paid annually before any profits are distributed.
VIII. (a) That full and accurate accounts of the transactions of the partnership shall be kept in proper books, and each party shall cause to be entered upon said partnership books a full and accurate account of all of his transactions in behalf of the partnership.
(b) That the books of the partnership shall be kept at the place of business of the partnership, and each party shall, at all times, have access to, and may inspect and copy, any of them.
IX. That no party shall, without the consent of the other parties, sell, assign, pledge or transfer his or her interest in this partnership, make, execute, deliver, endorse, or guaranty any commercial paper, nor agree to answer for, or indemnify against, any act, debt, default, or misconduct of any person, or partnership (other than that of the parties hereto) or corporation.X. (a) That, at the end of each calendar year, a full and accurate inventory shall be prepared, and*2453 the assets, liabilities and income, both gross and net, shall be ascertained, and the net profits, or net loss, of the partnership, shall be fixed and determined.
*1150 (b) That the net profits, or net loss, shall be divided equally between the parties hereto, and the account of each shall be credited, or debited, as the case may be, with his proportionate share thereof.
XI. That, if one of the parties shall die, during the continuation of the partnership, the survivors shall, upon the terms and conditions hereinafter set out, continue as partners, it being understood and agreed between the parties hereto, that the interest of said deceased partner shall be purchased by the surviving partners upon the terms and conditions as hereinafter set out.XII. In the event of the death of any of the partners, the value of the interest of said deceased partner shall be appraised and the amount thereof paid to the executor or administrator of said deceased partners. The value of said share of said deceased partner in said partnership shall be determined by the surviving partners and the executor or administrator of said deceased partner. If this value can not be agreed upon*2454 by said parties, it is to be settled and determined by the method hereinafter provided.
XIII. That, if any disagreement shall arise between the parties, in respect of the conduct of the partnership business, or as to the value of the share of any deceased partner, or in respect of any other matter, cause, or thing, whatsoever, not herein otherwise provided for, the same shall be decided and determined by arbitrators, one arbitrator to be selected by the partnership and one by the disagreeing partner or partners, or in the event of death by their legal representatives, and both of said arbitrators shall select a third arbitrator, and the decision of two of such arbitrators, when made in writing, shall be conclusive upon the parties hereto.IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and seals, the day and year first above written.
On her income-tax return for 1922 Flora H. Shoemaker deducted the $25,000 payment to her mother as a business expense, and for the year 1923 the partnership deducted that amount in computing its distributive net income. The respondent has restored to income for each of the years the amount thus deducted, thereby increasing*2455 Flora H. Shoemaker's income by $25,000 for 1922, and the income of each of the petitioners for 1923 in the amount of $4,166.66.
OPINION.
LANSDON: The questions presented herein were considered and disposed of in , where we held that a terminable interest in property purchased in consideration of a promise to pay an annuity to the grantor represented a capital investment which should be exhausted over the life of the estate so acquired. In that case there was no proof of the value of the estate acquired and the deduction to which petitioner was entitled could not be determined.
In the instant case the contract of December 8, 1921, provided for the absolute sale and transfer by Charlotte S. Holmes of her life interest in the estate of her husband, which we have found to have had a value of at least $92,500, in consideration of a promise to pay ber an annuity of $25,000.
*1151 We consider the Keitel case, supra, controlling here and, in conformity with our opinion in that case, the petitioner, Flora H. Shoemaker, is entitled to deduct $25,000 for exhaustion of the terminable estate acquired, in computing her taxable*2456 income for 1922. A like amount should be deducted in computing the distributable partnership net income for 1923. Cf. .
Decision will be entered under Rule 50.