*863 A partnership agreement, between partners engaged in the insurance business, provided among other things that upon the death of a partner his pro rata share of partnership earnings up to the date of death should be paid to his legal representatives, and that thereafter the surviving members should pay, in monthly installments the share of profits which would have accrued to the deceased partner for a period of 30 months had he lived. Held, that, under the agreement, the monthly payments made by the surviving partners to the legal representatives of the deceased partner's estate represented the purchase price of the deceased partner's interest in the firm, and such monthly payments, although measured by the partnership's earnings, did not constitute taxable income to the deceased partner's estate.
*487 This proceeding involves a deficiency of $2,701.47 in income taxes for 1933. The errors alleged are (a) that respondent erroneously included in petitioner's taxable income for the year 1933 an item of $23,252 alleged to be partnership income, *864 and (b) that respondent failed to allow a proper offset against the alleged deficiency by reason of an inferentially resulting overpayment of estate taxes growing out of the same item.
The proceeding was submitted upon a stipulation of facts with attached exhibits and briefs. We set forth in our findings of fact only those portions of the stipulation and the documentary evidence deemed pertinent to the question presented.
FINDINGS OF FACT.
Bavier C. Miller, a citizen and resident of Chicago, Illinois, died December 8, 1931, leaving a last will and testament under the terms *488 of which the Northern Trust Co. and Grace M. Haskins were nominated and thereafter duly qualified as executors and trustees.
At the date of decedent's death he was and had been for many years prior thereto a member of a partnership engaged in the insurance business in Chicago under the name and style of "Critchell, Miller, Whitney and Barbour." On May 25, 1927, the members of this partnership entered into a written partnership agreement, to be effective for a period of four years from June 1, 1927. On May 22, 1931, the partnership agreement was extended to and until June 1, 1932, and at*865 the time of decedent's death the partnership agreement of May 25, 1927, was in full force and effect. The agreement by express terms was made binding on the heirs, executors, administrators, and assigns of the parties thereto.
The pertinent portions of said partnership agreement are as follows:
EXPENSES AND PROFITS
All the expenses of the conduct and management of said business are to be charged to an account to be called and known as "the expense account," and the profits from such business shall be disposed of at the end of each month, or as soon thereafter as practicable, as stated more specifically as follows, between the parties hereto in proportion to their respective interests, as follows:
| INDIVIDUAL INTERESTS | |
| Bavier C. Miller | 20.442 per cent |
| Charles P. Whitney | 20.442 per cent |
| Lyman M. Drake | 23.566 per cent |
| Clarence S. Pellet | 19.4 per cent |
| Nelson J. Bennett | 13.15 per cent |
| Frank Barbour | 3. per cent |
Subject, however, to the rights of the legal representatives of any deceased partner to receive whatever amount shall be due under the terms of this agreement, as hereinafter provided.
* * *
DISSOLUTION FOR MISCONDUCT
In the event of*866 the violation of this agreement by any of the members, the said co-partnership, at the option of the remaining partners, shall be and become, by such breach of contract, immediately dissolved as to the member so violating this contract, by written notice being served on the member so breaking this contract; and that in case of such dissolution, the books of the co-partnership shall be closed and balanced, and the party guilty of such breach shall be paid any sum then found to be standing to his credit, less his share of any liabilities, or shall pay any balance that may be due from him to said firm; and the party so violating this agreement shall forfeit to the other parties all claim or any interest in and to the value of the business and good-will of said co-partnership as fixed and liquidated damages for his breach of this agreement.
*489 CONTINUATION BY REMAINING MEMBERS
And it is further mutually agreed that if the said firm shall be dissolved by the breach of this contract by any member, then the remaining members shall continue the business of said firm under the same firm name (the interest of the one who had broken this agreement being distributed among them per*867 capita), and the party guilty of such breach of contract shall not engage for the period of five years from that date in the insurance business in said Cook County in any capacity, either directly or indirectly, in his name or in any other name, and in consideration thereof he shall be paid within thirty days of such partial dissolution, his pro rata share of the undivided profits of said co-partnership, and during a period of three years (if he does not engage in the insurance business in Cook County, Illinois) next ensuing in monthly installments, a sum equal to one-half (1/2) what would have been his share in the profits of said firm if the had not subjected himself to the penalties herein provided, and the co-partnership herein created shall be extended as to the other members of such co-partnership for the term of this agreement or for a period of three (3) years from the date of such partial dissolution.
INTEREST OF DECEASED MEMBER
In the event of the death of any of the parties hereto, during the term of this co-partnership, the interest of the deceased partner then remaining in said business shall cease, and his or their legal representative shall be paid by the surviving*868 members of said co-partnership within sixty days after the date of his death, the pro rata share of such deceased partner in the undivided profits of such co-partnership up to the date of his death and thereafter for a period of thirty (30) months there shall be paid to the legal representative of such deceased partner or partners in monthly installments, the share of the profits which would have accrued to said deceased partner or partners had he or they lived. It being expressly understood and agreed that the payments to the legal representatives of such deceased partner herein provided for, shall extinguish all claims on account of the interest of said deceased member. The interest of such deceased member to be divided between said surviving co-partners per capita. The profits to be so paid to said legal representative to be borne by the parties to whom such interest shall pass per capita. It is understood and agreed by all the parties hereto that the legal representatives of any deceased partner shall be required to use reasonable influence to obtain the continuance of the patronage of the firm hereby created, by the customers of such deceased partner after the death of*869 such partner.
IT IS FURTHER AGREED between the parties hereto that in lieu of the provision here made for the payment of the interest of a deceased partner in said co-partnership, the surviving partners, (a majority of them shall decide), shall have the option, privilege or right to pay to the legal representative of any deceased partner or partners within sixty (60) days of the death of such deceased partner or partners in full of the interest of such deceased partner or partners in said co-partnership, an amount equal to the share of the profits by such deceased partner received or credited to him upon the books of the firm during the period of thirty months next preceding the death of such deceased partner, computed at the percentage of his interest at the time of his death, provided, however, that the right to exercise this option shall not be availed of if during said thirty (30) months' period preceding the death of any member, there existed a rate war and/or other extraordinary happenings which seriously affected the profits of said co-partnership. In case of the death of any such *490 partner as herein provided, the co-partnership shall be extended if necessary, *870 so that the same shall not terminate for at least thirty (30) months from and after the date of such death. In the event that the option herein provided shall not be exercised by said surviving partners, or a majority of them, within said sixty days' period, then the interest of such deceased partner or partners shall be liquidated and paid in the manner and upon the conditions hereinbefore first mentioned.
IT IS FURTHER AGREED that, in the event said surviving partners elect to pay the representatives of such deceased partner or partners an amount equal to his share of said profits for said thirty months' period as aforesaid, that then and upon payment of said amount, the interest of such deceased partner or partners in said co-partnership estate shall immediately terminate, and neither his heirs, administrators, executors nor other legal representatives shall have the right to demand or received [receive] from said co-partnership, or from its property and assets, any other sum or sums of money.
Following the death of Bavier C. Miller, the petitioners filed a Federal estate tax return in which they reported his partnership interest (in addition to decedent's share of partnership*871 profits accrued at the date of his death) at a value at the date of death of $41,800, and paid the Federal estate tax thereon.
During the years 1932, 1933, and 1934 the surviving partners paid to the legal representatives of Bavier C. Miller, deceased, in discharge of the provisions of said partnership agreement, the total sum of $55,338.85, which was in addition to the decedent's share of the partnership profits that had accrued at the date of his death. Of said amount of $55,338.85, the amounts paid in the years 1932, 1933, and 1934 were $12,955.77, $17,882.16, and $24,500.92, respectively. Of the amount of $17,882.16 paid by the surviving partners to the legal representatives of Bavier C. Miller, deceased, during the year 1933, $3,790.89 was paid to the executors, and the balance, $14,091.27, was paid to the testamentary trustees.
The partnership net income as finally determined for Federal income tax purposes for the years 1932 and 1933 was $102,973.98 and $100,167.15, respectively.
After the death of Bavier Co. Miller, a controversy arose between the life tenants and the remaindermen under his will as to whether the payments totaling $55,338.85 represented income or*872 corpus. A bill in equity was thereupon filed by Northern Trust Co. and Grace M. Haskins, the testamentary trustees, in the Superior Court of Cook County, Illinois, asking that court to construe the will and the partnership agreement of Bavier C. Miller, deceased, and to give them instructions as to the distribution of the moneys received by them in payment of their testator's interest in the partnership. By its decree of November 12, 1935, the Superior Court of Cook County determined that the said sum of $55,338.85 was corpus, representing the proceeds of a sale to the surviving partners of Bavier C. Miller's *491 interest in the partnership, and that it was not income and was not distributable in whole or in part to the life tenants. On November 30, 1935, the executors of the estate of Henrietta Miller, deceased wife of Bavier C. Miller, filed a petition in said cause asking that the court determine a specified amount of said sum as belonging to the life tenant and that such sum be paid to them as executors of her estate. On January 21, 1936, an order was entered denying the prayer of the petition. In that order the court recited its decree of November 12, 1935, and the*873 facts therein found, and dismissed the petition on the ground that it raised the same questions determined by the decree of November 12, 1935. Thereupon the executors prosecuted an appeal from the decree of the Superior Court to the Appellate Court of Illinois, , which court, during the year 1936, delivered its opinion affirming the order of the Superior Court. The opinion of the Appellate Court sets forth at length the decree entered by the Superior Court November 12, 1935. A copy of the Appellate Court's opinion was incorporated in and made a part of the stipulation of facts herein.
OPINION.
ARNOLD: The principal issue in this proceeding is whether the partnership agreement provided for a sale of the decedent's partnership interest to his surviving partners, or whether that agreement contemplated a continuation of the partnership with decedent's legal representatives sharing in the profits the same as decedent would have shared had he lived. All of the facts have been stipulated, including the amount of the partnership's net income for the taxable year. In accordance with the terms of the partnership agreement*874 the surviving partners paid the legal representatives of the decedent $17,882.16 during the taxable year, and we have to determine whether these payments represented a portion of the purchase price of decedent's partnership interest by the surviving partners or whether it was income to petitioner's estate as the estate's proportionate part of the partnership earnings.
Petitioner contends that the transaction provided for in the partnership agreement and carried out as hereinabove set forth, constituted a sale; that the decisions of this Board and the Federal courts support his view; that the Illinois courts have held this identical transaction to be a sale in ; and that the decision of the state court is binding upon this Board in so far as it states the local law applicable to partnership contracts.
The respondent's brief concedes that the Government is taking an opposite position in this proceeding from the position which it has *492 taken in the Lyman M. Drake and Clarence S. Pellet proceedings, Docket Nos. 79653, 85261, 79648, and 85262, which proceedings involve the same partnership agreement, the partnership*875 net income for the years 1932 and 1933, and two of the surviving partners of this decedent. The respondent's position is that the Government is entitled to its tax on the net income of the partnership, and that, in order to protect the Government's revenues, it is necessary to include in the taxable income of this petitioner, and in the taxable incomes of the surviving partners, that portion of the partnership income attributable to the decedent's interest. Whether petitioner or the surviving partners pay the tax on this portion (20.442 percent) of the partnership net income depends upon whether the partnership agreement provided for a sale, or a continuation of the partnership with the decedent's legal representatives participating in the earnings.
The partnership agreement provides, inter alia, that upon the death of any partner his interest "then remaining in said business shall cease"; that the deceased partner's interest should be "divided between said surviving co-partners per capita"; and that the profits to be paid to the decedent's legal representatives should be borne "by the parties to whom such interest shall pass per capita." These provisions definitely*876 terminate the partner's interest upon death and provide for a taking over of that interest per capita by the surviving partners, binding each survivor, individually, to pay his proportionate part of the amount due the decedent for his interest in the partnership. The yardstick that the parties agreed to use in measuring the value of a deceased partner's interest was the share of the profits which the decedent would have been entitled to had he lived an additional 30 months, and the deceased, while living, agreed for himself, his heirs, executors, administrators, and assigns that the payment of this determinable sum should extinguish all his interest in the partnership at the time of his death and all claims that he might have against the firm.
One indication that the partners recognized that their interests in the firm had value under the articles of copartnership is contained in the paragraphs dealing with the expulsion of a partner for breach of the partnership agreement. The partners agreed that the penalty for any such breach was the immediate dissolution of the partnership as to such member, a balancing of accounts as between the firm and the guilty party, and the forfeiture*877 by the partner violating the agreement of "all claim or any other interest in and to the value of the business and good-will of said co-partnership as fixed and liquidated damages for his breach of this agreement." As further evidence of the value of a partner's interest, the parties agreed that, if the guilty partner refrained from engaging in the insurance *493 business in Cook County in any capacity, directly or indirectly, in consideration thereof he should receive a sum equal to one-half of what would have been his share in the profits of the firm for a period of three years.
Another indication that the partners recognized that their interest in the firm had value was the right granted to buy a deceased partner's interest by payment of a lump sum equal to his share of the firm's profits for the 30 months preceding his death, thereby clearly indicating that the sum to be paid was determinable by the deceased partner's interest in profits, not as such, but as a yardstick to value his interest in the partnership at the time of his death.
Furthermore, the provision for payment to the legal representatives of a deceased partner of his share in the partnership earnings*878 up to the date of his death indicates that the partnership was not to be continued for a period of 30 months after death and that his right to share in the partnership earnings, as such, was to end when he became no longer active in behalf of the partnership.
Following the provisions for the payment of the pro rata share of during a period of 30 months after death, to which a deceased partner would be entitled had he lived, it is provided that "in lieu of the provision here made for the payment of the interest of a deceased partner in said co-partnership" such interest may be acquired by paying within 60 days after death an amount equal to the deceased partner's share of earnings during the 30 months next preceding death, at the option of the surviving partners. This paragraph of the agreement is clearly one for the purchase and sale of a deceased partner's interest in the firm at the time of death. The expression in this paragraph, "in lieu of the provision here made for the payment of the interest of a deceased partner in said copartnership", evidently refers to the right given in the preceding paragraph to pay for a period of 30 months after death the share of the profits which*879 would have accrued to a deceased partner had he lived, and shows that the parties to the agreement intended the money to be paid under either method was "for the payment of the interest" of a deceased partner, and was not a distribution of partnership earnings, as such.
While our own interpretation of the partnership agreement convinces us that the parties intended to realize on their interests in the case of the death of any one of them, by binding the survivors to purchase the interest of the deceased partner, we need not rely solely upon our personal convictions, as we have the benefit of a court interpretation of the agreement. Subsequent to the death of Bavier C. Miller the life tenants and the remaindermen under his will became involved in a dispute as to whether the payments under the partnership *494 agreement represented income or corpus. The testamentary trustees under the decedent's will filed a bill in equity in the Superior Court of Cook County requesting the court to construe the will and agreement, and to instruct them as to the distribution of the payments received. The trustees were joined in this request by the other parties in interest. By its decree*880 of November 12, 1935, the court fully discussed the will and partnership agreement, and held that the agreement provided for a sale and that the payments represented corpus and not income distributable to the life beneficiaries. The court retained jurisdiction of the subject matter and the parties to the action for the purpose of passing upon any further question that might arise on petition of either party in carrying out the trust pursuant to the terms of the decree.
Thereafter, on November 30, 1935, a new petition was filed by parties interested in the prior action, which petition the Superior Court dismissed by its order of January 21, 1936. The appeal to the Appellate Court followed, and in , the court, after reviewing the Superior Court's decree of November 12, 1935, and the other facts, held that the decree of November 12, 1935, was final and binding, and affirmed the Superior Court in its action of January 21, 1936, upon the ground that the petition of November 30, 1935, presented a renewal of the same questions already decided. The Appellate Court set forth at length the earlier decree of the Superior Court in interpreting the partnership*881 agreement now before us with respect to the provisions of Bavier C. Miller's will. We quote the following findings of the Superior Court which were incorporated in the decision of the Appellate Court:
* * *
That at the time of the making of said co-partnership agreement, it was the intention of the parties thereto to acquire and purchase the interest of any deceased partner by the payment to his legal representatives of a sum of money, the amount of which should be equal to the amount of the profits which such deceased partner would have received had he lived and continued to be a member of said firm.
That under the terms of said articles of co-partnership, the legal representatives of said Bavier C. Miller did not become partners in said firm and were not entitled to share in any profits nor were they required or obliged to pay or share in any losses which might be sustained in carrying on said business by the surviving members thereof.
That the legal representatives of said Bavier C. Miller did not have the right to participate and did not participate in the affairs of said business so carried on by the surviving members and were not required to nor did they contribute*882 in any way to the success or operation of said business.
That said legal representatives did not contribute any money, property or other capital work or labor to the business carried on by said surviving members after the death of said Bavier C. Miller.
That prior to 1901 when the said Bavier C. Miller became a member of said firm of Critchell, Miller, Whitney & Barbour, and for many years prior thereto, *495 the said Bavier C. Miller had been associated with others in the insurance brokerage business in the said City of Chicago, and thereby became and was well and favorably known to many persons requiring the service of insurance agents and brokers.
That by reason of such prior experience and by reason of his membership in the firm of Critchell, Miller, Whitney & Barbour, and by reason of extensive advertising, the firm of which deceased was a member became well and favorably known to the insurance public and there was thereby created a large and valuable good will by said firm in the insurance world in said city, and which good will existed and was of large value at the time of the death of said Bavier C. Miller.
That said firm of Critchell, Miller, Whitney & Barbour*883 was at the time of the death of said Bavier C. Miller, one of the large and favorably well known insurance agents or brokers in said city, doing an annual business of between three and four million dollars in insurance premiums, and that by reason thereof, said firm had created and established in the insurance field a large and valuable good will which enured [inured] to the benefit and advantage of the surviving members of said firm and which would have been of comparatively little value if the death of said Bavier C. Miller had worked a complete and final termination of the business formerly carried on by said firm.
That said Bavier C. Miller and his co-partners were men of large experience in the insurance field and each had built up during their partnership association an individual clientele; that the value of an insurance agency and brokerage business consists largely of the probability that insurance originally written as a result of the efforts of a member of the agency, will be renewed from year to year through the same agency; that the value of the tangible assets of the partnership existing at the time of the death of Bavier C. Miller was small in comparison with the*884 value of its good will and that after the death of Bavier C. Miller, his personal clientele was solicited by the surviving members for a continuation of the business originally procured by Bavier C. Miller, and that the efforts of the surviving members in that respect for a limited period of time met with a substantial degree of success.
That it was the intention and purpose of all of the members of said firm, including said Bavier C. Miller in his lifetime, to keep and conserve said good will, whereby they provided and agreed that upon the death of any partner the survivors should become entitled to the good will so created and established by paying to the legal representatives of a deceased partner, a sum of money, the exact amount of which would be an amount equal to the share of the profits received by or credited upon the books of the firm to the deceased partner during the period of thirty months next preceding his death; or a sum of money the exact amount of which should be ascertained and determined at the expiration of thirty months after the death of any partner and which amount would be equal to the profits to which such deceased partner would be entitled had he lived*885 and continued as a partner in said firm.
And the court finds that the payment of said sum of Fifty-five Thousand Three Hundred Thirty-Eight Dollars and Ninety-Five Cents ($55,338.95), to the legal representatives of said decedent constituted a purchase by the surviving members of the interest which said decedent had in said firm at the time of his death, and was in extinguishment of any and all interest which decedent or his estate might have in the assets, good will or other property belonging to said co-partnership at the time of the death of said Bavier C. Miller.
That the death of said decedent dissolved the then existing partnership and that after the death of said decedent, his legal representatives had no right, *496 title or interest in said co-partnership nor in any of its property or assets, other than a claim against the surviving members of said firm in their individual capacities, under their agreement for the purchase of the interest of said decedent as specified, and set forth in said articles of co-partnership as extended.
In addition to the decision of the Illinois court we have been referred to the opinions of the Federal courts and this Board which*886 have determined the principle here involved in petitioner's favor. In , affirming ; certiorari denied, , the First Circuit was asked by a surviving partner of an insurance agency and brokerage business to permit the deduction of payments, made to the estate of a deceased member in accordance with the terms of the partnership agreement, as ordinary and necessary expenses in arriving at the partnership net income and the distributive shares of the partners therein. The terms of the partnership agreement, as to Hill, were substantially the same as the partnership agreement here in question, except as to the period of time over which payments were to be made to the deceased partner's estate. The court and this Board held that the payments made to the estate were not deductible as ordinary and necessary expenses because such payments were made by the surviving partners in the purchase of a capital asset. The court pointed out that, even if the new partnership agreed to pay the estate of the deceased member out of the net profits of the business of the new partnership, it would*887 still be the purchase of a capital asset out of the earnings of the new partnership which belonged to and otherwise would have been disbributed to the partners. See also ; , affirming on this point, . Cf. ; ; and .
Although the Supreme Court held in , that the estate of a deceased partner was liable for income tax on its share of the firm's profits for the agreed period after the partner's death, it also recognized that situations might arise where such payments would not be taxable as income. In that case the articles of copartnership provided that a deceased partner's estate should "receive the same interests, or participate in the losses to the same extent" as the deceased partner would if living. Here there is no such provision as to participation in losses. *888 Furthermore, the Court stated that "Where the effect of the contract is that the deceased partner's estate shall leave his interest in the business and the surviving partners shall acquire it by payments to the estate, the transaction is a sale, and payments made to the estate are for the account of the survivors. It results that the surviving partners are taxable upon firm profits and the estate is not." In our opinion this is exactly *497 what the partners of Critchell, Miller, Whitney & Barbour intended by their agreement of May 25, 1927, when they provided that the deceased partner's interest should cease at death, his interest should be divided among the surviving partners per capita, and the profits to be paid the decedent's estate should be borne by the parties to whom his interest had passed per capita.
In arriving at our conclusion we have examined the decisions in ; ; , and others, but find them distinguishable either as to the facts involved or as to the principle considered.
*889 Considering all the facts and circumstances herein, together with the cited authorities, it is our opinion that the agreement of May 25, 1927, as extended, provided for a sale of the decedent's interest in the partnership to the surviving partners, that the surviving partners individually obligated themselves to purchase the interest of any partner dying, that payments received pursuant thereto represented a part of the corpus of the decedent's estate, and that no part of the profits of the partnership should be returned by petitioners as taxable income of the decedent's estate.
In this view of the principal issue it becomes unnecessary to consider petitioner's second allegation of error, which was in the nature of an alternative issue, although not specifically pleaded as such.
Decision will be entered for the petitioner.