*2289 The proper method of reporting income and losses by a member of a partnership determined.
*962 The Commissioner determined deficiencies in the petitioner's income taxes for the calendar years 1922 and 1924 in the amounts of $2,806.18 and $7,222.26, respectively. The petitioner has waived all allegations of error except one, that the Commissioner erred in including in income for 1924, $47,899.17, the amount of a debit balance canceled by a partnership upon the petitioner's retirement from the firm. On May 15, 1929, the respondent tendered an amended answer and moved the Board for permission to file the same. On May 23, 1929, this motion was granted. By this amended answer the respondent averred "that the net income as shown by the deficiency letter for 1922 should be increased by $3,108.03, as no deductible loss was sustained by the petitioner during the year 1921 from a regular trade or business in accordance with section 204 of the Revenue Act of 1921," and also "that the net income shown in the deficiency*2290 letter for 1924 should be increased by $3,297.09 as the deductible loss sustained by the petitioner in accordance with section 206 of the Revenue Act of 1924 was $148.73."
*963 FINDINGS OF FACT.
The petitioner is a resident of Ridgewood, N.J. In 1919 he formed a partnership with a man named Bolles and a man named Jelke to conduct a brokerage business in New York City. The petitioner and Bolles had had considerable experience as brokers, dealing in stocks and bonds. Jelke had had no such experience. The petitioner and Bolles desired to engaged in the brokerage business, but they had no capital. Jelke had considerable capital and he furnished all of the original capital of the firm. This firm was not successful, and in 1921 Bolles retired from the business and the partnership was dissolved. At this time a debit balance in Bolles' account was transferred one-half to the account of the petitioner and one-half to the account of Jelke.
On October 1, 1921, a new partnership known as Jelke, Hood & Co., was formed by Jelke, A. M. Main, and the petitioner. This firm continued the brokerage business of its predecessor in New York City. By the terms of this partnership*2291 agreement Jelke again contributed the necessary capital. He contributed $50,000 in cash and his seat on the New York Stock Exchange, and agreed to provide the firm with the use of additional capital when needed. The Petitioner and Main had no capital to contribute. They agreed to leave one-half of their share of the profits in the firm until their capital contributions amounted to $25,000 and $10,000 respectively. Interest was to be credited on capital contributions of the partners. Jelke was given the sole and absolute right to direct and control the conduct of the business, but was only required to devote such time and attention to the business as in his judgment might be necessary. Main and the petitioner were required to devote their entire time and attention to the business. The agreement also provided that there should be paid and charged to the general expense of the partnership, a sum not in excess of $4,000 which Jelke might use for expenses in aiding the business of the partnership, $12,000 per annum to the petitioner as compensation for his personal services, and $6,000 per annum to Main as compensation for his personal services. Paragraph 7 of the agreement provided*2292 as follows:
All gains, profits and increase that shall come, grow, or arise from or by means of the said business shall be divided between the parties hereto on the following basis, to wit:
Fifty-six per cent (56%) to the party of the first part;
Thirty-nine per cent (39%) to the party of the second part;
Five per cent (5%) to the party of the third part
and all losses happening in the course of said business shall be borne in the same proportions, unless the same shall occur through the wilful neglect or default (and not the mistake or error) of any of the said parties, in which event the loss so incurred shall be made good by the party through whose neglect or default such losses shall arise.
*964 Upon dissolution, the assets and property of the partnership remaining after discharge of the liabilities of the partnership and the expenses of liquidating the same were to be applied in payment to each of the parties of (a) any unpaid interest on contributions to capital of the firm; (b) any unpaid installment of drawing account; (c) his share of undistributed profits; and (d) the amount of capital contributed by him to the business of the partnership, and the surplus, *2293 if any, was to be divided between the parties on the same percentage basis as that on which they divided the profits. Under certain circumstances if there was an impairment of capital, Jelke had the right to terminate the partnership on notice.
The agreement contained no specific provision in regard to the liability of the petitioner for any debit balance in his account resulting from firm losses which might exist at the time he should withdraw from the firm. It was understood, however, between the petitioner and Jelke that the petitioner was not to be liable for any debit balance in his account in case he withdrew from the firm.
The petitioner withdrew from the partnership on January 31, 1924. In the meantime one or two other men had been taken into the firm and one at least had withdrawn from the firm. The percentages of profit sharing were changed at each of these times. An audit of the books of the firm disclosed that there was a debit balance due from the petitioner to the firm as of January 21, 1924, in the amount of $47,899.17. This amount was transferred to the account of Jelke, who never expected or requested the petitioner to pay the amount. The petitioner was*2294 not financially able to pay the amount at that time. When the petitioner retired from the firm, he and the other partners exchanged general releases in regard to claims or liabilities resulting from the partnership of which he formerly was a member. They also entered into an agreement whereby the other partners, who were to continue the business, agreed to hold the petitioner harmless from any and all liability in connection with the partnership business, and in which he assigned to the others all of his right, title and interest in and to the partnership business.
The Commissioner added the amount of $47,899.17 to the income reported by the petitioner for 1924, and, after making other additions not at issue, thus determined net income for that year to be $55,053.03. The total tax on this amount was determined to be $7,222.26, the amount of the deficiency, no tax having been assessed or paid. In the statement accompanying the deficiency notice, the petitioner was advised as follows:
Your corrected net income of $7,130.43 for 1921 * * * reflecting proposed deficiencies of $190.63 for 1921 included the disallowance of $10,848 deducted as bad debts. This amount represented the*2295 one-half debit charge on the partnership's books against your retired partner, Mr. Boles, which amount you assumed individually in connection with a like individual charge to your *965 partner, Mr. Frazier Jelke. The disallowance of $10,838 was later allowed * * * reflecting no tax due for 1921.
Assuming that $13,956.03 (which amount included the individual debit charge of $10,848) was correctly reported as net loss from business in 1921 on your 1922 return, and which latter amount was disallowed in revenue agent's report of April 27, 1926, the difference or $3,108.03 has been allowed as a net loss for 1921, and this amount deducted from the 1922 revised net income of $31,401.60 as shown by the supplemental report of January 13, 1927, making a corrected net income of $28,293.57.
During the existence of the partnership, the petitioner received $1,000 per month from the firm, and his percentage of the profits or losses of the firm were credited or debited to his account. Except for the $1,000 withdrawn each month and for one-half of his share of any profits which were credited to his account, the petitioner never withdrew any funds from the partnership. The petitioner*2296 always took his share of the partnership losses as a deduction on his income-tax return. A considerable portion of the debit balance in the petitioner's account on January 31, 1924, resulted from the fact that one-half of the losses previously charged to the account of each retiring partner was, after the retirement of each partner, charged to the petitioner's account. When such charges were made in the petitioner's account, he deducted the amount of the losses on his income-tax return. The partnership at times wrote down its securities below cost and the results of such write-downs were reflected by debits in the petitioner's account on the books of the firm.
In determining the deficiency for 1924, the Commissioner allowed a deduction of $3,331.35 as a net loss for 1923. If the Commissioner had not deducted, in computing the net loss for 1923, a certain amount representing the petitioner's share of the loss of Jelke, Hood & Co., the petitioner would not have had a net loss for 1923.
In determining the deficiency for 1924, the Commissioner allowed the petitioner the benefit of $558.70 representing his share of the loss of Jelke, Hood & Co. for January, 1924, and he also adjusted*2297 the petitioner's net income by a deduction of $538.94, which he explained as "to adjustment per partnership report."
OPINION.
MURDOCK: As long as the petitioner continued with the firm, of course, the debits in his account had an effect upon his share of any profits the firm might have, since, under the agreement, these debits would have to be offset by credits before he would have any capital, and the capital would have to amount to $25,000 before he could withdraw his full share of the profits. But the petitioner testified that in all of their partnerships he and Jelke had an agreement that in case the business was not successful, and the petitioner's account showed a net debit, the ultimate loss would fall *966 upon Jelke, and the petitioner would never be called upon to make good the debit in case he left the firm. Other evidence in the case tends to support the petitioner's testimony that he was never to make good the part of the firm's losses charged to his account. For example, when he began his relations with Jelke, the petitioner had no capital, whereas Jelke appears to have been a man of considerable wealth; the petitioner never contributed any capital to the*2298 firm except such as was credited to his capital account when the firm had some profits; and he never had funds from which he could have paid the debit balance standing in his account. When other partners retired, they did not pay the debit balance in their accounts.
The petitioner, in reporting his income, and the Commissioner in adjusting that income, have failed to give effect to such an agreement. Probably the latter did not know of its existence. But the evidence here shows that it did exist, and we can not disregard it. The petitioner's income has been improperly reported and adjusted. He was not entitled to deduct any part of the losses of the firm, since he would never have to pay any part of those losses, and he should have reported only one-half of the profits of the firm until such time as his account no longer showed a net debit. The Commissioner erred in including $47,899.17 in the petitioner's income for 1924.
The year 1921 is not before us, but the petitioner has been given the benefit of a deduction for 1922 representing a net loss in 1921, when, if his income for 1921 had been properly computed, he would not have had a net loss for 1921. Thus, the Commissioner*2299 erred in allowing him credit for any net loss for 1921 in connection with his 1922 income tax. The year 1923 is not before us, but the petitioner would have had taxable income in 1923 instead of a net loss if his income for that year had been properly computed, and the Commissioner erred in allowing the deduction of a net loss for 1923 in computing the petitioner's income for 1924. Likewise for 1924, the Commissioner erred in reducing the petitioner's income for 1924 on account of losses or adjustments to the income of the partnership for the month of January, 1924. We have been asked to make no other adjustments in the petitioner's income, and from the evidence we can make none.
Judgment will be entered under Rule 50.