*34 Decision will be entered under Rule 50.
Income from a sheep-ranching business consisting principally of the proceeds from the sale of wool and lambs, held, taxable to the petitioner, notwithstanding his assignment of a portion of the sheep to his minor children as gifts.
*805 This*35 proceeding involves income tax deficiencies for the period January 1 to October 31, 1942, and for the fiscal years ended October 31, 1944 and 1945, in the respective amounts of $ 15,661.88, $ 12,255.98, and $ 4,126.93, and a delinquency penalty for the year ended October 31, 1942, of $ 783.10. It has been stipulated that the petitioner is entitled to certain deductions for freight costs, truck repairs, and labor, as set out in the stipulation. Other issues were waived by the petitioner. The two questions remaining for our determination are (1) whether there should be included in petitioner's returns all of the income from his sheep-ranching business, a part of which he allocated to his four minor children, who reported it in their returns, and (2) whether petitioner is entitled to have his income for the short period January 1 to October 31, 1942, computed under the provisions of section 47 (c) (2), Internal Revenue Code.
*806 FINDINGS OF FACT.
The petitioner is a resident of Craig, Colorado. His income tax returns for the years involved were filed with the collector for the district of Colorado.
The petitioner's business is sheep ranching. He owns outright about 30,000 *36 acres of ranch lands and leases about 20,000 acres of privately owned land and 40,000 acres of public lands. He runs on an average of about 4,000 to 6,000 sheep. His brother-in-law, Albert Reuse, is employed as foreman of the ranch on a salary basis and also receives a share of the profits. He originally owned about 300 sheep, which were commingled with petitioner's sheep, and he owns some land which is used seasonally for grazing.
The petitioner is a naturalized citizen of the United States. He immigrated to this country from Austria when he was fifteen years of age. He started in the sheep-ranching business for himself in 1927, after working as a sheep herder for other ranchers in Colorado and Wyoming and engaging in several partnership or profit-sharing ventures on a limited scale.
In the fall of 1942 the petitioner undertook to make gifts of approximately one-third of the sheep which he then owned to his four minor children, Dean, 13 years of age; Mary, 11; Rosalie, 9; and Carmen, 6. He assigned to each of the children, by a bill of sale dated October 7, 1942, "500 Cross-Bred Ewes with lambs and all increase." These assignments were recorded in the county assessor's records*37 and reported in Federal and state gift tax returns. Thereafter, 500 of the ewes were branded with the initial of the first name of each of the children. This brand was in addition to the petitioner's registered brand "V", which was stamped on all of the sheep. The brands were stamped on the backs of the sheep with oil paint. In time this paint would wash off, so as not to damage the wool. The children were told that they were being given the sheep and some of them helped with the branding. Only ewes were assigned to the children. About 175 rams were kept for breeding purposes.
Records of the ranch operations were kept in a ledger by the petitioner's wife. After the assignments described above, she set up a ledger account for each of the children, with a credit entry of $ 5,000 ("500 head Sheep at $ 10.00"). There was a debit in each account in 1942 of an item of $ 505.98 representing two months' running expense, and on October 31, 1942, a credit of $ 5,757.86, designated as "Lamb Sales."
During 1943 and 1944 all of the proceeds from the sales of wool and of lambs and all expenses of operation were apportioned among the petitioner and Reuse and petitioner's four children. *38 The children's *807 allotments were in proportion to the number of sheep which they were said to own. There was never any actual division of the sheep, or of the lambs or the wool which they produced.
The petitioner managed the business, handling all of the sales of wool and lambs and the purchase of new stock and supplies. After paying Reuse his apportioned share of the receipts from the sales, the petitioner deposited the balance in his individual bank account. The children's alleged shares were credited to them in their ledger accounts. In October of each year the children's accounts were charged with a proportionate part of the general expenses. These expenses were based on an estimate made by the petitioner of the total cost per head of running the sheep for that year. This estimate amounted to $ 8 per head in 1942, $ 8.471 per head in 1943, and $ 8.92 per head in 1944. The children's accounts were also charged with a proportionate part of the state and Federal taxes for each year.
There has never been any payment to the children of the money credited to them in their ledger accounts or any segregation of those funds, except that a bank account was opened with a deposit*39 of $ 100 for the oldest child, Dean, in April 1944, when he was 16 years of age.
From time to time Government bonds have been purchased and charged to the several accounts. In October 1948 a 1,600-acre tract of grazing land was purchased in the son's name at a cost of $ 9,500, which was charged to his account.
All of the children were attending school during the taxable years involved and none of them did regular work on the ranch. The girls were too young to be of much service in the business. The son did help take care of the sheep and do odd jobs during his vacations. He received wages for some of his services, amounting to several hundred dollars in 1944 and 1945, which he reported in his individual income tax returns.
Separate Federal income tax returns were filed for the petitioner and the four children for the taxable years involved. All of the children's returns show the same amount of income from the ranch each year. This income amounted to $ 5,251.86 for the period January 1 to October 31, 1942, $ 2,871.49 for the period November 1, 1942, to October 31, 1943, $ 2,444.65 for the fiscal year ended October 31, 1944, and $ 2,840.36 for the year ended October 31, 1945. *40 In his individual returns for the same years the petitioner reported income from the ranch business in the respective amounts of $ 30,331.60, $ 22,797.54, $ 19,352.11, and $ 5,936.67. No credits for dependents were claimed in the petitioner's return on account of the children.
In determining the deficiencies herein the respondent refused to recognize the alleged gifts of sheep to the children and included all of the profits from the ranch in the petitioner's individual returns.
*808 Prior to 1942 the petitioner made his returns on a calendar year basis. For 1942, pursuant to permission granted by the respondent, he changed to a fiscal year ending October 31. In making this change he filed a return for the short period January 1 to October 31, 1942, and reported therein income to $ 30,331.60. The respondent increased this amount to $ 53,370.62, the increase being due principally to his refusal to recognize the gifts to the children, which he then annualized as provided in section 47 (c) (1), Internal Revenue Code. This annualization resulted in net income of $ 64,044.74 (12/10 of $ 53,370.62). The petitioner did not make application for relief under section 47 (c) (2).
OPINION.
*41 The first and principal issue here relates to the treatment of the income allocated to and reported by the petitioner's four minor children as earnings attributable to the sheep which the petitioner assigned to them in 1942. There is no question of a family partnership, as petitioner points out in his brief. There was never any partnership agreement or any arrangement whereby petitioner and the children were to operate the ranch as a joint venture. The petitioner simply undertook to convey to each of his four children by a bill of sale a certain number of sheep, comprising altogether about one-third of the entire herd, with the expectation that a proportional part of the income from the ranch would belong to the children and be taxable to them. While the petitioner denies that tax avoidance was his chief motive in making the assignment to the children, he admits that he was aware of the tax savings that were expected to be accomplished. The circumstances leave little doubt in our minds that in effect, if not in design, the whole arrangement was nothing more than a reallocation of income in the family group. It resulted in no material change in the economic status of either the*42 petitioner or the children. The petitioner continued to run the business as a unit, or as a joint venture with his brother-in-law, just as he had done before the assignments were made. He paid all of the expenses initially, although he later allocated some of them to the children, and handled all of the sales of wool and lambs. He deposited all of these proceeds in his individual bank account and kept them under his control and subject to his own use at all times. Except for the entries in the books kept by petitioner's wife, the children had no claim to any of the income.
The ranch profits were attributable for the most part to the management of the business as a whole and the care of the sheep. The two principal products sold were wool and lambs. The ewes, which were the subject matter of the alleged gifts, were not sold except as culls. *809 There is no evidence as to how many of these were sold in any of the years. In the assignments to the children the ewes were valued at only $ 10 a head, while, according to the petitioner's estimate used in allocating the expenses, the cost of running them amounted to between $ 8 and $ 9 a head in each of the taxable years. The*43 petitioner testified in this proceeding that the yearly cost of running sheep was anywhere from $ 10 to $ 20 a head. There is no evidence before us as to what return, on a percentage basis or otherwise, an owner of sheep might be able to realize from the sale of wool and lambs produced by them, merely by reason of such ownership and without contributing to the care and feeding of the herd or the management of the business.
It is fundamental in the tax law that income must be taxed to the person who earns it. Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579. In Doll v. Commissioner, 149 Fed. (2d) 239, affirming 2 T.C. 276">2 T. C. 276; certiorari denied, 326 U.S. 725">326 U.S. 725, the Court said:
* * * Since tax liability on income from capital is based on ownership, the criterion there has to do with possession of attributes of ownership by the taxpayer -- such as control by ( Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, 580; Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 119; Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, 335;*44 Corliss v. Bowers, 281 U.S. 376">281 U.S. 376; 378) or benefits to him ( Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 119; Douglas v. Willcuts, 296 U.S. 1">296 U.S. 1, 9). Where the income is from labor, a test is who "earned" the income ( Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 119; Lucas v. Earl, 281 U.S. 111">281 U.S. 111, 114; and see Commissioner of Internal Revenue v. Laughton, 9 Cir., 113 F. (2d) 103). Where the income is from combined labor and capital a test is the personality who or which "produced" the income ( Burnet v. Leininger, 285 U.S. 136">285 U.S. 136, 141).
It seems to us that it would require a complete disregard of the realities of the situation here to say that the income in dispute was earned not by the petitioner himself, but by the children.
We held in Robert E. Werner, 7 T. C. 39, that the entire income of a machine tool manufacturing business which the taxpayer assigned in toto to his wife was taxable to him. We said:
* * * In our view of the instant *45 case the "income in question was essentially created by the use of Tri-State's assets in conjunction with talents, skill, experience, and organization originating with and controlled by the petitioner. The bare legal title to such assets, we think, was not the essential element in the production of such income under the circumstances.
That case was followed in J. M. Henson, 10 T. C. 491, where the facts were said to be indistinguishable. The Henson case was reversed by the United States Court of Appeals for the Fifth Circuit in Henson v. Commissioner, 174 Fed. (2d) 846. The court took the view that the wife was entitled to, and was, therefore, taxable on, the entire income of the business because of her "undisputed and absolute ownership" of it, by virtue of the gift from her husband.
We venture no opinion here as to whether, on like facts, we would be willing to accept the views of the court as expressed in the Henson*810 case. The facts in the instant case differ in that here the petitioner assigned to his minor children not the whole of his ranching business, or portions of the whole, but fractional*46 interests in only one of several types of capital used in the business. It was the kind of transfer that comprised the initial step in the formation of the family partnership in Commissioner v. Tower, 327 U.S. 280">327 U.S. 280, and similar cases. The petitioner here stopped one step short of the usual family partnership arrangement, the execution of the partnership agreement. It would require strange reasoning indeed to permit the circumvention of the rule of the Tower case by the simple expedient of stopping just short of the point which the Supreme Court has marked as within the tax zone.
We think the respondent correctly determined that all of the income allocated to the children is includible in petitioner's individual returns.
In computing petitioner's income for the short period January 1 to October 21, 1942, the respondent annualized petitioner's income in accordance with the provisions of section 47 (c) (1), Internal Revenue Code. The petitioner contends that the respondent should have computed his income under section 47 (c) (2). The methods of computation under each of these subsections are described therein as follows:
(c) Income Placed on*47 Annual Basis. --
(1) General rule. -- If a separate return is made under subsection (a) on account of a change in the accounting period, the net income, computed on the basis of the period for which separate return is made (referred to in this subsection as "the short period"), shall be placed on an annual basis by multiplying the amount thereof by twelve, and dividing by the number of months in the short period. The tax shall be such part of the tax computed on such annual basis as the number of months in the short period is of twelve months.
(2) Exception. -- If the taxpayer establishes the amount of his net income for the period of twelve months beginning with the first day of the short period, computed as if such twelve-month period were a taxable year, under the law applicable to such year, then the tax for the short, period shall be reduced to an amount which is such part of the tax computed on the net income for such twelve-month period as the net income computed on the basis of the short period is of the net income for the twelve-month period. * * * The benefits of this paragraph shall not be allowed unless the taxpayer, at such time as regulations prescribed hereunder*48 require (but not after the time prescribed for the filing of the return for the first taxable year which ends on or after twelve months after the beginning of the short period), makes application therefor in accordance with such regulations. Such application, in case the return was filed without regard to this paragraph, shall be considered a claim for credit or refund with respect to the amount by which the tax is reduced under this paragraph. The Commissioner, with the approval of the Secretary, shall prescribe such regulations as he may deem necessary for the application of this paragraph. [Emphasis supplied.]
The statute clearly provides that the benefits of this paragraph shall not be allowed unless the taxpayer makes application therefor in accordance *811 with the regulations. The petitioner did not make application for the benefits of subsection 47 (c) (2) in accordance with the Commissioner's regulations or otherwise. His failure to do so is not explained. In any event, this Court is powerless to aid him. The filing of the application is a condition precedent which we have no authority to waive.
Decision will be entered under Rule 50.