*127 Decision will be entered under Rule 50.
Husband and wife who operated a business as equal partners and who both contributed capital and performed services, held, entitled to report the profits equally in their individual income tax returns from February 14, 1939.
*814 This proceeding involves deficiencies in income tax for the calendar years 1939 and 1940 in the amounts of $ 7,188.85 and $ 10,467.06, respectively. The only question is whether petitioner is taxable on all of the profits from a wholesale beer business which he and his wife operated as equal partners, or whether the profits are taxable one-half to him and one-half to his wife.
FINDINGS OF FACT.
Petitioner is a resident of Grand Rapids, Michigan. He filed his income tax returns for 1939 and 1940 with the collector of internal revenue for the district of Michigan.
Prior to 1933 petitioner operated a malt business in Grand Rapids. Gladys Dauksza, whom he later married, operated a branch*128 store for him. She began work for petitioner in 1932, when she was about 25 years of age. In 1933 she started working in petitioner's main store.
About May 1, 1933, after the sale of beer was legalized, petitioner went into the wholesale beer business under the trade name of West Side Beer Co. The first carload shipment of beer arrived with a sight draft for approximately $ 3,000 attached to the bill of lading. Petitioner did not have sufficient funds of his own to pay the draft and Gladys Dauksza paid one-half of it. She had some savings of her own and borrowed the balance from her parents. This money remained invested in the business from the date of payment.
Gladys Dauksza became engaged to be married to petitioner some time during 1933 and they were married in 1936. In the meantime she continued to work for petitioner, devoting all her time to the beer business after its organization. She took care of the office work while petitioner spent most of his time selling, and for a time delivering, the beer himself. Her duties consisted of waiting on customers, looking after the correspondence, replenishing the stock, *815 checking the trucks in and out, and taking care*129 of other office details. She worked long hours and was often at the office from eight in the morning until eleven o'clock at night. She received a salary of $ 8 a week during 1933 and 1934, $ 16 a week during 1935, and $ 50 a week during 1936, 1937, and 1938.
After their marriage in 1936 petitioner and his wife continued to operate the West Side Beer Co. in about the same way that they had in prior years. Petitioner spent most of his time selling and looking after outside matters while his wife managed the office. Her duties and responsibilities increased with the growth of the business. She hired and fired employees (there were about 30 employees in 1940), looked after the purchase and distribution of the beer and wine, held "pep" meetings for the salesmen and truck drivers, straightened out complaints, and performed other managerial duties. She and petitioner usually talked over the more important business matters and together determined all questions of policy.
In 1935 petitioner filed with the County Clerk a "Certificate of Persons Conducting Business Under Assumed Name" in which he certified that he was conducting the business of West Side Beer Co. as sole owner. No change*130 was made in this registration up to or during the taxable years 1939 and 1940. Licenses to sell beer and wine were issued to "West Side Beer Company, Felix Zukaitis & Gladys Zukaitis" on May 1, 1940.
In the latter part of 1937, or early in 1938, petitioner and his wife consulted their attorney, John J. Smolenski, of Grand Rapids, about forming a partnership. They represented to the attorney that they both had money invested in the business and that they each wanted protection of their rights in it; that they had considered themselves partners in the business for some time; and that they wanted a partnership agreement in writing. The attorney told them that it was a difficult thing to do because under the laws of Michigan husband and wife partnerships were not valid. However, under their direction the attorney later drew up a partnership agreement which petitioner and his wife executed on February 14, 1939. The agreement provided in part as follows:
Whereas, the inventory of the physical assets of the West Side Beer Company as of and ending December 31, 1938 total the sum of $ 99,897.09, as certified to by Certified Public Accountant M. M. Berman, copy of which certificate is *131 hereto attached and marked Exhibit A, and
Whereas, the said Gladys Zukaitis has given considerable of her time, effort and energy and assistance in the operation and conduct in the development of the West Side Beer Company, for which she did not receive compensation, and
Whereas, it is the purpose of this agreement to create Gladys Zukaitis as an equal partner with the said Felix V. Zukaitis in the ownership and the operation of the West Side Beer Company, a co-partnership.
*816 Therefore, it is mutually agreed and understood by and between Felix V. Zukaitis and his wife Gladys Zukaitis as follows:
1. The said Felix V. Zukaitis hereby makes a gift of $ 49,948.54 to the said Gladys Zukaitis, and the said Gladys Zukaitis hereby accepts such gift of $ 49,948.54 comprising $ 49,948.54 of the physical assets of the said West Side Beer Company as represented by the inventory ending December 31st, 1938.
2. The said co-partnership of Felix V. Zukaitis and Gladys Zukaitis doing business as the West Side Beer Company shall continue until the same is dissolved by mutual written agreement of the said parties, or dissolved by death of one of the parties, or by legal dissolution.
3. Each of*132 such parties shall be equal partners and shall share equally in the profits of said West Side Beer Company, and shall also share equally in the losses of the said co-partnership, and shall also individually be responsible for the debts and liabilities of said co-partnership.
4. The said co-partnership shall do business and be known as the West Side Beer Company.
5. The General Manager of said business shall be the said Felix V. Zukaitis, having complete charge in the actual operation of said business, based upon the policies that may be set up and agreed upon between the said two partners.
6. It is further mutually agreed and understood that neither partner will sell, dispose of, incumber his or her respective one-half (1/2) interest in this co-partnership, without a mutual agreement in writing, and that neither partner will in any way interfere in the operation of said co-partnership, with Felix V. Zukaitis who is herein agreed upon and designated as the General Manager of said business.
7. It is hereby further mutually agreed and understood by and between the said Felix V. Zukaitis and Gladys Zukaitis, that each of said partners will give all of their time, efforts and energy as*133 may be necessary in the successful operation of said business as may from time to time be agreed upon.
8. This agreement was heretofore entered into and became effective as of January 1st, 1939, but not reduced to writing in this form until on this the 14th day of February, 1939, inasmuch as the inventory could not be certified to by the Certified Public Accountant until furnished on February 14th, 1939.
Soon after the partnership agreement was executed the attorney sought to have it recorded, but the county clerk refused to record it.
Petitioner filed a gift tax return for 1939 in which he reported a gift to his wife of $ 49,948.54 and paid a gift tax thereon of $ 89.23.
There was no change in the conduct of the business of the West Side Beer Co. under the partnership agreement. Separate investment accounts for petitioner and his wife were set up in the books as of January 1, 1939, showing credits of $ 49,948.55 and $ 49,948.54, respectively. Additional credits representing one-half of the net profits of the business were made to the accounts in the respective amounts of $ 27,449.97 and $ 27,449.98 as of December 31, 1939, and $ 25,239.72 and $ 25,239.71 as of December 31, 1940. *134 Petitioner's account shows debits of $ 33,692.95 in 1939 and $ 26,576.45 in 1940, while that of his wife shows debits of $ 29,342.71 in 1939 and $ 10,255.81 in 1940. At December 31, 1940, petitioner's account showed a balance *817 of $ 50,132.55 and his wife's a balance of $ 63,803.42. Petitioner's wife withdrew the following amounts from the business in 1939 and 1940:
| 1939 | 1940 | |
| Cash | $ 21,646.30 | $ 570.90 |
| Purchase of securities | 6,725.00 | |
| Personal bills paid | 880.76 | 487.52 |
| Income tax | 90.65 | 3,322.39 |
| Purchase of realty | 5,875.00 | |
| Total | 29,342.71 | 10,255.81 |
The real estate item of $ 5,875 shown above represented one-half of the purchase price of real estate which petitioner and his wife purchased in their joint names in 1940. In 1936, shortly after their marriage, petitioner and his wife purchased a home in Grand Rapids in their joint names. In 1937 they purchased as tenants by the entireties a lot on which they constructed a commercial building at a cost of $ 57,000. The cost of construction was paid with funds of the West Side Beer Co. and $ 10,000 which petitioner and his wife borrowed from the bank on their joint note.
Partnership returns on form *135 1065 were filed in the name of West Side Beer Co. for 1939 and 1940, showing the following items:
| 1939 | 1940 | |
| Gross receipts | $ 804,716.39 | $ 781,726.38 |
| Gross profits | 172,768.80 | 167,761.97 |
| Salaries and wages | 56,032.23 | 57,937.87 |
| Net income | 55,422.81 | 50,949.29 |
Petitioner's wife had savings bank accounts in her own name in which she deposited $ 11,850 in 1939 and $ 1,330 in 1940. She also kept a large amount of cash in a safe deposit box which was registered in her name.
Petitioner and his wife filed separate individual income tax returns for 1939 and 1940 in which each reported one-half of the net profits of the West Side Beer Co. as shown in the partnership returns for those years. In his determination of the deficiencies herein the respondent included all of the partnership earnings in petitioner's income on the ground that despite petitioner's transfer of a one-half interest in the West Side Beer Co. business to his wife under the partnership agreement of February 14, 1939, petitioner "retained dominion, control, and administration of the business."
OPINION.
Petitioner contends that he and his wife operated the West Side Beer Co. as equal partners and that each of*136 them is taxable *818 on one-half of the profits of the business for 1939 and 1940. Respondent contends that petitioner operated the business as a sole proprietorship and that the alleged partnership was "a fiction and a sham; that although in form it appeared to be a partnership it was not such in substance, being merely a means by which this petitioner might avoid the payment of income tax on a substantial portion of his income."
We think that the evidence supports petitioner's contentions as to the existence of the partnership from February 14, 1939. There can be no doubt that petitioner and his wife intended by their agreement of February 14, 1939, to join in the operation of the business of the West Side Beer Co. as equal partners and that each should be entitled to one-half of the profits of the business from the date of the execution of the partnership agreement. Petitioner's wife had taken an active part in the business since its inception in 1931. From a small beginning in that year she and petitioner, working together and with their combined capital, had built up a business of considerable size by 1939. For several years petitioner's wife worked long hours for comparatively*137 small pay. Her duties and responsibilities increased with the growth of the business. During the taxable years 1939 and 1940 and for several prior years she had complete management of the office and performed various important duties. She managed the office while petitioner spent most of his time on outside matters. The evidence shows, we think, that the success of the business was due as much to her efforts as to those of petitioner. Petitioner's wife testified, and her testimony is uncontradicted, that she furnished $ 1,500 of the capital upon which the business was begun in 1931. She thus had a stake in the business from the beginning, apart from her interest as an employee. In , the court stressed the importance of the fact that the wives there furnished the original capital, saying in its opinion:
* * * Though the present case is one where the services of Humphreys and Day contributed to the earnings of the firm, the capital furnished by their wives was what started the business, and this and the additional capital which they later contributed helped to furnish the moneys necessary to conduct*138 it. * * *
Respondent's contention that petitioner obtained the $ 1,500 from his wife (then Gladys Dauksza) as a loan is not supported by the evidence before us. It does not appear that either of the parties ever treated it as a loan in their dealings with one another or so regarded it. To the contrary the evidence is that petitioner's wife always treated it as a capital contribution to the business.
In , the Supreme Court defined a partnership as follows:
The requisites of a partnership are that the parties must have joined together to carry on a trade or adventure for their common benefit, each contributing *819 property or services, and having a community of interest in the profits. .
Here, as pointed out, petitioner and his wife in a very real sense "joined together to carry on a trade or adventure for their common benefit." Here, too, the wife contributed both capital, in a substantial amount, and services commensurate with those contributed by petitioner.
The respondent in his brief does not place any great reliance upon the fact*139 that husband and wife partnerships were not fully recognized under the laws of the State of Michigan prior to 1942. It has been held in a number of cases that, while under the Michigan law the wife can not be held liable upon the contracts of a partnership in which she and her hubsand are partners, the wife is not deprived of her right to a division of the profits from a business which she and her husband operate as a partnership and is not relieved of the obligation to report her share of the income from the business in her individual income tax return. See ; ; ; ; .
The petitioner claims that his wife was an equal partner in the business of the West Side Beer Co. from January 1, 1939. The petitioner's wife testified, however, that she did not think that she was entitled "to any of the earnings of the business prior to the formal execution of the partnership agreement," *140 which was on February 14, 1939. We are of the opinion, therefore, that the petitioner is taxable upon the entire profits of the business to February 14, 1939, and to only one-half of the profits during the balance of 1939 and for the calendar year 1940. The profits of the business allocable to the period January 1 to February 14, 1939, are such portion of the profits for the entire calendar year 1939 as the number of days from January 1 to February 14, 1939, bears to 365 days.
Decision will be entered under Rule 50.
Harron, J., dissenting: There is, in this proceeding, a somewhat difficult problem in the weighing of the evidence. The evidence consists almost entirely of the testimony of petitioner's wife. Petitioner did not testify, although he was available. The testimony of the wife is unsatisfactory in many respects, and in such situation, the case of petitioner is greatly weakened by his failure to offer testimony. The majority view is that petitioner's wife "contributed both capital, in substantial amount, and services commensurate with those contributed by petitioner." If that conclusion represents a correct judgment of *820 all of the facts, then there*141 is much to support petitioner's contention that he and his wife, in 1939 and 1940, carried on a business in partnership. But I am unable to agree with the above conclusion. I do not think it is supported by the evidence.
It is necessary to make some comment upon the evidence. It was stated at the hearing that petitioner rested his case upon the arrangements which he made in 1939, even though evidence was offered which related to the origin and early conduct of petitioner's business. Petitioner does not contend that he did not conduct his business as a sole proprietorship prior to 1939. The evidence clearly shows that he did. The question is whether the arrangements in 1939 effected a change from a sole proprietorship to a partnership.
The majority view gives much weight to the testimony of Mrs. Zukaitis relating to an advance of $ 1,500 to petitioner in 1933, concluding that from the start she "had a stake in the business." I find the testimony upon this point unconvincing. Part of the testimony is as follows:
Q. You didn't expect to get the $ 1,500 back?A. Well, we had intentions of getting married, so I didn't worry about it.
Q. Will you answer the question, please? Did*142 you expect to get that $ 1,500 back when you put it in?
A. Well, yes.[Further questions and answers.]
Q. Then you would say you didn't expect to get it back?A. Well, if I was going to be married to him, I wouldn't. I would expect to get it back, but we had intentions of getting married.
Q. Because you were going to get married, you didn't expect it back?
A. That's right.Later the witness was asked if she had made any loans to petitioner's business in 1939 or 1940.
Q. For the year 1940, did you loan any money to your husband?A. No. The loan was originally in 1933.Elsewhere in her testimony, Mrs. Zukaitis stated that she made an investment in the business in 1933 with a verbal understanding that she would be a partner in the business, but at another time she testified that she did not consider that she was entitled to any of the earnings of the business prior to the execution of the formal partnership agreement.
In 1933 Mrs. Zukaitis did not have $ 1,500 of her own. Some of that amount, not stated, she obtained from her parents, under arrangements which are not disclosed.
Mrs. Zukaitis' testimony on this point demonstrates, in my opinion, that there was, in fact, no understanding*143 with her husband about the effect of her making $ 1,500 available to him, other than that she and *821 her parents helped him along on the basis of a gift. I consider all of the testimony on this item as wholly irrelevant and immaterial to the issue presented, and I believe that the question should be considered chiefly in the light of the facts relating to the general nature of the business involved, and the manner in which the business was conducted prior to and after the 1939 arrangements.
The nature of the business involved is of chief importance because of petitioner's theory that the wife contributed capital and services in such degree that it can be said that the parties were carrying on a business in partnership. The income of the business is derived from sales of large inventories of beer and wines, of which there was apparently a quick turnover. The inventory of goods purchased in 1938, 1939, and 1940 cost $ 538,209, $ 630,896, and $ 619,803, and in each year almost all of the goods were sold, the inventory on hand at the close of each year averaging only $ 15,000. The gross receipts in each of the above years were $ 727,390, $ 804,716, and $ 781,726, and the net*144 income was around $ 50,000 a year. Petitioner did the buying and was the chief salesman. He seems to have employed salesmen, in addition. Salaries paid to others in each year totaled $ 49,453, $ 56,032, and $ 57,937. The only conclusion which can be drawn, reasonably, is that the earnings of the business were due to petitioner's skill in buying, selling, and managing the business. The capital required in the business in the taxable years and in the preceding year, 1938, taken for comparison, was cash. Obviously, petitioner's wife did not make any actual contribution to the working capital of the business. Petitioner purportedly made a gift to his wife of an interest in one-half of the physical assets in the business as they stood at the end of 1938. Those assets were chiefly office and warehouse equipment, refrigerators and trucks, all useful and necessary implements in the business but not income-producing.
Under such facts, the business involved is so like the types of business which were involved in ; certiorari denied, ; ;*145 certiorari denied, ; and , that I consider those cases to control the issue in this case.
In , guiding principles are set forth for the determination of the question which is presented. The court said that an arrangement between husband and wife may be sufficient to constitute a legal partnership under local law, but that such result is not determinative; that the question is whether the arrangement is sufficient to effect a change in the husband's economic status for income tax purposes under the Federal income tax law. The court set forth two *822 tests: (1) The change in the method of operating a business must be real and substantial rather than a mere change in form; (2) an essentially new and different economic unit must be formed.
The court in the Earp case found its course charted by certain Supreme Court decisions to which reference was made. The court cited many instances where the Supreme Court has disregarded formal arrangements in order that effect could be given to the dominant purpose of*146 the revenue laws, which is to tax income to those who earn it or otherwise create the right to receive it. The creation of marital partnerships is often only a device to multiply one economic unit into two or more. If it is merely such device, it is not entitled to recognition under the Federal income tax law.
The partnership arrangements in this case effected no change in the conduct of petitioner's business. Petitioner continued to conduct and direct selling and to carry on the negotiations for credit and purchases. It was provided in the agreement that petitioner should be the general manager of the business, with complete charge of the actual operation of the business. That provision operated merely to continue in petitioner the same authority which he had always exercised. Petitioner's wife was not given any voice in the management of the business under the agreement. Her duties were not enlarged. She did not participate in buying, selling, or managing. The business was carried on in exactly the same way as it had been prior to 1939. The arrangements did not result in the "creation and carrying on of a new joint enterprise or uniting their joint efforts or substance*147 in a new undertaking." An essentially new and different economic unit was not formed. The business received no new property or capital, but operated with the same assets and capital which had been built up by petitioner as the sole proprietor of the business. Where everything of value to a business is contributed by one person and all of the profits are actually earned by that individual, then all of the profits are taxable solely to him. Here, "all of the profits of the business were earned" by petitioner after the arrangements which he made in 1939, in exactly the same way that they had been earned prior to 1939, notwithstanding the fact that the wife had at all times contributed some services to the business, formerly for a salary.
It is contended, in effect, that the alleged gift of an interest to the wife changed the economic status of petitioner. In fact it did not, except to establish the basis for a reallocation of income. The question can not be determined by a process of rationalization about the division of income. The subject matter of the gift*148 did not produce income. The wife was restricted in her command over the property in which she was given an interest. Until the business is liquidated, and a *823 distribution of assets is made, the wife's interest is more fanciful than real. See . The entire arrangement amounted to no more than an effort to transfer one-half of future earnings resulting from petitioner's efforts to the wife. Under such circumstances, the wife received distributions of earnings solely because of the marital relationship.
The chief variation in the facts in this case from the facts in the Earp, Schroder, and Mead cases is that petitioner's wife had been a paid employee prior to the arrangements, and that she continued to render some services afterwards, but without being paid a salary. But see , where the fact that the wife contributed services to the business was held not to be determinative where the income of the business was produced primarily by the efforts of the husband.
The majority view regards the evidence as showing that Mrs. Zukaitis "had complete management*149 of the office and performed various important duties," and that "her duties and responsibilities had increased with the growth of the business." Here again, I am obliged to record a respectful dissent on the matter of what the evidence shows. There is the testimony of Joseph Tauter, an employee in the business. He testified that during 1938 and the taxable years he took care of the office and the maintenance of equipment in addition to keeping the books and records. The partnership agreement recites that petitioner shall be the manager of the business. There is a large doubt in my mind whether Mrs. Zukaitis' services were as important as she obviously attempted to make them in her testimony. She was a part-time worker in 1938 and through the taxable years. Her services decreased rather than increased during the period in question. Petitioner's wife did render some services in the business, but there is little concrete evidence from which to make any conclusion about the value of her services to the business. She had been an employee. She had received full payment in salaries for her services. She so testified and her testimony conflicts with the recital in the partnership*150 agreement that she had given her efforts to the business without compensation, which appears to have been an untrue recitation of the facts. Her services appear to me to have been largely clerical, however earnest she may have been in her desire to help her husband. Under all of the facts, I believe that the services of petitioner's wife to his business in the taxable years were not sufficiently connected with the production of the large income of the business to provide a basis for holding that she carried on a business in partnership with petitioner. This is not to say that there cannot be any instance where a wife's services in a business constitute the carrying on of a business in partnership. But the rule cannot be that in every *824 instance where a wife contributes some minor services far removed from the earning of the income of the business there is a carrying on of a partnership business within the scope of the revenue acts. Each case should stand on its particular facts.
I believe that the holding in this case should be that this marital partnership is not entitled to recognition for income tax purposes.