*25 Decision will be entered for the respondent.
Petitioners had conducted a business of manufacturing tools and gages in partnership since 1935, beginning with small capital. Earnings were used to increase production capacity. Earnings reached new peaks in 1940 and early 1941. In order to reduce their own income tax liabilities, petitioners formally received their wives into the partnership late in 1941 as limited partners, with the express provision that the wives were not to have any voice in the conduct of the business. Each petitioner transferred on the firm's books one-half of his capital account to new capital accounts in the names of the wives. Held, that the wives did not contribute any capital originating with themselves to the business; that since no capital or services were contributed by the wives, they can not be recognized as partners of petitioners for income tax purposes; and that no real change was effected in the composition of the original partnership of which only petitioners were members. Commissioner v. Tower, 327 U.S. 280">327 U.S. 280, followed.
*1228 These proceedings were consolidated for hearing. Deficiencies in income tax for the year 1941 were determined as follows:
| James L. Pritchard, Docket No. 4049 | $ 4,594.27 |
| Edwin M. Douglas, Docket No. 4050 | $ 4,665.81 |
| George A. Cronkhite, Docket No. 4051 | $ 4,383.07 |
The only question is whether the wives of the petitioners were members of a partnership. The question relates to the last three months of 1941. Respondent held that they were not, and that each *1229 petitioner is taxable for the share of the partnership income reported by his wife. In each case, respondent added $ 7,228.01 to the income of the petitioner under section 22 (a) of the Internal Revenue Code.
Petitioners filed their returns with the collector for the*27 district of Michigan.
FINDINGS OF FACT.
Petitioners live in or near Detroit, Michigan. They are married, and the names of their wives are Zella E. Pritchard, Adelia Douglas, and Hattie M. Cronkhite.
In 1935 Pritchard and Douglas became partners under an oral agreement. They conducted a business in Detroit under the name of Troy Tool & Gage Co. The business was the manufacture of tools, dies, jigs, gages, fixtures, and special machinery. Pritchard contributed $ 286.29 to the business and Douglas contributed $ 271.76 and a small quantity of tools.
Pritchard was 23 years old in 1935. He had a high school education and other education in accounting and the liberal arts. He was studying law. He was the office manager of the partnership. He worked for the business on a part time arrangement, and was employed full time as a collection agent for a finance company at $ 200 per month. In 1937 he gave up his job with the finance company and thereafter devoted all of his time to the partnership business. Later, he reverted to a part time status. In December 1941 he resumed full time employment by the partnership at a salary of $ 125 per week.
Douglas was 26 years old in 1935. He is*28 a machinist. He had worked for the Vinco Tool Co. and was experienced in machine work and the manufacture of gages. He was the general manager of the partnership.
During a short period in 1935 A. G. Van Hove was a member of the partnership. Pritchard and Douglas purchased his interest for $ 2,510 in 1935.
Cronkhite was admitted to the partnership in January 1936. He was 50 years old, and had 20 years experience in the tool business, which included experience in making jigs and fixtures. He made no capital contribution, but agreed to pay Pritchard and Douglas, personally, $ 2,500, out of his share of partnership earnings, which he paid in three years.
The three partners agreed that each would be paid salaries for services rendered, and that profits and losses would be divided equally.
The partnership began its business with not more than five secondhand lathes which cost about $ 50 each. As the business grew, the work was specialized in the making of precision gages out of steel.
The assets and liabilities of the partnership, according to balance *1230 sheets, as of December 31 of 1938, 1939, 1940, and September 30, 1941, were as is shown in schedule A.
| Schedule A | |||||
| ASSETS | |||||
| Office | |||||
| Current | equipment, | ||||
| assets | Machinery | Tools | good will | Total | |
| and other | assets | ||||
| assets | |||||
| Dec. 31, 1938 | $ 5,514.57 | $ 7,888.23 | $ 1,815.91 | $ 985.05 | $ 16,203.76 |
| Dec. 31, 1939 | 7,321.64 | 8,293.03 | 1,813.97 | 985.05 | 18,413.69 |
| Dec. 31, 1940 | 47,772.24 | 13,288.48 | 3,428.21 | 492.64 | 64,981.57 |
| Sept. 30, 1941 | 85,998.08 | 25,712.72 | 4,450.07 | 771.24 | 116,932.11 |
| LIABILITIES | ||||
| Capital accounts | ||||
| Liabilities | ||||
| Pritchard | Douglas | Cronkhite | ||
| Dec. 31, 1938 | $ 3,372.81 | $ 4,277.05 | $ 4,277.05 | $ 4,277.05 |
| Dec. 31, 1939 | 4,798.86 | 4,662.40 | 4,662.40 | 4,662.39 |
| Dec. 31, 1940 | 11,325.72 | 17,951.95 | 17,951.95 | 17,951.95 |
| Sept. 30, 1941 | 10,047.00 | 35,628.37 | 35,628.37 | 35,628.37 |
| LIABILITIES | ||
| Total | Total | |
| capital | liabilities | |
| Dec. 31, 1938 | $ 12,831.15 | $ 16,203.76 |
| Dec. 31, 1939 | 13,614.83 | 18,413.69 |
| Dec. 31, 1940 | 53,655.85 | 64,981.57 |
| Sept. 30, 1941 | 106,885.11 | 116,932.11 |
During the early years of the partnership most of the earnings were used to purchase machinery and equipment. No additional contributions were made by the partners. The net earnings shown by the profits and loss account were credited to a surplus and undivided profits account; all withdrawals were charged to this account. The difference between the net earnings credited and the cash withdrawals debited was distributed equally to the capital accounts of the partners.
The gross receipts of the partnership for 1940 were $ 147,849.19; gross profits were $ 68,494; and the net income amounted to $ 46,206.32. During the first nine months of operation*30 in 1941 the gross receipts were $ 348,136.47; gross profits were $ 185,774.63; and the net income reported on the return for the period ended September 30, 1941, was $ 123,156.31. The profit and loss account showed a profit of $ 112,661.01 for the same period, of which the three petitioners had actually withdrawn $ 59,631.75, leaving undistributed profits of $ 53,029.26, which was credited to the capital accounts of the partners in the amounts of $ 17,676.42 each. Each partner had a balance of $ 35,628.37 in his capital account as of September 30, 1941.
From 1936 to September 30, 1941, each of the petitioners had a one-third interest in the partnership, and all cash withdrawals were equal with the exception of salaries.
In 1940 the business of the Troy Co. was greatly increased over prior years, and during the first six months of 1941 it increased greatly, as is shown above, comparing 1940 gross sales of $ 147,849 with 1941 gross sales for nine months of $ 348,136. The Detroit automobile *1231 companies were handling tool production programs for foreign governments. There was a very great increase in the demand for machine tools. Pritchard realized that the great increase*31 in the business of the partnership would result in correspondingly large increases in the income taxes of the partners. He believed that the partnership business would continue to increase in volume. In July 1941 he originated an idea of taking the wives of the partners into the partnership. The purpose was to reduce the surtax on the income of the respective partners. There was no other purpose, except possibly to reduce eventual estate taxes. The partnership business did not need additional capital and, for that matter, the respective wives did not have any capital of their own to contribute to the business. The wives were women of no business experience and they devoted their time to home-making. Pritchard's proposal was agreed to by the other two partners, and a plan was developed to take the wives into the partnership as limited partners.
In pursuance of the plan each petitioner on September 30, 1941, assigned to his wife an undivided one-half of his interest in the Troy Tool & Gage Co. partnership "for and in consideration of the love and affection which a man bears for his wife." 1 Subsequently, each petitioner filed a gift tax return for 1941, reporting the gift of*32 one-half of his one-third interest in the business and reporting the value of the gift as $ 17,814.18. No gift tax was payable under the gift tax returns.
No change in the business resulted from executing the plan. The operations of the business were the same. No new set of books was opened, but capital accounts in the names of the wives were opened in the books of account, and entries were made reducing the capital accounts of petitioners by the amounts entered to open the wives' accounts.
A partnership agreement was not executed on September 30, 1941, but an agreement was executed later in 1941, which was thereafter destroyed upon the execution of another limited partnership agreement which was executed on January 2, 1942.
A certificate of limited partnership was executed on November 1, 1941. The document was duly filed with the clerk of Wayne County. This document provided*33 that petitioners Douglas, Cronkhite, and Pritchard were the general partners and that their wives were the limited partners; that the term of the partnership was to be three years unless dissolved earlier by mutual agreement; and that the partnership could be extended an additional three years. The document stated that all of the partners contributed $ 17,814.18 each; that the limited partners had not agreed to make any "additional contributions *1232 to capital"; that the business of the firm should be conducted by the general partners and that the limited partners should have no voice in the operation and management of the firm's business; that the general partners should be entitled to reasonable compensation for their services, their compensation to be charged as an operating expense of the business and not against their shares of the net profits; and that whether or not the net profits computed at the rate of 16 2/3 per cent to each of the six partners should be "actually distributed" should rest "in the discretion of the general partners."
The certificate of limited partnership executed on November 1, 1941, is incorporated herein by this reference.
On December 2, 1941, *34 petitioners and their wives entered into an escrow agreement, with the Detroit Trust Co. as escrow agent. The purpose of the agreement was to arrange for the sale of the interest of a general partner and of the interest of his wife, if the husband predeceased the wife, to the surviving partners. The escrow agreement provided in part as follows:
I.Each General Partner hereby agrees for himself, his heirs and legal representatives, to sell to the surviving Partners, as of the date of his death, all his right, title and interest in and to said partnership business, and the surviving Partners hereby agree to purchase the same on the terms and conditions and for the purchase price hereinafter set forth.
Should Edwin M. Douglas predecease Adelia Douglas, then and in that event Adelia Douglas hereby agrees for herself, her heirs and legal representatives, to sell to the surviving Partners as of the date of the death of Edwin M. Douglas all her right, title and interest in and to said partnership business, and the surviving Partners hereby agree to purchase the same on the terms and conditions and for the purchase price hereinafter set forth.
Should George A. Cronkhite predecease Hattie*35 M. Cronkhite, then and in that event Hattie M. Cronkhite hereby agrees for herself, her heirs and legal representatives, to sell to the surviving Partners as of the date of the death of George A. Cronkhite all her right, title and interest in and to said partnership business, and the surviving Partners hereby agree to purchase the same on the terms and conditions and for the purchase price hereinafter set forth.
Should James L. Pritchard predecease Zella E. Pritchard, then and in that event Zella E. Pritchard hereby agrees for herself, her heirs and legal representatives, to sell to the surviving Partners as of the date of the death of James L. Pritchard all her right, title and interest in and to said partnership business, and the surviving partners hereby agree to purchase the same on the terms and conditions and for the purchase price hereinafter set forth.
II.Each Partner, party hereto, does hereby agree to make, execute and deposit with the Escrow Agent an assignment or bill of sale each to the others of all his or her right, title and interest in and to said partnership business and assets which he or she now owns or may hereafter acquire.
*1233 The Escrow Agent shall *36 hold such assignments or bills of sale deposited with it as Escrow Agent, together with any other assignments or bills of sale which may be hereafter deposited with it as Escrow Agent under this Agreement, upon the terms and conditions hereinafter set forth.
III.Each of the General Partners has caused certain insurance to be issued on his life, which said insurance is made payable to beneficiaries named by him, in the manner selected by him, said policies of insurance being deposited with the Detroit Trust Company, as Escrow Agent.
A list of the policies of insurance on the lives of the General Partners is appended hereto as "Schedule A," the contents of which Schedule shall constitute conclusive evidence that the insurance policies listed thereon are subject to the terms of this Escrow Agreement.
The right is hereby reserved to each General Partner to cause additional policies of insurance to be issued on his life and to be made subject to the terms of this Escrow Agreement, any such additional insurance becoming subject to the terms hereof when the same shall be listed upon "Schedule A."
Any insurance which shall at any time be listed upon "Schedule A" hereof shall be considered*37 for the benefit of the Partners, parties to this Agreement, and the proceeds derived from any such policies of insurance by reason of the death of the insured shall be used to carry out the terms of this Agreement, and each of the General Partners hereby agrees that he will not borrow against any of the insurance subject hereto nor otherwise encumber the same without the consent of the other Partners and will regard any dividends upon such policies, any cash values accruing thereto, and any and all other benefits which shall inure to any of said policies, as the mutual property of the Partners, parties hereto, to accrue for the benefit of the Partners in accordance with the terms of this Agreement.
* * * *
VI.The purchase price or consideration which shall be paid to a deceased General Partner, his heirs or legal representatives, or to beneficiaries named by him in said policies, and to his wife for her limited partnership interest, in the event she survives him, shall be as follows:
(1) Until changed in accordance with the terms of this Agreement, the value of each Partner's interest in the partnership business and assets, for the purpose of purchase and sale hereunder, shall be*38 Twelve Thousand Five Hundred ($ 12,500.00) Dollars.
(2) This value may be changed at any time by the mutual agreement of the Partners. The value so mutually agreed upon shall be put in writing, signed by the Partners, and served upon the Detroit Trust Company, as Escrow Agent, and in the event of such writing being served, then the purchase price named in the last such writing to be served upon the Escrow Agent shall govern rather than the price herein fixed.
(3) In addition to the amounts payable under parts (1) or (2) of this paragraph, there shall be paid in accordance with the terms and provisions of this Agreement an amount equal to the sums which have been contributed by such deceased General Partner to the payment of premiums upon the insurance subject hereto, the amount of such reimbursement to be determined by reference to the records of the respective insurance companies issuing such policies subject hereto.
*1234 (4) If the amounts payable under parts (1) or (2) and (3) of this paragraph shall not be as great as the amount of insurance which shall become payable by virtue of the death of any General Partner, then and in that event the amount of the insurance proceeds*39 actually payable shall be the minimum purchase price which shall be paid for the interest of any deceased General Partner and the interest of his wife, should she survive him.
* * * *
The entire escrow agreement is incorporated herein by this reference.
On January 2, 1942, articles of limited partnership were executed by petitioners and their wives, the terms of which were substantially the same as the provisions of the certificate of limited partnership executed on November 1, 1941. A second certificate of limited partnership was executed on January 2, 1942, in which it was provided, inter alia, that "No right is given to any limited partner to demand and receive property other than cash in return for her contribution."
The business of Troy Tool & Gage Co. during the last three months of 1941, and at all times during 1941, was conducted by petitioners, their wives having no voice in the management of the business. Petitioners' wives did not render any services to the business. Petitioners determined the amounts of their own respective salaries.
All of the capital of the limited partnership which was agreed to on or about October 1, 1941, originated with petitioners, and was*40 the accumulation of their joint efforts in the prior conduct of the partnership, which consisted of only the three petitioners. The earnings of the limited partnership during the last three months of 1941 were the result of the skill and services of petitioners in the conduct of a business which required special skill.
The partnership which existed during the first nine months of 1941, consisting of only the three petitioners, continued in existence during the last three months of 1941, and the formal admission of the wives of petitioners into the partnership as limited partners on October 1, 1941, did not effect any real change in the original, existing partnership for purposes of liability for Federal income tax upon the earnings of the business. Petitioners and their wives did not intend to carry on the business in question as partners, and they did not do so. Rather, the three petitioners intended to and did, by themselves only, conduct the business in question as a partnership.
OPINION.
The respondent has determined that the income of the Troy Tool & Gage Co. for the period October 1 to December 31, 1941, is taxable in equal shares to the three petitioners under section 22(a) *41 of the Internal Revenue Code. In the case of each petitioner his determination is that the wife of each petitioner *1235 was not a member of the Troy Tool & Gage Co. partnership in the year 1941. A partnership in which the three petitioners were the only members had existed, and that partnership is the only partnership which the respondent recognizes for income tax purposes. His position is that the formal arrangements which were made in the latter part of 1941 to establish a new partnership in which the three wives were admitted as limited partners were ineffective to relieve each petitioner from income tax upon an entire one-third share of the earnings of the firm.
These proceedings were tried and the briefs were filed prior to the Supreme Court decision in Commissioner v. Tower, 327 U.S. 280">327 U.S. 280. The question presented here is controlled by the Tower case.
Petitioners presented a lengthy amount of evidence relating to the formal arrangements for creating a new limited partnership in which their wives were the limited partners. Consideration has been given to all of the evidence to discover whether the facts here distinguish these proceedings*42 in principle from the Tower case. No distinguishing facts are found in the evidence. The details do not contribute anything to the decision to be made, and, therefore, the findings of fact have not been enlarged to include the quantity of detail of record. That is not to say that all of the evidence has not been carefully weighed and examined. It has been examined. The question is such that substance is of greater importance than form. That the limited partnership may have been valid under Michigan law has no greater bearing upon the question here than it had in the Tower case. The important and governing conclusion from the evidence is that no one of the wives contributed services or capital which originated with her to the business. The business did not need additional capital; it did not receive any. However carefully the various documents were drawn to change the existing partnership of the three petitioners into a new partnership of petitioners and their wives, the documentation failed to bring about any real change in the existing partnership consisting of only the three petitioners, and their wives can not be recognized as their partners for purposes of the*43 tax involved.
See also Lowry v. Commissioner, 154 Fed. (2d) 448; certiorari denied, U.S. (Oct. 14, 1946); Canfield v. Commissioner, 154 Fed. (2d) 1016; Thorrez v. Commissioner, 155 Fed. (2d) 794.
It should be noted that petitioners' arrangements were such that they retained control over distributions of earnings to partners. They were to receive salaries in such amounts as they might determine themselves, and the firm's earnings after salaries were to be held or distributed as they directed. Tax savings to petitioners was an admitted reason for making the arrangements at a time when earnings had greatly increased and were still increasing. It is difficult to find *1236 here anything more than an attempt by petitioners to reallocate their income within each family unit.
Respondent's determination that each petitioner is liable for tax upon one-third of the income of the Troy Tool & Gage Co. for the last three months of 1941 is sustained.
Decision will be entered for the respondent.
Footnotes
1. On November 26, 1940, each petitioner had executed a will by which each bequeathed to his wife all of his interest in Troy Tool & Gage Co.↩