*194 Decisions will be entered for the respondent.
1. Petitioners are copartners, carrying on a manufacturing business under the name of Union Manufacturing Co. They have two children. Each owns an undivided one-half interest in the business and is entitled to receive one-half of the profits each year. As of January 1, 1943, each petitioner purportedly gave an undivided, one-sixteenth interest in the business to each child. Neither child contributed any capital originating with himself, and during 1943 neither child performed any services in the business. Under the facts, held, that petitioners did not create a new and bona fide partnership in 1943, and that their two children were not copartners with them in the conduct of the partnership business known as Union Manufacturing Co. Commissioner v. Tower, 327 U.S. 280">327 U.S. 280, followed.
2. Each petitioner paid personal income taxes to the State of California for the year 1942 under the California income tax law. The California income taxes were not paid in connection with the carrying on of a trade or business, or otherwise, within the meaning of section 451 (a) (3), I. R. C.Held, that under*195 the provisions of section 451 (a) (3) the amount which is paid for state income taxes is not deductible in computing victory tax net income.
*818 Respondent has determined deficiencies in income tax as follows:
| Petitioner | Docket No. | 1943 | 1944 |
| Anna Harris | 12984 | $ 5,662.73 | $ 18,136.67 |
| Morris Harris | 12985 | 6,035.87 | 18,693.10 |
There are two questions presented, whether two children are*197 members of a partnership, and whether income taxes of the State of California are deductible in computing the victory tax net income for the year 1943.
Petitioners filed separate income tax returns with the collector for the sixth district of California.
*819 FINDINGS OF FACT.
Morris Harris and Anna Harris are husband and wife. They reside in Los Angeles, California. Albert J. Harris and Betty Harris are children of petitioners. They were nineteen years old and sixteen years old, respectively, in 1943.
Petitioners are associated together as equal copartners under the firm name of Union Manufacturing Co. They had been associated in partnership for many years prior to 1943. Each owns a one-half interest in the partnership and profits, under a written agreement dated April 1, 1937, which covers a term of 10 years.
Union Manufacturing Co. has its main plant in Los Angeles. It carries on the business of the manufacture and sale of men's work and sport clothes.
In 1909 Morris Harris began this enterprise. The capital employed has been built up by retaining profits from year to year. Morris Harris is the manager. In 1941 the volume of sales was around $ 2,000,000. In 1942 *198 about 400 people were employed in the Los Angeles plant. Union Manufacturing Co. had a second place of business in 1942 in El Paso, Texas, where around 100 people were employed; and the employment in El Paso increased to about 300 later. Morris Harris owns the land and building where the Los Angeles plant is located, and it does not appear as an asset in the balance sheet of the firm. In 1942 the Los Angeles plant and real estate had a value of around $ 300,000, without equipment. The equipment which is used in the plant consists of various kinds of machinery and sewing machines. In the manufacturing departments there are several floor ladies under one superintendent. The goods manufactured are sold all over the United States. In 1942 the market was limited to the Rocky Mountain and Pacific coast regions and 10 or 12 salesmen were employed on a commission basis. In 1942, and thereafter, goods were sold in chain stores. Morris receives a salary of about $ 200 a week, which constitutes a drawing account against his share of the profits.
As of December 31, 1942, the Union Manufacturing Co. had assets of $ 945,975.23, of which inventory amounted to $ 538,992. Liabilities amounted*199 to only $ 9,065.40, leaving net assets of $ 936,909.83.
As of December 31, 1942, after the addition of one-half of 1942 profits, the balance of the capital account of Morris Harris was $ 471,351.04, and the balance of the capital account of Anna Harris was $ 465,558.79.
The balance sheet of the partnership as of December 31, 1942, was as follows:
| ASSETS | |||
| Petty cash | $ 35.49 | ||
| Union Bank & Trust Co. checking acct | 166,571.62 | ||
| Union Bank & Trust Co. pay roll acct | 100.00 | ||
| State National Bank, El Paso, Tex | $ 7,797.08 | ||
| Accounts receivable -- good | 187,880.36 | ||
| Accounts receivable -- doubtful | 1,788.20 | ||
| Loans to employees | 106.73 | ||
| Inventory 12/21/42 | 538,992.70 | ||
| Machinery | 40,211.68 | ||
| Furniture and fixtures | 694.09 | ||
| Automobile | 859.80 | ||
| Stationery and printing | 400.00 | ||
| Prepaid insurance | 537.48 | ||
| Total | 945,975.23 | ||
| LIABILITIES | |||
| Employees -- salaries, commissions, etc | 449.94 | ||
| Social Security -- employees | 2,240.74 | ||
| Social Security -- firm | 6,374.72 | ||
| 9,065.40 | |||
| CAPITAL | |||
| M. Harris | $ 359,705.94 | ||
| Less: | |||
| Drawing acct | $ 28,050.00 | ||
| Income tax 1941 | 86,238.30 | ||
| Income tax 1940 (add.) | 92.08 | 114,380.38 | |
| 245,325.56 | |||
| Plus 1/2 1942 profits | 226,025.48 | 471,351.04 | |
| A. Harris | 334,699.14 | ||
| Less: | |||
| Drawing acct | $ 14,949.35 | ||
| Income tax 1941 | 80,216.48 | 95,165.83 | |
| 239,533.31 | |||
| Plus 1/2 1942 profits | 226,025.48 | 465,558.79 | |
| Total | 945,975.23 |
*200 *820 The son of petitioners, Albert, finished high school in June 1941; he entered the University of Virginia in the fall of 1941. He continued in the University of Virginia for the academic year 1941-1942, returning to Los Angeles in June of 1942. During the summer of 1942 he attended evening classes at the University of Southern California, where he took special courses in textiles. In September 1942 he entered the textiles school of the University of North Carolina at Raleigh, North Carolina. He returned home for the Christmas holidays of 1942. He enlisted in the Army in December 1942. Thereafter, he returned to Raleigh, North Carolina, where he remained at the University of North Carolina until April 1943, when he was called for active duty in the armed forces. He was in the service from April *821 1943 until January 1946. Upon his discharge from the service he returned to Los Angeles and went to work in the business of Union Manufacturing Co.
Betty, petitioners' daughter, attended school during the years 1943 and 1944 at either University High School, Flintridge School, or Mills College, in California.
In 1942, in the summer months and at Christmas, petitioners*201 discussed the matter of making a gift of an interest in the partnership to their son, and they considered it fair to do the same for their daughter. The arrangement discussed was not carried to any formal agreement; there was no written agreement; and there were no instruments of gifts or assignments or transfers drawn up or executed. In the discussions, Anna Harris was to make gift of part of her partnership interest to her son Albert, and Morris Harris was to make gift of part of his interest to his daughter Betty. The gifts were to be made on or about January 2, 1943.
On September 16, 1943, book entries were made in the capital accounts of Anna and Morris Harris, and ledger sheets were made opening capital accounts in the names of Albert and Betty. However, instead of making book entries to show a transfer of an interest from Anna to her son Albert, and from Morris to his daughter Betty, the entries which were made transferred an amount out of Anna's capital account to Betty, and an amount out of Morris' capital account to Albert. These bookkeeping entries did not correspond with or reflect statements which were made on Form 709, gift tax return, to the effect that Anna Harris*202 had made gift to Albert Harris on January 2, 1943, of an undivided one-sixteenth interest in the property and assets of Union Manufacturing Co., and that Morris Harris had made gift to Betty Harris on January 2, 1943, of an undivided one-sixteenth interest in the property and assets of Union Manufacturing Co. The gift tax return of each petitioner was dated September 27, 1943.
The capital account of Morris Harris on September 16, 1943, was debited with the amount $ 34,083.70, and a capital account in the name of Albert Harris was credited with the same amount as of January 1, 1943, by a transfer from the capital account of Morris Harris.
The capital account of Anna Harris was debited on September 16, 1943, in the amount of $ 34,083.70, and a capital account in the name of Betty Harris was credited with the same amount as of January 1, 1943, by transfer from the capital account of Anna Harris.
Entries were made in the general journal on September 16, 1943, of the same debits and credits from and to capital accounts as were made in the four respective ledger capital accounts, with the notation:
To transfer above interest in company to Albert and Betty Harris, son and daughter, one-sixteenth*203 each, based on M. Harris' interest, $ 270,049.36 and A. Harris' interest, $ 275,289.73.
*822 The business of Union Manufacturing Co. was conducted during 1943 and 1944 in the same way as it had been conducted in 1942 and prior thereto. No services were rendered to or in the business by the children, Albert and Betty, during 1943 and 1944. Neither one of the children contributed any capital of their own to the existing partnership business in 1943 or 1944, or in 1942 or prior thereto.
When, prior to 1943, Albert went to the place of business to do work of some general type which a school boy could do, after school hours and during school vacations, he was not paid any amount.
Neither Albert nor Betty withdrew any sum from the Union Manufacturing Co. during 1943 and 1944. However, debits to each of their capital accounts were made at the end of 1942 and 1943 for taxes on income which was attributed to each under bookkeeping entries made in their capital accounts. At the end of 1943 and of 1944, the capital account of Albert and of Betty were each credited with one-sixteenth of the earnings for each year. At the end of 1943 the balance in the capital account of each of the *204 children was $ 46,074.86.
During 1943 and 1944, the partnership, carrying on business under the name of Union Manufacturing Co., had two members only, Anna and Morris Harris. Albert and Betty Harris were not bona fide members of the partnership. There was no creation of a new and bona fide partnership of four members in 1943.
Personal income taxes for the year 1942 were paid to the State of California by Morris Harris in the amount of $ 26,746.65, and by Anna Harris in the amount of $ 25,256.18. Petitioners, in computing their victory tax liability for the year 1943, deducted the above amounts of California tax in their respective returns. Respondent disallowed each deduction in determining each petitioner's net income subject to 1943 victory tax.
OPINION.
Anna and Morris Harris are copartners in the partnership which conducts business as Union Manufacturing Co. The partnership, consisting of the petitioners, is not questioned by the Commissioner. But respondent has determined that their son and daughter were not members of a copartnership with petitioners, and he has taxed to petitioners income which was reported as the children's shares of the earnings of Union Manufacturing*205 Co. in 1943 and 1944. The question is whether one-sixteenth of the earnings of the above business is taxable to Albert Harris, and the same proportion to Betty Harris, as partners in Union Manufacturing Co., as petitioners contend; or whether such portions of the earnings are taxable to petitioners as part of the share of each in the earnings of the partnership of which they are indisputably partners.
Admittedly, Albert and Betty Harris did not have capital of their *823 own to contribute to a business venture as the contribution of partners. Petitioners allege that they made gifts of undivided one-sixteenth interests in a going business venture and that, thereupon, each child recontributed what he is said to have received, namely, an undivided interest. Respondent does not admit that any completed gifts in praesenti were made to the children. It is pointed out that one issue presented by the pleadings is whether the alleged gifts were made. In amended petitions, each petitioner alleges, inter alia, that on January 2, 1943, he and she gave an undivided part of his and her interest to each one of the children. Respondent denies this pleading in his amended answer. *206 It is necessary, therefore, to consider the question which is put in issue, namely, whether bona fide gifts in praesenti were made.
The petitioners contend that a partnership was created on January 1, 1943, in which each child was a copartner, and that the partnership should be recognized for Federal income tax purposes. This question is put in issue by the pleadings of the petitioners that on January 2, 1943, the four members of the family agreed to associate themselves as copartners, which pleading the respondent has denied.
Petitioners state that they are familiar with the rule set forth in Commissioner v. Tower, 327 U.S. 280">327 U.S. 280. They argue that the rule of that case, applied to the facts of this case, compels a holding that the alleged partnership of January 2, 1943, including the two children, must be recognized for Federal income tax purposes. Respondent argues that petitioners have misconstrued the rule of the Tower case. He cites the Tower case in support of his determination, and other cases where it has been applied, namely, John G. Scherf, 7 T.C. 346">7 T. C. 346; affd., 161 Fed. (2d) 495;*207 certiorari denied, 332 U.S. 810">332 U.S. 810; M. M. Monroe, 7 T. C. 278; Jacob De Korse, 5 T. C. 94; affd., 158 Fed. (2d) 801; W. M. Mauldin, 5 T. C. 743; affd., 155 Fed. (2d) 666; and O. William Lowry, 3 T. C. 730; affd., 154 Fed. (2d) 448; certiorari denied, 329 U.S. 725">329 U.S. 725.
Petitioners are in no better position in this case than were the taxpayers in John G. Scherf, supra;Jacob De Korse, supra; and W. M. Mauldin, supra. Their contentions are not new, but have been considered, under similar facts, in many cases by this Court, and other courts. In other words, petitioners present a contention by which, in effect, they ask to have the underlying principles in this type of issue reviewed for them. We think it is unnecessary to do so, other than to point out that the question arises under section 22 (a) of the Internal Revenue Code, which broadly defines*208 the gross income which is to be taxed to an individual as including "gains or profits and income derived from any source whatever." The revenue acts do not recognize partnerships as taxable entities separate and apart from the individual partners, but provide that "Individuals carrying on business *824 in partnership shall be liable for income tax only in their individual capacity." See sec. 181, I. R. C. And, since the partners are liable for tax in their individual capacity, the broad scope of section 22 (a) must be considered.
Here, as in the Tower case, and a line of cases which have followed in its path, two members of a family have undertaken to apportion their income among the members of the family group. In this case the arrangement purports to divide two tax units into four. The evidence fails to show that there was any intent that either one of the children would join with petitioners in "carrying on business in partnership" in the taxable years (sec. 181, I. R. C.); or that there was any real change in the control over the income by the petitioners. Section 22 (a) of the Internal Revenue Code is the cornerstone of the Supreme Court's decision in the Tower*209 case. Petitioners fail to understand that they have the burden of proving that something less than their respective 50 per cent shares of the income of an established business is taxable to them under sections 22 (a) and 181, for they pass lightly over the matter of proving that bona fide gifts of interests were made, and of proving that their two children were, in fact, carrying on a business with them in partnership. They miss the force of the phrase which appears at least twice in the opinion in the Tower case, which they even quote, to wit, that the issue turns on whether the junior members of the family and the senior members of the family "really intended to carry on business in partnership" in the taxable years, because they do not perceive that the Supreme Court clearly stated what factors should be shown as a matter of proof of such intent. The Supreme Court observed that:
* * * A partnership is generally said to be created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, * * * or business, and when there is a community of interest in the profits and losses. * * * A husband and wife [parent and child] may, under*210 certain circumstances, become partners for tax, as for other, purposes. If she [the wife or child] either invests capital originating with her or substantially contributes to the control and management of the business, or otherwise performs vital additional services, or does all of these things she may be a partner as contemplated by * * * 26 U. S. C. A. Int. Rev. Code, pars. 181, 182.
The contention that the daughter, Betty, was a partner in the Union Manufacturing business is particularly without merit. There is no evidence that she desired to, or intended to, or did carry on the business enterprise in partnership with her parents in the taxable years. She was about seventeen years old in 1943; she had no capital of her own; and she performed no services in the business. There is no evidence of a completed transfer of an interest in the business to her such as would put in her complete dominion and control over an interest in the business and the earnings thereof, and such as would remove from the alleged donor (mother or father, whichever claims to have made *825 the gift -- the record on this point being confused) control over his or her purported interest and share of*211 earnings. See Edson v. Lucas, 40 Fed. (2d) 398, and cases cited therein. The evidence with respect to the alleged gift to Betty is merely that if a gift were made to the son, it would be fair to make a like gift to the daughter. Whichever petitioner alleges to have made this gift intended that the interest should be retained in the business as well as the earnings, nothing to the contrary having been shown by competent evidence. We are unable to find that a bona fide gift was made to Betty of a present interest in the business. We sustain the respondent's determination that one-sixteenth of the earnings attributed to her is taxable to the alleged donor, either Anna or Morris Harris.
In support of their contention that the son, Albert, was a copartner with them in their business during 1943 and 1944, petitioners refer us to certain cases where it has been held, upon particular facts, that a father and son were copartners. The holdings in such cases do not provide these petitioners authority in support of their contention. Such cases are distinguishable on their particular facts. Also, Weizer v. Commissioner, 165 Fed. (2d) 172,*212 is inapposite, the facts being quite different.
Albert had an ambition to go into his father's business. He had done various things about the plant and office, without pay, during vacations and after school prior to 1943. But none of his activities, considering his youthful age and consequent limitations, had been sufficiently substantial to have taken him into any substantial or important work in the business before 1943. Cf. John G. Scherf, supra.In 1943 and 1944 his absence, therefore, was not absence from a business activity in which he had previously rooted himself. Therefore, little weight can be given his casual activities at his father's "shop" as a school boy, and full weight must be accorded the fact that he rendered no services whatsoever during 1943 and 1944. See M. M. Monroe, supra.
Albert contributed no capital to the Union Manufacturing Co. business originating with himself. Furthermore, the evidence is not present to show that the purported gift to Albert of an interest in the business was a completed gift in praesenti which vested in him complete dominion and control over an interest in and earnings*213 of the business. Edson v. Lucas, supra.There was no written partnership agreement. The alleged verbal agreement was a loose one. There is no evidence to show clearly that the usual terms of a partnership agreement were worked out so as to definitely establish the rights and duties of the son if he were to really carry on a business in partnership with his parents during the taxable years. The only inference which can be made from the record is that management of the business was to remain in Morris Harris, and that he was to continue to control the *826 business and the earnings, as far as his children might be concerned. Partnership books were not closed. There were only bookkeeping entries which served to provide the basis for allocating earnings to the young son, who was in school at first and later in the Army.
Upon consideration of all of the facts, we can not find that Albert was a bona fide copartner in the business in 1943 and 1944. Applying the rationale of the Tower case, we sustain respondent's determination. See John G. Scherf, supra.
The second question is whether state income taxes*214 are deductible in computing victory tax net income.
Section 172 (a) of the 1942 Revenue Act enacted a new tax, called the victory tax, which was to be levied upon income in years beginning after December 31, 1942. Section 172 (a) of the 1942 Revenue Act added new provisions to the Internal Revenue Code, sections 450 to 456. These provisions of the Internal Revenue Code provided for the computation of the new tax without reference to chapter 1, income tax, of the Internal Revenue Code, except where the statutory provisions relating to the computation of net income for the income tax were specifically made to apply by cross-reference. That is to say, the computation of the income tax and the computation of the victory tax are separate, the first being covered by subchapters A, B, and C; and the second being covered by subchapter D. For example, section 21 of the Internal Revenue Code (subchapter B, part 1) defines "net income" for purposes of the income tax; and section 451 of the Internal Revenue Code (subchapter D, part 1) defines "victory tax net income." Also, the respective subchapters make specific provisions for the various types of deductions which are allowable in computing*215 "net income" and "victory tax net income."
It must be kept in mind that all deductions are a matter of legislative grace. The question which is now raised by the petitioners under the victory tax net income provisions of the Internal Revenue Code must be considered upon the basis of the specific statutory provisions which allow deductions. Section 451 (a) (3) states what taxes may be deducted in computing "victory tax net income." The provision is as follows:
SEC. 451. VICTORY TAX NET INCOME.
(a) Definition. --
* * * *
(3) Taxes. -- Amounts allowable as a deduction by section 23 (c), to the extent such amounts are paid or incurred in connection with the carrying on of a trade or business, or in connection with property used in the trade or business, or in connection with property held for the production of income.
The subsection above quoted contains a limitation. First, there is cross-reference to section 23 (c) of the Internal Revenue Code, which relates to the deduction of taxes generally for the purpose of computing *827 "net income." Under section 23 (c) there is the general provision that taxes paid or accrued within the taxable year are deductible, but the exceptions*216 to the general rule are set forth. Income taxes paid to a state are not within the exceptions, and they are deductible in computing net income for the income tax.
However, the limitation contained in section 451 (a) (3) is that only those taxes which are deductible under section 23 (c) which "are paid or incurred in connection with the carrying on of a trade or business, or in connection with the property used in the trade or business, or in connection with property held for the production of income" may be deducted for the purpose of computing the victory tax net income.
It is our understanding that the California income tax is a personal income tax, which, like the Federal income tax, is imposed upon income derived from all sources. Petitioners do not cite any cases which give contrary construction of the California statute. We do not have the personal income tax returns of the petitioners in evidence -- neither the state nor the Federal returns. It is assumed that most of the income of the petitioners which was reported for both state and Federal income tax was derived chiefly from the partnership business. Petitioners argue that the state income tax was a tax which was paid*217 or incurred in connection with the carrying on of a business within the meaning of section 451 (a) (3) because the income which was taxed by the state was derived from a business.
The construction which the petitioners would have placed upon section 451 (a) (3) does not, in our opinion, give proper consideration to the wording of the pertinent section. The state income tax was not incurred "in connection with the carrying on of the business." Those words have a clear meaning, but, if it is necessary to undertake to clarify them, we think that the words mean a tax which is incurred as an incident to the carrying on of business in the sense that a business expense is incurred in carrying on a business; that is to say, something which must be paid in order to do business.
The specific question raised by petitioners is covered by a ruling of the Commissioner, I. T. 3644, which comes to the conclusion that "the personal income taxes imposed by the various states are not deductible in whole or in part in computing victory tax net income under section 451 (a) (3) of the Internal Revenue Code, supra." We think this ruling is correct and that the report of the Committee on Finance of *218 the Senate, which accompanied the Revenue Bill of 1942, supports the Commissioner's ruling. See C. B. 1944, p. 373; Senate Report No. 1631, 77th Cong., 2d sess. (C. B. 1942-2, 504, 509).
Petitioners think that the ruling set forth in I. T. 3644 may be in conflict with another ruling of the Commissioner, I. T. 3829, C. B. *828 1946-2, p. 38. The latter ruling was made in connection with the deductions allowed for the purposes of computing adjusted gross income under section 22 (n) (1) of the Internal Revenue Code. That section relates to the income tax. We think that the ruling made under I. T. 3829 does not apply in making an interpretation of section 451 (a) (3), which relates to the computation of victory tax net income. It has been noted before that state income taxes are deductible for the purpose of computing the income tax, and the ruling in I. T. 3829 is consistent with the statutory allowance of deduction for state income tax. The crux of the matter is that the Congress did not see fit to permit deduction of state income taxes in the computation of the victory tax net income for the purpose of the victory tax. 1 We think that this is a complete answer to the petitioners' *219 contention.
Decisions will be entered for the respondent.
Footnotes
1. See Senate Report No. 1631, 77th Cong., 2d sess. (C. B. 1942-2, p. 509), where the following is stated:
"Since the victory tax does not allow any deduction for state income taxes your Commitee deemed it advisable to provide that the total income tax and victory tax should not exceed 90% of the taxpayer's net income * * *."↩