1951 U.S. Tax Ct. LEXIS 103">*103 Decision will be entered under Rule 50.
1. Petitioner in 1939 inherited one-third of his father's interest in a 1937 farmers' cooperative wine marketing pool. During the period 1939 through 1945, wine and other products from the pool were sold and profits of the pool were computed and currently distributed. Such proceeds as the petitioner realized in 1944 and 1945 from such liquidation of this wine pool, when added to proceeds which he had received earlier, exceeded the 1939 fair market value of his inherited interest. Held, that the amounts received by the petitioner in 1944 and 1945 from the liquidation of the pool in excess of the fair market value of his interest therein when he acquired it constituted capital gains in the years in which received.
2. For the year 1944 petitioner and his wife filed separate income tax returns on which they erroneously reported separate income of the petitioner as community property income and then split the surtax exemptions allowable for their three dependent children, the wife taking two of such credits and the petitioner, one. Respondent in auditing their returns corrected the error, adjusted the income of each and disallowed the1951 U.S. Tax Ct. LEXIS 103">*104 two surtax exemptions claimed by the wife. Petitioner claimed the right to take these additional surtax exemptions, which claim was contested by the respondent. Petitioner furnished all the support for the three children for the year 1944. Held, that the petitioner is entitled to the two additional surtax exemptions. His wife's claim therefor on her return was the result of error in treating petitioner's separate income as community property income and an adjustment can be made since the wife's pending claim for refund acquiesces in the denial to her of such two surtax exemptions.
17 T.C. 260">*261 The respondent determined income tax deficiencies against the petitioner for the years 1944 and 1945 in the respective amounts of $ 1,018.92 and $ 6.80. Petitioner claimed overpayments of $ 106.67 and $ 265.16 for the years 1944 and 1945, respectively.
The following questions are presented:
(1) Are the amounts the petitioner realized from proceeds received by him in the years 1944 and 1945 in liquidation of his inherited interest in a farmers' cooperative wine marketing pool which were in excess of his share of the estimated value of the pool for estate tax purposes taxable and, if so, are these amounts taxable as ordinary income or as capital gains?
(2) Did the respondent err in denying to petitioner additional1951 U.S. Tax Ct. LEXIS 103">*106 exemptions for two of his children claimed by him as dependents?
FINDINGS OF FACT.
The facts with respect to the first issue presented herein were stipulated by the parties and we find them as stipulated.
The petitioner resides in Lodi, California. He filed his income tax returns for the calendar years 1944 and 1945 with the collector of internal revenue for the first district of California.
In the year 1939 the father of the petitioner died, and the petitioner and his two sisters each inherited an undivided one-third interest in all of the property of their father, hereinafter sometimes referred to as the decedent.
Included in the property inherited from the decedent by the petitioner and his sisters were interests in six annual vintage pools (vintage years being 1933 to 1938, inclusive) of a farmers' cooperative wine marketing association, of which the decedent had been a member, and certain vineyard property which the petitioner and his sisters as partners operated under the firm name and style of Maley Ranch.
The decedent had been engaged during his lifetime in the business of farming on land which he had held as a life tenant, and his principal crop was wine grapes. He kept1951 U.S. Tax Ct. LEXIS 103">*107 his books and filed his income tax returns on a cash receipts and disbursements basis of accounting. In order better to market his wine grapes, he acquired a membership 17 T.C. 260">*262 interest in the Woodbridge Vineyard Association, a nonprofit farmers' cooperative marketing association organized under the provisions of chapter 4 of the Agricultural Code of the State of California. The chief activities of this association consist of processing its members' grapes into wine, brandy, and other grape products, and of marketing such products on a cooperative basis for such members. For the vintage years 1933 to 1938, inclusive, the decedent entered into marketing agreements with the association. The provisions of the marketing agreement entered into by the decedent for the vintage years 1937 and 1938 read as follows:
1. In consideration of One Dollar ($ 1.00), receipt whereof is acknowledged and of the covenants herein contained, the undersigned member hereby sells and conveys and agrees to pick, haul, and deliver to said Association for the purposes of crushing, processing, and selling of all of the grapes now growing or which may be hereafter grown upon any grape producing property described1951 U.S. Tax Ct. LEXIS 103">*108 in the exhibit marked "Description" attached hereto and by reference made a part hereof, owned by him or which is in his possession, as tenant or under contract to purchase, or otherwise. Member agrees to deliver said fruit at such time and place or places, and from time to time and in such quantities as said Association may direct. The provisions hereof shall not require the delivery to it by members of Tokay and other varieties which have been determined by a proper resolution of the Board of Directors to be table varieties, provided such non-delivered grapes are actually packed and sold for table use. All so called "strippings" must be delivered to the Association subject to the same conditions and provisions as wine varieties.
2. The association agrees to receive, crush, process, and sell said fruit.
3. This agreement shall continue in effect for a term of five years from date and thereafter until cancelled by either party hereto.
4. The by-laws of the Association and the preorganization contract between the Association, its members, and the Woodbridge Fruit Company is a part of this agreement, and is binding upon each of the parties hereto.
5. Member expressly agrees that 1951 U.S. Tax Ct. LEXIS 103">*109 he will not dispose of his fruit otherwise than to said Association, as herein provided; and that in event he shall fail, refuse or delay to pick and deliver his said fruit to the Association within five (5) days after demand therefor, the Association shall have the right at its option, at any time or times thereafter, and from time to time, to enter into the possession of his said premises without further notice or formality and pick said fruit, or any part thereof, and take the same to the Winery of the Association and process and sell the same, all at member's cost and expense, which said cost and expense shall and will be retained by the Association out of any moneys received from the sale of any of such processed fruit.
6. The actual damages which will be sustained by the Association in event of the failure or refusal of any member to pick and deliver his said fruit as herein provided, and the further detriment and injury to the Association because of the effect of such breach upon the Association and its efficiency, and the expenses to which the Association may be put, and the damage caused by outlays incurred and to be incurred by it in anticipation and providing means for processing1951 U.S. Tax Ct. LEXIS 103">*110 and selling said fruit, are impossible to estimate or fix, and, therefore, the same are estimated and agreed upon as $ 5.00 per ton for each ton of grapes grown and sold or disposed of, which sum shall be allowed in any action 17 T.C. 260">*263 brought by the Association to recover damages for the breach of this agreement should it elect, as it may elect, to bring such action.
7. The member concedes that in order to process properly the maximum quantities of grapes which may be presented to it by its members, that the Association has been required to make large investments in buildings, cooperage and equipment, and further concedes that large annual expenses for general overhead and payment of principal obligations are required, and that in order to operate efficiently the business of the Association, that at least 15,000 tons of grapes should be crushed annually from the deliveries of the members; Therefore, if in any one year hereafter deliveries of grapes to the Association shall in the aggregate be less than 15,000 tons, and Member delivers a deficient quantity of grapes as such deficient quantity is hereinafter defined, then in that event the Board of Directors in its discretion may 1951 U.S. Tax Ct. LEXIS 103">*111 exact from Member a charge of an amount not to exceed $ 2.50 for each ton of grapes in which Member's delivery of grapes for that year is deficient. Member hereby agrees to pay to the Association any such charge of an amount not to exceed $ 2.50 a ton of such deficiency as said amount is fixed by the Board of Directors.
8. Member shall be deemed to have delivered a deficient quantity of grapes to the Association in any year in which the aggregate deliveries of grapes by all Members to the Association are less than 15,000 tons if Member fails to deliver to the Association in that year at least tons.
Paragraph 4 of the marketing agreement incorporates the by-laws of the association into the agreement as a part thereof. Article XVIII of such by-laws reads in part as follows:
Every Member of the Association must enter into a written agreement between himself and the Association fixing and defining his rights, duties, and obligations; the form of agreement to be such as the Board of Directors may require; and the same may be changed from time to time, as the Board of Directors may deem best.
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This Association shall have a power coupled with an interest therein, with respect1951 U.S. Tax Ct. LEXIS 103">*112 to all fruit affected by such written agreement. Such fruit shall become the property of said Association immediately, upon delivery thereof to it. Such agreement shall be specifically enforceable by the Association.
The association commingled the decedent's grapes delivered to it pursuant to this agreement with those of other farmer-members in a single pool, processed the grapes, and marketed the products derived therefrom in the following manner: The grapes were first delivered to the association's winery, where a record was made and kept of their weight, variety, and sugar content as shown by tested samples of each lot delivered. From these records the relative shares of the members of the pool were computed in percentages of the whole annual crush of the association according to agreed adjustments with respect to the relative values of different grape varieties and of fruit of higher or lower sugar content. The association crushed the grapes and processed them into wine, brandy, and certain byproducts and in so doing incurred expenses for such items as labor, fuel, and power. The finished products were marketed by the association, after further 17 T.C. 260">*264 outlays by it for1951 U.S. Tax Ct. LEXIS 103">*113 packaging, taxes, freight, salaries, advertising, and similar selling expenses. The association recouped such processing and marketing expenses on the first proceeds of the sale of the products of the particular pool for which these expenses were incurred. When further sale proceeds were received they were distributed from time to time to the members of each annual vintage pool according to each member's previously determined percentage of interest therein.
At the date of decedent's death, May 30, 1939, he had remaining unliquidated interests as a member of six annual vintage pools of the association which were valued for Federal estate tax purposes as follows:
| 1933 pool | $ 4,422.52 |
| 1934 pool | 7,401.70 |
| 1935 pool | 6,217.14 |
| 1936 pool | 5,109.39 |
| 1937 pool | 14,000.00 |
| 1938 pool | 22,500.00 |
Prior to January 1, 1944, petitioner and his sisters had received in liquidation of the 1937 pool (the only one involved in the deficiency) payments totaling $ 11,269.48. During the calendar years 1944 and 1945, they received in further liquidation of this pool total sums of $ 4,010.46 and $ 971.63, respectively. The sum of the payments received in 1944, plus payments received prior to that1951 U.S. Tax Ct. LEXIS 103">*114 year, exceeded the value for estate tax purposes of the decedent's interest in the 1937 pool by $ 1,279.94, and the $ 971.63 received in 1945 constituted a further payment in excess of the value for estate tax purposes. Petitioner's shares in these excess payments were one-third of $ 1,279.94, or $ 426.65, in 1944, and one-third of $ 971.63, or $ 323.88, in 1945.
During all of the year 1944 the petitioner was married to and living with his wife, Mabel B. Maley, and their three minor children, Norman, Betty, and Joseph. The petitioner and his wife filed separate income tax returns for that year. The petitioner claimed on his return and was allowed one surtax exemption for a dependent, his son Joseph. Surtax exemptions for two other dependents, his children Norman and Betty, were claimed on the wife's separate return.
In preparing and filing their returns for the year 1944, all of the petitioner's income was returned as taxable, one-half on his and one-half on his wife's return. There was also reported on her return separate property income of $ 511.22 from Buck Ranch, a partnership, making the total adjusted gross income reported by her $ 33,385.40. Upon audit of the returns 1951 U.S. Tax Ct. LEXIS 103">*115 the respondent transferred to the petitioner's return from his wife's, $ 31,636.52, which was separate income of the petitioner which had been erroneously included in his wife's return. That adjustment, which is not the subject of dispute by either spouse, left a corrected adjusted gross income of $ 1,748.88 17 T.C. 260">*265 taxable on the wife's return. The amount was composed of her separate income, as aforesaid, of $ 511.22 and community property income of $ 1,237.66, representing one-half of a salary of $ 2,475.33 earned by the petitioner as an employee of the Shell Oil Company and of which he received a net amount of $ 2,160.94 after withholdings for Federal income tax and state and Federal social security taxes. When the respondent adjusted the amount of Mabel B. Maley's income, he disallowed the two surtax exemptions for her two children claimed as credits on her return. On July 21, 1948, Mabel B. Maley acquiesced in the disallowance of the two surtax exemptions and filed a duly verified claim for refund of the overassessment of $ 14,805.41, and this claim had not been paid to the date of this hearing.
During the year 1944 the petitioner paid living expenses in the amount of $ 1951 U.S. Tax Ct. LEXIS 103">*116 6,000 for all members of the Maley family, consisting of the petitioner, his wife and three children. In the year 1944 the petitioner furnished more than one-half the support for each of his three children.
OPINION.
The first issue involves the question whether in the years 1944 and 1945 the petitioner did, as a matter of fact, realize any gains on the liquidation of his interest inherited from his father in the 1937 wine pool and, if such gains were realized, whether they were taxable as ordinary income or as capital gains.
On the date of decedent's death, his interest in the 1937 wine pool was valued for Federal estate tax purposes at $ 14,000. That this amount represented the fair market value of decedent's interest in the pool on the date of his death has not been put in issue. Accordingly, we hold that pursuant to section 113 of the Internal Revenue Code, one-third of this amount (1/3 of $ 14,000, or $ 4,666.67), petitioner's inherited interest, is the correct (unadjusted) basis for the determination of any gain or loss which petitioner may have realized in 1944 or 1945, the taxable years in question. 1
1951 U.S. Tax Ct. LEXIS 103">*117 As we stated in our findings of fact above, of the proceeds received by the petitioner from the liquidation of the 1937 wine pool, $ 426.65 received in 1944 and $ 323.88 received in 1945 represent amounts received by him in excess of the 1939 fair market value of his inherited interest in that pool. Before we can determine whether such excess payments constituted taxable gains in 1944 and 1945, it is necessary to 17 T.C. 260">*266 examine the decedent's relationship with the association and determine the nature of the interest in the pool which petitioner inherited from the decedent.
The marketing agreement set out in our findings of fact, which the decedent, as a member of the Woodbridge Vineyard Association, entered into with that association, bound him for a period of 5 years to deliver wine grapes to the association for processing into wine to be sold by the association. While it might be argued that the language in this agreement to the effect that the "member hereby sells and conveys" grapes, etc., and the language contained in the by-laws (incorporated into the contract by reference) to the effect that the grapes were to become the property of the association on delivery to it support1951 U.S. Tax Ct. LEXIS 103">*118 the proposition that the parties intended a sale of grapes to take place, we believe that this language merely indicates the intent of the parties that legal title in such grapes was to pass on delivery to the association. Furthermore, we believe that the manner in which the association operated indicated that no sale was intended to take place. The agreement named no sales price, nor any method whereby a sales price could be determined, neither does the evidence show that the parties at any time intended that the members of the pool were to receive at some future time a reasonable value for the grapes delivered. The association did not even make any advances to its members on their delivery of grapes to it. It is clear that the parties intended that each member should deliver his crop of grapes to the pool, bear his proportionate share of the expenses of the pool and, after the wine or other products were sold, receive his share of the profits, all of which were the property of the members of the pool.
In similar cases where the question of the relationship between a marketing cooperative, organized under chapter 4 of the Agricultural Code of the State of California, and its 1951 U.S. Tax Ct. LEXIS 103">*119 members has arisen, the courts have stated that this relationship is one of trust. California & Hawaiian Sugar Refining Corp. Ltd. v. Commissioner, 163 F.2d 531; San Joaquin Valley Poultry Producers Association v. Commissioner, 136 F.2d 382; Bogardus v. Santa Ana Walnut Growers Assn., 108 P. 2d 52. 2 Accordingly, we hold that the relationship between 17 T.C. 260">*267 the Woodbridge Vineyard Association and its members was not that of vendor and vendee and the parties did not contract for the sale of grapes by the members to the association.
1951 U.S. Tax Ct. LEXIS 103">*120 Since the producer-members did not sell their grapes to the association, it follows that after such grapes were delivered and became part of a certain wine pool each producer-member at all times retained an equitable interest in that pool in proportion to the quantity of grapes he had contributed and was entitled to his pro rata share of the profits realized from the sale of the products of that pool. It is also apparent that while the value of any producer-member's interest in a given pool might be estimated as of any given date, the amount of his profit or income could not be fixed until after the pool was liquidated, that is, after the wine and other products of the pool were sold and the processing, marketing and other expenses set off against such proceeds. On the date of petitioner's father's death in 1939 a substantial part of the 1937 pool, which contained his grapes, had not yet been liquidated. Petitioner and his sisters succeeded to their father's interest in this pool and a value was placed on such interest for Federal estate tax purposes. Liquidation of this pool took place thereafter during the period 1939-1945. The association during this period made payments to1951 U.S. Tax Ct. LEXIS 103">*121 the petitioner of such liquidation proceeds and in 1944 and 1945 such payments, when added to previous payments, exceeded the 1939 fair market value of petitioner's inherited interest in the 1937 pool.
From the foregoing consideration of the relationship between the decedent and the association and also the manner in which the association operated, it is apparent that the petitioner inherited from his father not merely an equitable interest in the 1937 pool measured by the value of the wine and other products at whatever stage of development they were in in 1939 but also the right to share in a certain percentage of any profits which would be realized over a period of years from the sales by the association, in the normal course of its business, of the finished products of this particular pool. It is also apparent that in the process of liquidating the pool, the sales of the wine and other products were made by the association on behalf of 17 T.C. 260">*268 the members and the proceeds of such sales were returned to the members after expenses were deducted therefrom.
It follows that part of the 1944 and all of the 1945 liquidation proceeds received by the petitioner represent an increment1951 U.S. Tax Ct. LEXIS 103">*122 over and above the value of his interest in the pool acquired in 1939. Accordingly, we hold these amounts, $ 426.65 received in 1944 and $ 323.88 received in 1945, constitute taxable gains to the petitioner in those years.
The taxability of such gains realized by the petitioner as capital gains depends on the question as to whether the petitioner's interest was a capital asset. "Capital assets" are defined in the Code as follows:
SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this title --
(1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), or real property used in the trade or business of the taxpayer;
It appears that the interest1951 U.S. Tax Ct. LEXIS 103">*123 of the petitioner acquired by inheritance in this particular wine pool is independent of petitioner's operation of his father's vineyard in partnership with his sisters, and is independent of any membership he himself may have later acquired in the association, and does not fall within the exclusions of section 117 of the Code. The petitioner's interest was, therefore, a capital asset held for more than 6 months and the gains realized on the distribution are taxable as a long term capital gain in each of the years in which such gains were realized, and we so hold.
The second issue concerns the petitioner's right to two additional exemptions for two of his children claimed as dependents pursuant to section 25 (b) 3 of the Internal Revenue Code. When the petitioner 17 T.C. 260">*269 and his wife filed separate returns for the year 1944 and erroneously divided the separate income of petitioner as the community property of both spouses, the wife claimed two surtax exemptions for two of their children and the petitioner claimed the surtax exemption for the other child. The respondent, upon auditing the returns, discovered their error in reporting the separate income of petitioner as community1951 U.S. Tax Ct. LEXIS 103">*124 income and made the necessary adjustments. He also disallowed the two surtax exemptions claimed as credits on Mabel B. Maley's return, in which denials she acquiesced.
1951 U.S. Tax Ct. LEXIS 103">*125 Were this a case where the treatment of the credits by the wife on her separate return remained unchallenged by the respondent, and petitioner's wife had not waived or was not willing to waive her claim to these two credits, we believe that the petitioner could not now claim these two additional surtax exemptions. A. L. Lusthaus, 3 T.C. 540, affd. 149 F.2d 232, 327 U.S. 293">327 U.S. 293. However, in this case the wife's claim on her return for the two surtax exemptions was due to erroneous inclusion of separate income of the petitioner as community income of both spouses. Furthermore, respondent had disallowed these two surtax exemptions on the wife's return, her claim for refund is based on this and the other adjustments made by the respondent, and the petitioner's evidence clearly proved his right to the two additional surtax exemptions. Accordingly, we hold that the petitioner is entitled to those two surtax exemptions.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
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(5) Property transmitted at death. -- If the property was acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. * * *↩
2. In California & Hawaiian Sugar Refining Corp. v. Commissioner, supra, the Circuit Court in reaching its conclusion as to the relationship in question stated:
It thus appears that under the California law the relationship created by the contract in the "passage of title, and the terms of purchase and sale," -- that is from the very beginning -- is that of a trust, with the members as settlors creating a trust estate for themselves as beneficiaries.
The Court also quoted at length and with approval from Bogardus v. Santa Ana Walnut Growers Assn., supra, decided by the District Court of Appeal, Fourth District, California. This quotation included the following language:
It is respondent's contention, with which we agree, that at all times the relationship between the grower member and the local association, and between the local association and the central association, was that of principal and agent, or beneficiary and trustee; that a fiduciary relationship existed which required at all times that these associations account to the grower member for all proceeds received from the sale of walnuts, and required the grower member to bear his proportionate share of all losses sustained in the marketing and sale of walnut products. [Cases cited.] Both of these cases [cited] involve actions between a member of a non-profit cooperative marketing association and said association for an accounting, and for the determination of rights involving proceeds received from sales of marketed products. In each of these two cases marketing contracts had been entered into between the purchaser and association, which contracts provided for the immediate passage of title and were otherwise couched in terms of outright purchase and sale. In each of the cases cited the court held that the provisions for passage of title, and the terms of purchase and sale, were merely for convenience in marketing operations, and that the real relationship between the parties was one of trust, or of a fiduciary character. * * *↩
3. SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME.
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(b) Credits for Surtax Only. --
(1) Credits. -- There shall be allowed for the purpose of the surtax, but not for the normal tax, the following credits against net income.
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(C) A surtax exemption of $ 500 for each dependent whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than $ 500, except that if such dependent is married the exemption in respect of such dependent shall not be allowed if such dependent has made a joint return with the other spouse under section 51 for a taxable year beginning in such calendar year.
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(3) Definition of dependent. -- As used in this chapter the term "dependent" means any of the following persons over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer:
(A) a son or daughter of the taxpayer, or a descendant of either,
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