*1204 1. The Commissioner included interest from certain obligations of the United States in the decedent's taxable income for the year 1921. Held, that the Commissioner did not err in so doing, the obligations not being particularly described in the record nor the date of their issue shown, and that the interest thereon was exempt by virtue of the provisions of section 213(b)(4) of the Revenue Act of 1921.
2. For services rendered in the matter of consolidating certain businesses and the organization of a corporation to effect such result, the decedent paid $10,000, and in computing net taxable income claimed the sum deductible as an ordinary and necessary expense of carrying on his business. Held, the Commissioner did not err in disallowing this amount as an ordinary and necessary expense of carrying on business.
3. In the circumstances stated in the findings of fact, held, the Commissioner committed error in his determination that the partnership of George D. Parker Co. was composed of only two persons instead of five persons. Held, further, that the Commissioner erred in determining that the George D. Parker Co., as a five-party partnership, was fictitious*1205 and fraudulent and that the income tax returns of decedent, George D. Parker (a member of the firm), filed for the years in issue, were false and fraudulent, and made for the purpose of evading income tax, and in authorizing the imposition of the 50 percent penalty asserted against him in each of said years.
4. The charge that false and fraudulent returns were made by decedent to evade income tax being determined otherwise, the running of the statute of limitations as to the assessment and collection of the deficiencies in question was not suspended.
5. The Commissioner's determination relative to the inclusion in the decedent's taxable income for 1924 and 1925 of dividends received in those years from the Tehmescal Oil Co. approved in part.
6. The salary of the decedent being conceded by the respondent to have been less in 1624, 1925, and 1926 than he computed it, held, the income credit allowable for those years should be recomputed under Rule 50, after giving effect to our determinations on issues herein.
7. The action of the Commissioner in adding to decedent's income for 1925 the sum of $30,290.40, claimed by decedent as a bad debt, approved in part.
*1232 These proceedings, which have been duly consolidated, are for the redetermination of deficiencies in income tax and penalties asserted against George D. Parker (deceased), of whose estate Clara B. Parker, the petitioner, is executrix.
The Commissioner's determination of deficiencies was as follows:
| Year | Docket No. | Deficiency | Penalty |
| 1921 | 32369 | $2,171.56 | $1,085.78 |
| 1922 | 28374 | 23,224.83 | 11,612.41 |
| 1923 | 44396 | 5,917.81 | 2,958.91 |
| 1924 | 44396 | $10,319.09 | $5,159.55 |
| 1925 | 44396 | 10,658.42 | 5,329.21 |
| 1926 | 44396 | 2,158.43 | 1,079.22 |
In each of the three cases amended petitions were filed and numerous errors were assigned. Some of the issues raised have been eliminated through concessions made by the respondent or by the petitioner.
*1233 With respect to the deficiency determined for the year 1921, errors were assigned, in substance, as follows:
(1) Failure to exempt from normal and surtax $3,012.50 interest on United States bonds*1207 in computing the decedent's tax liability.
(2) Adding to net taxable income $4,718.21 asserted by respondent to represent excessive depreciation on patents. [Now conceded error by the respondent.]
(3) Refusing to recognize a partnership agreement between five certain persons operating under the firm name of George D. Parker Co.
(4) Adding to decedent's net taxable income the sum of $12,749.03 which he never received and to which he was not entitled.
(5) Adding to decedent's taxable income the sum of $10,000 paid to George X. Wendling for services rendered decedent.
(6) Adding to decedent's tax liability $1,085.76 as penalty asserted under section 250(b) of the Revenue Act of 1921.
(7) Asserting any deficiency, inasmuch as the statute of limitations had expired on the assessment and collection of the tax.
With respect to the deficiencies determined for the year 1922, the errors assigned were:
(1) Failure to allow as a deduction from decedent's income a business loss of at least $6,361.58, sustained in 1921.
(2) Failure to allow as a deduction from income taxes paid in the amount of $233.49. [Now conceded error by the respondent.]
(3) Same as error (3) *1208 for the year 1921.
(4) Adding to decedent's net taxable income $39,338.83 not received by decedent and to which he was not entitled.
(5) Same as error (2) for the year 1921 and now conceded error by respondent.
(6) Adding to decedent's tax liability $11,612.41 as penalty asserted under section 250(b) of the Revenue Act of 1921.
With respect to deficiencies determined for the years 1923 to 1926, inclusive, the errors assigned were as follows:
(1) Adding to decedent's income for each of said years $600 as salary. [Now conceded error by respondent.]
(2) Same as error (3) for the year 1921.
(3) Adding to decedent's net taxable income for the year 1923 the sum of $18,705.35; for the year 1924, $8,890.65; for 1925, $30,290.40; and for the year 1926, $1,031.27, representing monies not received by him and to which he was not entitled.
(4) Determining the profit on the sale of "Mulberry" property in 1923 by reducing the cost of March 1, 1913, value by depreciation. [Correctness of respondent's determination now conceded by petitioner.]
(5) Asserting a deficiency for the year 1923, the statute of limitations having barred assessment and collection of tax for said*1209 year.
(6) Overstating decedent's tax liability for 1923, $13, by showing in deficiency notice that decedent on his original return for said year paid only $1,576.69, whereas $1,589.69 was paid.
(7) Increasing for 1924 decedent's net taxable income by the sum of $8,334.50, alleged to represent dividends received from Tehmescal Oil Co.
*1234 (8) Adding to decedent's tax liability for each of the years 1923 to 1926, inclusive, a sum alleged to represent a 50 percent penalty under the applicable revenue acts for such years, respectively.
(9) Computing the earned income credit allowable for the years 1924, 1925 and 1926.
(10) Refusing, for the year 1925, to recognize an ordinary loss from the sale of stock of the H. T. Wilkerson oil lease and treating same as a capital loss. [Now conceded respondent did not err in so refusing.]
(11) Adding to decedent's income for 1925 the sum of $30,290.40 alleged to represent understatement of partnership income.
FINDINGS OF FACT.
George D. Parker, who was for many years a resident of Riverside, California, filed the original petitions in the three cases herein, consolidated for hearing. He died in August 1930 and his*1210 wife, Clara B. Parker, was thereafter appointed and duly qualified as executrix of his estate and as such filed amended petitions in all three cases.
The decedent was for years engaged in the citrus fruit industry, particularly in that phase of the work relating to the washing, drying, sorting, and packing of fruits. He invented a number of laborsaving devices for use in the industry and secured patents on some, the most valuable of which was a box-nailing machine. He manufactured his inventions and carried on his business over a period of years under the name of the Parker Machine Works and developed a very successful business. He had a competitor, Fred Stebler, also living in Riverside, who owned valuable patents on labor-saving devices of the same character as Parker's and carried on the same character of business, under the name of the California Iron Works. Bitter feeling developed between Parker and Stebler, followed by patent and other litigation between them. Certain friends of theirs persuaded them to terminate their competition and consolidate the two businesses. With a view to effecting such a result a conference was held in the law office of George A. Sarau at*1211 Riverside, California, attended by George D. Parker and H. L. Carnahan, his legal adviser, and N. A. Acker, his patent attorney; Fred Stebler and George A. Sarau, his legal adviser, and F. S. Lyon, his patent attorney; George X. Wendling; and W. B. Clancy. Prior to the conference Parker had agreed to pay Wendling $10,000 for his services in helping effect a plan of consolidation of the competing businesses, and Stebler made a similar agreement with Clancy. As a result of the conference and negotiations Parker and Stebler agreed to form a corporation (Stebler-Parker Co.) in which they would be equally interested and to which the assets of certain of their individual businesses would be transferred. An agreement to that effect, *1235 bearing date of December 29, 1920, provided for the formation of a corporation with an authorized capital of $750,000, divided into 7,500 shares of the par value of $100 each, consisting of 3,000 shares of preferred stock, 3,000 shares of common stock designated as class A, and 1,500 shares of common stock designated as class B. The agreement provided how the stock should be apportioned to Parker and Stebler and that certain shares of common stock*1212 issued to them would be controlled by a voting trust, in which they would be named as trustees. It was further provided that 100 shares of the class A common stock would be transferred to Wendling and Clancy, each, they, however, taking it somewhat in the nature of security for the amounts to be paid them and subject to the voting trust agreement mentioned, which granted to Parker and Stebler an option to purchase, during the life of the voting trust agreement, the 200 shares at the par value thereof, such purchase or payment when made resulting in Wendling and Clancy eventually receiving the $10,000 previously agreed to be paid each.
The foregoing agreement was modified by an agreement dated January 5, 1921, providing that the capital stock of the proposed corporation should be divided into "3,000 shares of preferred stock to which a preference is granted; 1,500 shares of stock to be designated as 'Convertible Common' stock, and 3,000 shares of common stock to which no preference is granted." There were other provisions, but none deemed material to the issues herein.
On May 17, 1921, George D. Parker, Fred Stebler, W. B. Clancy, and George X. Wendling, as parties of the first*1213 part, entered into an agreement with George D. Parker and Fred Stebler, called voting trustees, in which it was provided that Stebler and Parker should for a period of seven years have management and control of the business and stock of the aforesaid corporation and the right to vote the stock. In the same year 100 voting trust certificates of the Stebler-Parker Co. of a par value were issued to Clancy and Wendling, each. In the preamble of the voting trust agreement it was set forth, among other things, that:
WHEREAS, heretofore on the 29th day of December, 1920, the said George D. Parker and the said Fred Stebler Pursuant to inducements offered by each to the other and by the said W. B. Clancy and Geo. X. Wendling to both, agreed to consolidate said businesses and to organize a corporation for such purpose and to transfer said property to such corporation, and
* * *
WHEREAS in consideration of the services rendered to them personally by said W. B. Clancy and said Geo. X. Wendling in connection with said consolidation, said George D. Parker and said Fred Stebler have agreed to assign and transfer, subject to their agreement, one hundred (100) shares of said common stock to*1214 said W. B. Clancy and one hundred (100) shares of said common stock to said George X. Wendling.
*1236 In 1922 Stebler and Parker discharged their obligations to Clancy and Wendling by the payment of $10,000 to each.
The decedent Parker conducted his business on the accrual basis and in his individual income tax return for 1921 claimed as a deductible ordinary and necessary business expense the $10,000 which he paid Wendling as aforesaid and asserted that the allowance of such would produce a net operating loss for 1921 of $6,351.58. The respondent disallowed the claimed deduction in its entirety and added the amount to decedent's taxable income.
In 1919 C. E. Brown was in the employ of George D. Parker as salesman for the Parker Automatic Box-Nailing machines. Through his efforts, three of the machines were sold to the Nestle Food Co., and negotiations were had and contract made for the sale of box shook to that company's numerous plants. Under the arrangement between Parker and Brown, the latter was receiving 5 percent, plus expenses, for selling box shook, provided the profits were 15 percent or more. The profits proved largely more than 15 percent and Brown became*1215 dissatisfied with the then existing arrangement and in the fall of 1919 insisted on a larger share of the profits. Parker finally expressed his willingness to form a partnership to carry on the box shook business. Brown made it known to Parker that his wife, Blanche G. Brown, shared equally with him in his business and indicated she was to be a partner. Parker, thereupon, informed Brown that Clara B. Parker and Catherine Barr, wife and mother-in-law, respectively, of Parker, were to be partners also.
Parker in 1919 consulted his attorney, H. L. Carnahan, concerning his business relations with Brown, which Parker very much desired continued, and was then advised by Carnahan to form a partnership with Brown, and Carnahan was later told he had done so. Carnahan had suggested that the Nestle Food Co. box shook contract be assigned to the partnership, advised Parker to have the partnership agreement reduced to writing, and suggested that he go to an attorney, George A. Sarau, and have him take care of the details.
George A. Sarau had several conferences with Parker in 1920 regarding the partnership, but not until 1921 were written articles of copartnership between Parker and the*1216 above named persons drafted. The articles of copartnership between Parker, his wife, his mother-in-law, Brown, and Brown's wife were prepared by Sarau from information given him by Parker on the date they were drafted.
The written articles or agreement between the five parties, purporting to create the partnership known as the George D. Parker Co., were signed in 1921 by all five of the alleged partners heretofore named, but on what specific date is not shown. The interest of each *1237 in the partnership was to be as follows: George D. Parker and wife, Clara B. Parker, one fourth each; C. E. Brown and wife, Blanche G. Brown, and Catherine Barr, one sixth each. It was recited in the contract that the partners had contributed the following amounts for the purpose of carrying on the business of the partnership:
| George D. Parker | $3,000 |
| Clara B. Parker | 3,000 |
| Catherine Barr | 2,000 |
| C. E. Brown | 2,000 |
| Blanche G. Brown | 2,000 |
| 12,000 |
No cash was in fact contributed, notes being given for the amounts stated.
The written contract also provided that George D. Parker should have the sole management and control of the partnership, and that he should be*1217 entitled to draw from the net profits of the business the sum of $1,000 per month, and that C. E. Brown should be entitled to draw therefrom the sum of $500 per month. No provision was made for withdrawals by the other partners.
The George D. Parker Co. on January 2, 1920, took over the business which previously had been conducted in the name of the Parker Machine Works and had been exclusively owned by George D. Parker. The partnership books were opened as of January 2, 1920, and the first entry in the newly opened books credited capital with $12,000, and charged notes receivable with a like amount, the notes being in the amounts and names heretofore stated.
On December 31, 1920, notes receivable account was credited with $12,000 and capital charged, reversing the original entry, and the notes were then returned to the makers.
The contract for the purchase and sale of box shook was executed by and between the Nestle Food Co. and the Parker Machine Works. The record does not show that the contract ever was actually assigned to the partnership of George D. Parker Co., though it was contemplated and so treated. During the entire period 1920-1926, inclusive, the box shook*1218 business was carried on under the firm name of George D. Parker Co.
The record does not show whether or not George D. Parker at any time filed with the county clerk of Riverside County, California, wherein the partnership was located, the certificate provided for by section 2466 of the Civil Code of California, relative to the names and the places of residence of the persons constituting the partnership of George D. Parker Co.
Parker was the active manager of the partnership at all times. Brown made the contracts, secured the orders, assisted in buying the *1238 goods, collected the money and transmitted it to Parker, and Brown and his wife received one third of the profits.
No meetings or business conferences are shown to have been held by all of the alleged partners and no regular distributions of profits were made to them. Mrs. Brown was represented by her husband, and Mrs. Parker and Mrs. Barr by George D. Parker. None of the three women ever had anything to do with the actual business of purchasing and selling box shook, though Mrs. Brown at times rendered her husband some assistance in the business.
The Parker Lumber & Box Co. was incorporated in February*1219 1920, for the purpose of manufacturing box shook. It acquired certain real estate, together with a sawmill and plant equipment formerly owned by the Northern Box & Lumber Co. at Everett, Washington.
Two thirds of the capital stock of the new company was issued to George D. Parker, the decedent, president of the corporation, and one third of the capital stock was issued to C. E. Brown, vice president. Later, Parker transferred $2,500 of his stock to one S. A. Marks of Riverside, California, who thereupon became secretary of the company, and Brown transferred the same amount of his stock to one Frank J. Pixley of Brooklyn, New York. Certain preferred stock of the new company was issued to the preferred stockholders of the Northern Box & Lumber Co.
During 1920, 1921, and 1922 the George D. Parker partnership made advances totaling $149,256.67 to the Parker Lumber & Box Co. To evidence these loans the corporation executed and delivered to the partnership promissory notes, all dated January 20, 1923, payable to the George D. Parker Co. These promissory notes were signed by George D. Parker as president and S. A. Marks as secretary of the Parker Lumber & Box Co., payable one year*1220 from date, with interest at 6 percent per annum, payable semiannually.
A total of $141,127.76 of these notes was at once distributed to the following alleged partners:
| Distributees | Notes distributed | Total |
| Clara B. Parker | $59,500.00 | |
| Do | 489.12 | |
| $59,989.12 | ||
| Catherine Barr | 37,500.00 | |
| Do | 312.23 | |
| 37,812.23 | ||
| Blanche G. Brown | 43,000.00 | |
| Do | 326.41 | |
| 43,326;41 | ||
| Total | 141,127.76 |
On or about January 20, 1923, the promissory note in the sum of $37,500 delivered to Catherine Barr was delivered by her to George *1239 D. Parker, who thereupon and at the same time executed and delivered to her his personal note in the sum of $37,500.
In 1925 promissory notes executed on January 20, 1923, by the Parker Lumber & Box Co., aggregating the sum of $45,628.91, were charged off the books of the George D. Parker Co. partnership as a bad debt.
An entry was made in the trade account of George D. Parker as of January 20, 1923, crediting "note of Parker Lumber & Box Co. given as adjustment of withdrawal account $37,500." This note of $37,500 is the same that was procured by Parker from Catherine Barr in exchange for his personal note, which is not shown*1221 ever to have been paid.
The promissory note in the amount of $59,500 received by Mrs. Parker on January 20, 1923, was also delivered by her to Parker. It does not appear that any consideration was paid by Parker for it.
The promissory note in the amount of $43,000 received by Mrs. Brown on January 20, 1923, was delivered to Parker in November 1929 as part of the settlement of a suit instituted by Mrs. Brown against Parker and others on April 24, 1928, to which further reference is hereinafter made.
The Parker Lumber & Box Co. did not pay any of the aforesaid promissory notes executed on January 20, 1923, amounting to $149,256.67.
From the date of its organization the Parker Lumber & Box Co.'s financial condition was unsatisfactory. In 1924 C. E. Brown, the vice president, made a trip through Texas and Louisiana in an attempt to sell the mill, but without success. As early as 1923 the financial condition of the Parker Lumber & Box Co. was very bad and grew worse, and the corporation could not have paid its debts in 1924. From time to time decedent, George D. Parker, made various and sundry advances to the corporation. Up to the year 1924 he had advanced, in addition*1222 to the cost of his stock, the sum of $196,407.79. During this year he took back a first mortgage on the lumber mill of the Parker Lumber & Box Co. in the amount of $100,000, which left an unsecured balance due decedent of $96,407.79. During the year 1925 decedent advanced an additional sum of $121,169.78 and took back a second mortgage of $100,000, which left an unsecured balance due decedent at the end of 1925 of $117,577.57. In 1926 withdrawals over advances were $12,291.72. During the year 1927 decedent, under his personal guarantee on certain loans made by banks to the corporation, assumed obligations to the banks of $87,557.49. This sum, added to the previous unsecured balance due him from the Parker Lumber & Box Co., made a total of $392,843.34 for advances, $200,000 of which was secured by the first and second mortgages referred to above.
*1240 A comparative statement of the assets, liabilities, and net worth of the Parker Lumber & Box Co. as of December 31, 1920-1928, inclusive, follows:
| Year | Assets | Liabilities | Net worth |
| 1920 | $329,363.05 | $233,427.12 | $95,935.93 |
| 1921 | 240,894.59 | 160,319.21 | 80,575.38 |
| 1922 | 323,119.03 | 282,572.89 | 40,546.14 |
| 1923 | 344,055.42 | 381,704.06 | 1 37,648.64 |
| 1924 | 269,269.64 | 432,458.10 | 1 163,188.46 |
| 1925 | $348,439.68 | $544,439.88 | 1 $196,000.20 |
| 1926 | 271,866.73 | 509,193.70 | 1 237,326.97 |
| 1927 | 18,566.58 | 297,474.67 | 1 278,908.09 |
| 1928 | 16,510.58 | 295,670.50 | 1 279,159.92 |
The respondent disallowed the claimed bad debt deduction in 1925 of $45,628.91 and as a result thereof added to George D. Parker's taxable income for that year the sum of $30,290.40.
Catherine Barr died on March 5, 1923. Some years prior thereto Mrs. Barr consulted her attorney, H. L. Carnahan, relative to the drafting of her will. At that time she mentioned the fact of an indebtedness of George D. Parker to her. Parker had also told Carnahan about his indebtedness to her, but not the amount thereof. The amount of the indebtedness was not mentioned to Carnahan when the partnership was discussed. Parker suggested that Mrs. Barr be given a share in the partnership as a matter of fairness, such share to represent the amount of the indebtedness, assuming the value of the Nestle Food Co. contract to be a partnership asset.
George A. Sarau was employed to act as attorney for the estate of Catherine Barr, of which Clara B. Parker was administratrix. The petition for letters of administration which he filed in 1923 contained a recital that the total value of the estate would not in all probabilty exceed the sum of $2,500. No supplemental inventory or appraisement*1224 to date of hearing herein, June 2, 1932, was filed and the estate is still open, due to difference of opinion relative to possible additional assets to be included.
On April 24, 1928, an action was instituted in the Superior Court of the State of California, in and for the County of Riverside, wherein Blanche G. Brown and C. E. Brown were named as parties plaintiff and George D. Parker, and Clara B. Parker, individually and as administratrix of the estate of Catherine Barr, were designated parties defendant. On May 23, 1929, C. E. Brown withdrew as a plaintiff and became a party defendant.
The complaint as filed in the suit recited the formation of the alleged five-party partnership (George D. Parker Co.) and the interest of each partner therein as heretofore stated; that the copartnership of George D. Parker Co. was in prosperous condition in 1921 to 1925, inclusive, and that George D. Parker took large amounts from the partnership and delivered same in 1921, 1922, and 1923, against her wishes, to the Parker Lumber & Box Co.; that Parker had *1241 refused to pay her pro rata share, one sixth, of the partnership profits; and that on December 31, 1926, there was due her*1225 from the partnership $58,995.82. It was prayed that the partnership be dissolved, an accounting taken of all the dealings and transactions thereof, its property sold for its debts and its liabilities paid off, and the surplus, if any, divided among the plaintiffs and defendants according to their respective interests.
The lawsuit thus instituted by Mrs. Brown did not come up for trial, but was finally dismissed on November 27, 1929. The basis of the settlement thus effected was as follows:
George D. Parker was to deposit $4,500 with the Citizens National Trust and Savings Bank of Riverside within thirty days after November 27, 1929, to be credited on the Browns' promissory note in the sum of $5,700 then held by said bank.
Parker was to deposit an additional $4,500 within sixty days after November 27, 1929, which amount was to be used to complete the payment of said $5,700 promissory note and the balance was to be deposited to C. E. Brown's account.
Upon full payment of $9,000 by Parker the bank was to deliver all certificates of stock of the Parker Lumber & Box Co. then owned by Brown and held as collateral security by the bank for the payment of said $5,700 note, to George*1226 D. Parker. George D. Parker was to make an additional payment of $6,000 in the form of checks to Blanche G. Brown and several other persons.
The payment of $9,000 by Parker to the Citizens National Trust & Savings Bank, as above set out, was, in fact, to secure a dismissal of the suit and to obtain full release of all liability to the Browns on account of any interest claimed in the partnership or in the Parker Lumber & Box Co., and was also in the nature of a loan to be repaid to Parker in accordance with the provisions of a written instrument dated November 22, 1929, provided the Parker Lumber & Box Co. should be sold over a certain amount.
On November 22, 1929, Blanche G. Brown and C. E. Brown each executed a full release and discharge to the individuals named as defendants in the suit. Mrs. Brown also executed a written receipt evidencing the payment aggregating $6,000 hereinbefore referred to, and both also transferred to George D. Parker all interests they had in the partnership.
The books and records of the George D. Parker Co. disclosed that on February 28, 1923, drawings and interest charged to C. E. Brown's drawing account amounted to the sum of $51,821.67, his*1227 personal note having been given to cover excess drawings in the sum of $24,309.06. The books disclosed that George D. Parker had withdrawn an aggregate of $122,475.34. The drawing accounts of the remaining three alleged partners reflected charges as follows:
| Mrs, Barr | $9,784.21 |
| Mrs. Parker | 11,405.58 |
| Mrs. Brown | 4,270.05 |
The George D. Parker Co. filed partnership returns for the entire period 1921-1926, inclusive. All of the returns disclosed the interests of the five alleged partners in the company to be in the proportions heretofore stated.
The net income shown on the partnership returns for the sixyear period is as follows:
| 1921 | $16,988.71 |
| 1922 | 52,451.78 |
| 1923 | 44,892.84 |
| 1924 | $21,187.44 |
| 1925 (loss) | 309.30 |
| 1926 | 2,475.04 |
There is no dispute as to the income except as to 1925. The parties are not in accord as to the true net income of the partnership for that year, due to the respondent's disallowance of a bad debt deduction claimed by the*1228 partnership in the sum of $45,628.91.
On April 27, 1922, George D. Parker made an initial payment of $500 on 1,000 shares of stock of the Tehmescal Oil Co. On May 8, 1922, the further sum of $4,500 was paid, and on May 30, 1922, $5,000, making a total investment at that time of $10,000 for 1,000 shares On March 29, 1923, an additional payment of $3,500 for more of the stock was made, resulting in a total of 1,417 shares, acquired at a cost of $13,500. The books of the Parker Machine Works Co. (which company George D. Parker owned) reflect the investment of $13,500 in the stock, but do not show ownership of any of the stock in Clara B. Parker, his wife. The books, however, indicate that she was credited with the amount of dividends that would be allocated to the owner of 500 shares of stock.
An auditor's report from the offices of the Tehmescal Oil Co. for 1922 showed 500 shares of the stock in the name of George D. Parker and an equal number in the name of Clara B. Parker, his wife. The evidence of record herein as to the total number of shares of the stock owned by the decedent and by his wife, if she owned any, is very confusing and unsatisfactory, possibly due to typographical*1229 errors or inadvertent statements of witnesses (Clara B. Parker being sick at the time of the hearing, did not attend nor testify), but as it stands it indicates that there were purchased 1,417 shares of the stock at a cost of $13,500. The amended petition (Docket No. 44396) alleges decedent purchased 1,917 shares for $8,500 and his wife 500 shares for $5,000, making a total for both of 2,417 shares at a cost of $13,500, and there is some evidence tending to so show.
The Tehmescal Oil Co. was dissolved on October 23, 1924, and certain trustees were appointed and empowered to conclude and settle the affairs of the corporation and distribute the remaining assets of *1243 the former stockholders. The first distributions were made during the year 1924, a total of $8,334.50 being received, of which the books of the Parker Machine Works reflected $6,709.50 as belonging to George D. Parker and $1,625 to his wife. During 1925 additional distributions were made, a total of $8,459.50 being received, of which said books reflected $6,709.50 as belonging to George D. Parker and $1,750 to his wife.
No part of the sum of $8,334.50 received in 1924 was reflected in the taxable income*1230 shown on the return filed by George D. Parker for that year. In his return for 1925 Parker included the sum of $3,856 (referred to in amended petition and brief as $3,544) as taxable dividends received that year from the Tehmescal Oil Co. The respondent added the sum of $8,334.50 to the taxpayer's taxable income for 1924 and added the sum of $5,165.50 to said taxpayer's income for the year 1925. In the amended petition, it is affirmatively stated and admitted that of the dividends received by the decedent in "1924 and 1925 only the sum of $4,981 thereof constitutes taxable income to the decedent and this amount is taxable during the year 1925 as a capital account limited to a tax of 12 1/2 per cent in accordance with the provisions of section 206 [208] of the Revenue Act of 1926." The respondent's counsel in his brief, without going into the computation by which the petitioner arrived at the quoted figure of $4,981, accepts it as representing the taxable income to the decedent in 1925 from the liquidating dividends.
The decedent, on March 15, 1922, filed his income tax return for the year 1921. There was no consent in writing extending the time for assessment and collection*1231 of the tax asserted. The deficiency notice was mailed to the decedent on September 20, 1927.
The decedent, on March 15, 1924, filed his income tax return for the year 1923 and there was no consent in writing extending the time for assessment and collection of the tax. The deficiency notice was mailed on March 12, 1929.
As to the other years involved, there is no contention that deficiency notices were not mailed in due time.
The respondent in his answers to the amended petitions in Docket Nos. 32369 and 44396 herein makes the affirmative declaration that the decedent, solely for the purpose of defrauding the Government of income taxes due and thereafter to become due from him, fraudulently connived to form, and did so form, an alleged partnership in which the decedent supposedly held a one-fourth interest and his wife one fourth, and Charles E. Brown and his wife, Blanche G. Brown, and Catherine Barr each a one-sixth interest. The respondent in his answers further alleges that the partnership that did exist was composed of only two members, George D. Parker, who *1244 held a two-thirds interest therein, and Charles E. Brown, who held a one-third interest, and that*1232 in none of the years involved herein was Clara B. Parker, Blanche G. Brown, or Catherine Barr a partner of or holder of any interest in the partnership known as the George D. Parker Co.
The respondent further alleged in his answers that, to the extent that the partnership purported to be comprised in part of each or any of the three women hereinbefore named, the representations by the decedent to that effect constituted a fraudulent and illegal attempt to evade payment of income taxes, within the meaning of section 1311 of the Revenue Act of 1921 (sec. 3176, Rev. Stat.).
It is conceded by respondent's counsel that the additional taxes asserted for the years 1921 and 1923 are barred unless the returns for those years are false and fraudulent within the meaning of the applicable revenue acts.
The respondent, in all the years in issue except 1921 and 1922, computed decedent's income tax on the basis of the existence of the partnership between only the decedent and C. E. Brown. Respondent in his computation failed to recognize the existence of any character of partnership between C. E. Brown and the decedent for the years 1921 and 1922, but at the hearing, through counsel, admitted*1233 such partnership existed for all the years in issue. He then insisted and still insists that no five-party partnership as alleged by the petitioner ever existed in any of the years in issue. The 1922 return of George D. Parker Co. shows a total net income of $52,451.78 and the personal return of George D. Parker for that year shows that of that amount he reported as income, as his proportional part, one fourth or $13,112.95. The respondent in computing the decedent's net income for 1922 increased his net taxable income by the difference between the two amounts, $39,338.83. It is admitted by counsel for the respondent that on the issue of a bona fide five-party partnership, a hearing was had in San Francisco, California, which resulted in the Committee on Appeals and Review of the Bureau of Internal Revenue reaching the conclusion that such a partnership existed between the five parties. Subsequently the Commissioner disapproved and reversed the committee's conclusion and recommendation on this question, holding as has been heretofore indicated.
OPINION.
SEAWELL: The deficiencies in income tax as determined by the respondent and contested by the petitioner are for the years*1234 1921 to 1926, both inclusive. In each of the three dockets involved numerous errors are assigned, raising many issues for our determination.
*1245 One issue, applicable to all the years involved, is the question of fraud, the respondent having asserted penalties in each of the years on the ground that there was no bona fide five-party partnership and that the decedent made false and fraudulent returns on the assumption that such partnership was bona fide, and did so to evade income taxes. As a determination of this question may dispose of a number of the errors assigned, we will consider it first.
The petitioner insists that in each of the years involved there was a bona fide partnership existing between George D. Parker, Clara B. Parker, his wife, her mother, Catherine Barr, and C. E. Brown and Blanche G. Brown, his wife, which partnership was carried on in the name of the George D. Parker Co.
Respondent through counsel has admitted that a partnership under the name George D. Parker Co., between George D. Parker and C. E. Brown, existed in all the years in issue. Prior to the hearing herein respondent did not recognize any partnership between George D. Parker and*1235 C. E. Brown for the years 1921 and 1922, though doing so for the other years in issue.
The voluminous evidence, consisting of oral testimony given at the hearing and dozens of exhibits filed, makes up a record not altogether consistent with the contentions of either petitioner or respondent. We have endeavored to set forth quite fully and fairly the facts established by the record. It shows that the decedent, George D. Parker, prior to 1921 consulted an attorney in reference to forming a partnership and an oral understanding or agreement was had between the decedent, Parker, and C. E. Brown, their wives, and Parker's mother-in-law, the five persons heretofore named, that they would constitute a partnership known as George D. Parker Co. Afterwards written articles of copartnership between them were prepared in 1921 by a lawyer and were signed by the five persons heretofore named. It was contemplated that the alleged partnership would acquire and hold the valuable Nestle Food Co. contract for supplying it with box shook and box shook was accordingly so supplied it, though the record does not disclose any formal assignment of the contract to the George D. Parker Co. partnership.
*1236 Considerable sums of money were advanced to the Parker Lumber & Box Co. by the George D. Parker Co., for which the Parker Lumber & Box Co. executed its notes, some of which were distributed to certain members of the firm of George D. Parker Co. and some retained by the partnership.
The lawyer who drew the articles of partnership and the five persons alleged to constitute the partnership considered that a bona fide partnership had been formed. One of the five persons, Blanche G. Brown in 1928 instituted suit for an accounting in the *1246 Superior Court of the State of California, Riverside County, against George D. Parker and his wife, Clara B. Parker, individually and as Administratrix of the estate of Catherine Barr, deceased, as set forth in our findings of fact. Mrs. Barr died in 1923 and her death worked a dissolution of the partnership (California Civil Code [1927, Deering] sec. 2450(3)), but did not, in a sense, absolutely terminate it, the evidence indicating that at the time of the hearing herein the affairs of the five-party partnership had not been wound up and Mrs. Barr's estate was still open and undetermined.
Some facts and circumstances shown appear, *1237 as heretofore stated, unusual and somewhat inconsistent with the idea of a bona fide five-party partnership between the persons alleged to constitute the same. We think such may reasonably be accounted for, however, when the partnership is viewed in the light of the business and family relationship existing between the parties as shown by the record. George D. Parker and C. E. Brown had been closely associated in business for years. Parker was very desirous of keeping Brown connected with him in business and, after being advised by his attorney that it would be advisable to form a partnership with Brown, proceeded to form one with Brown and the persons heretofore named, on the basis stated in our findings of fact. The partnership was somewhat in the nature of a two-family business arrangement, Parker and his wife and mother-in-law on the one side and Brown and his wife on the other, the two men continuing actively to carry on the business, the women partners being satisfied to have their interests looked after by the men. This character of partnership we think largely accounts for the manner in which the business was conducted and book entries made with respect to the business.
*1238 Upon a careful consideration of the entire record we are of the opinion and hold that the charge of fraud is not sustained, that there was a bona fide partnership between the five persons asserted by the petitioner to have constituted the firm of George D. Parker Co., and that it continued to exist after the death of Mrs. Barr for the purpose of winding up its affairs.
Having, on the record presented, determined that the respondent's allegations of falsity and fraud with respect to the asserted partnership and the tax returns based on same, made by the decedent in the years in issue, are not sustained, it follows, and we so hold, that the fraud penalties imposed were not warranted and may not be assessed and collected.
It is conceded by counsel for respondent, and properly so, that in order to sustain the deficiencies in income tax proposed and assess and collect the same for the years 1921 (Docket No. 32369) and *1247 1923 (Docket No. 44396) it is incumbent upon the respondent to prove fraud, as otherwise the statute of limitations pleaded would operate as a bar to assessment and collection. The record shows that the deficiency notices were mailed after the four-year*1239 period prescribed by the applicable sections of the Revenue Acts of 1921 and 1924; that no consent in writing extending such period for assessment is shown to have been executed by the decedent or the petitioner, who has pleaded the bar of the statute of limitations. It is our opinion, therefore, and we so hold, that the assessment and collection of the deficiencies alleged in the aforesaid dockets for the years 1921 and 1923 may not be made, being barred by the statute of limitations.
Notwithstanding our determination that the deficiency proposed by the respondent for the year 1921 is barred by the statute of limitations, it is necessary for the issues raised by the assignment of errors in respect to the year 1921 be determined by us in view of the fact that the petitioner asserts that the respondent failed to allow as a deduction in 1922 a net loss of at least $6,361.58 sustained in 1921.
The first error assigned with respect to the deficiency asserted for 1921 is the failure of the respondent to exempt from that year's income tax $3,012.50 interest received by the decedent on certain United States bonds, referred to in the testimony as "6 percent United States Certificates" *1240 but not further specifically described. The petitioner apparently assumed that because the amount stated, $3,012.50, represents interest on the aforesaid securities such interest is necessarily tax-exempt. The obligations or certificates in question are shown to have been purchased in 1919 or 1920. Under the Revenue Act of 1921 the interest on certain securities is exempt from tax. However, it is provided in section 213(b)(4) of that act that:
* * * In the case of obligations of the United States issued after September 1, 1917 (other than postal savings certificates of deposit), and in the case of bonds issued by the War Finance Corporation, the interest shall be exempt only if and to the extent provided in the respective Acts authorizing the issue thereof as amended and supplemented and shall be excluded from gross income only if and to the extent it is wholly exempt to the taxpayer from income, war-profits and excess-profits taxes.
The petitioner insists that aforesaid interest should be excluded in computing decedent's net income, but in our opinion, and we so hold, the evidence adduced is not sufficient to warrant such determination. The petitioner not having shown the*1241 specific character of the United States obligations or certificates, nor when they were issued, and that the interest is exempt under the terms of the section of the statute quoted, and the respondent's determination being presumptively correct, we approve the same on this issue.
*1248 The respondent has conceded that he committed error as asserted in assignments 2 and 5 for the years 1921 and 1922, respectively, and we so hold.
The decedent, George D. Parker, for the year 1921 reported $4,249.68, or one fourth of the George D. Parker Co. partnership income ($16,998.71) as taxable, on the theory that the George D. Parker Co. was a bona fide five-party partnership in which the decedent's interest was only one fourth, and such we have already held. The respondent, however, at the time of his original determination and the mailing of deficiency notice, determined there was in fact no partnership, but that the entire business of the George D. Parker Co. was owned by the decedent, and therefore added to his taxable income for 1921 the difference between the aforesaid two amounts or the sum of $12,749.03 (see fourth assignment of error for year 1921), which action on the part*1242 of the respondent we are of the opinion and hold was error.
The petitioner also assigns as error (5) the action of the respondent in adding to net taxable income for 1921 the sum of $10,000 paid George X. Wendling under the circumstances stated in our findings of fact.
In behalf of the petitioner it is insisted that the payment of the $10,000 to Wendling by the decedent was an ordinary and necessary expense of doing business and should be allowed as a proper deduction in computing net income in the year 1921, when the obligation to pay accrued - the decedent's books being kept and his returns made on the accrual basis - or in the year 1922, when the payment was made. The record shows that the $10,000 payment made to Wendling by George D. Parker was for services rendered in connection with the consolidation of certain businesses of the decedent and Fred Stebler and the organization of a corporation for such purpose. In the circumstances described, we are of the opinion and hold that the payment did not constitute an ordinary and necessary expense of carrying on business within the meaning of the applicable section of the Revenue Act of 1921 and the respondent did not err in*1243 failing to allow such as a deduction in either 1921 or 1922 in computing the net taxable income of the decedent. .
With respect to the year 1922, Docket No. 28374, the first error assigned is the failure of the respondent in computing net income to allow as a deduction an alleged net business loss of at least $6,361.58 sustained in 1921. This question of the deductibility of any alleged net loss for 1921 from the net income for 1922 will be disposed of under Rule 50, after proper effect is given to the issues heretofore considered and decided by us relative to the year 1921.
*1249 The second assignment of error, relative to the failure to allow as a proper deduction when computing net taxable income for 1922 certain taxes paid in the amount of $233.49, respondent concedes is error and we so determine. The third and sixth errors assigned relative to 1922 we already have determined in favor of the petitioner.
The fourth assignment of error relative to the year 1922, that the respondent added to the taxable income of the decedent Parker $39,338.83 which he did not receive and to which he was not entitled, is*1244 in our opinion, and we so hold, well taken. The record shows that the net income of the partnership of George D. Parker Co. as returned for 1922 was $52,451.78 and that the respondent in computing decedent's net taxable income did not recognize any partnership as existing between decedent Parker and C. E. Brown or other persons and therefore included the entire amount of $52,451.78 as taxable income, whereas in accordance with petitioner's contention and our already expressed determination the George D. Parker Co. was a five-party partnership, the decedent's net income from such partnership being only his proportional share of its income, which was one fourth, or $13,112.95 as returned by the decedent.
The respondent concedes the fifth error assigned, and we approve his action in so doing.
With respect to deficiencies determined for the years 1923 to 1926, both inclusive, the respondent concedes he erred in adding to decedent's income for each of those years $600 as salary, as alleged in the first assignment of error, and we so determine.
We have heretofore determined that the respondent erred in failing to recognize for the years in issue the five-party partnership constituting*1245 the George D. Parker Co. and in asserting fraud penalties, which determinations dispose of assignments of error numbered 2 and 8 for the years 1923-1926, inclusive.
The amounts set forth in the third assignment of error respecting the years 1923 to 1926, inclusive, which were added by the respondent to the decedent's net taxable income for the years and in the respective sums stated, represent, as determined by the respondent, income received by the decedent in the several years mentioned in that assignment and not returned by him. Such determinations by the respondent were made on the theory that the partnership of George D. Parker Co. was composed of only two members, the decedent, Parker, as the owner of a two-thirds interest and C. E. Brown, the owner of a one-third interest. We already have determined herein that the partnership was a five-party partnership with interests owned by certain persons in the proportions stated in our findings of fact, and the respondent's determination and allocation of partnership interests otherwise in said years was, in our opinion, error and should be corrected *1250 on the basis of the five-party partnership, and we so hold. Any deficiency*1246 for 1923 we have held is barred.
The amount of net income received by the partnership for the years in issue is not in dispute, except as to the true net income for 1925, the lack of agreement as to which is due to the respondent's disallowance of the bad debt deduction claimed by the partnership in the sum of $45,628.91. The record shows that the alleged bad debt, claimed as a deduction in 1925 and then charged off as such by the partnership of George D. Parker Co., represented a portion of the notes (amounting to $149,256.67) which the corporation, Parker Lumber & Box Co., executed to the partnership for money advanced or loaned it as set forth in our findings of fact. The record further shows that none of the notes so executed were ever paid; that the corporation was never operated successfully, but always at a loss; that it was in very bad financial condition as early as 1923, and that in 1925 its liabilities far exceeded its assets. While such appears from the evidence to have been the situation in 1925, other facts are also shown, to wit: That cash and accounts receivable were approximately doubled at the end of 1925 over 1923 and 1924; miscellaneous current assets remained*1247 about the same; the merchandise inventories were decidedly better than in 1924; that land, buildings, and equipment at $234,898.38 constituted a substantial increase over 1924, such assets amounting to more in 1925 than they had in any previous year except 1923. The large increase of liabilities in 1925 over 1924 was due to the $100,000 mortgage heretofore described. Furthermore, the advances of cash to the Parker Lumber & Box Co. did not cease in 1925, advances of cash being also made in 1926. It is true the financial condition of the corporation from the date of its organization was never satisfactory, but, upon the whole evidence on that subject, we are of the opinion that the corporation's financial condition was not any worse, nor ascertained to be so, in 1925 than in 1924, and we are further of the opinion and hold that the charge-off by the partnership in 1925 of the sum of $45,628.91 as a bad or worthless debt and the claim of that amount as a deduction by the partnership was not justified by the record. In view of the fact that the partnership was a five-party partnership instead of being composed of only two members as respondent determined, the respondent was not warranted*1248 in adding the amount of $30,290.40 to the decedent's net taxable income for 1925, assigned as error in the third and eleventh assignments. In our opinion, and we so hold, only to the extent of the decedent's partnership interest in the alleged bad debt should his net taxable income for 1925 be increased.
The petitioner concedes, and we so determine, that the respondent did not commit error as alleged in assignments 4 and 10.
*1251 We have heretofore herein held that the statute of limitations bars the assessment and collection of any deficiency for 1923, which disposes of assignments of error 5 and 6.
Relative to the seventh assignment of error, with respect to respondent's increasing decedent's net taxable income for 1924 by alleged dividends from the Tehmescal Oil Co. in the amount of $8,334.50, in our opinion, and we so hold, the record shows that the distributions made by that company in 1924 and 1925, in the respective amounts of $8,334.50 and $8,459.50, and received by the decedent Parker and his wife, Clara B. Parker, in the proportions set forth in our findings of fact, were made in liquidation.
The decedent is shown to have received of such liquidating*1249 dividends $6,709.50 in each of the years 1924 and 1925, or the total sum of $13,149. The respondent, as shown, has agreed to accept $4,981 as the amount of income derived from liquidating dividends on which the petitioner is taxable in 1925, the amount being approximately the difference between the amount of dividends actually received by the decedent in 1924 and 1925 and the cost ($8,500) of the shares, as alleged in the petition, purchased and owned by the decedent. In view of the unsatisfactory condition of the record with respect to the correct number of shares purchased and owned by the decedent and his wife and the concession and acceptance by respondent's counsel that approximately the difference between $8,500 and the amount ($13,149) of liquidating dividends received by decedent, or the sum of $4,981, is all that the petitioner should in 1925 be taxable on as income from the liquidating dividends, we are of the opinion and hold that the actual difference between the alleged cost of shares to decedent, $8,500, and the liquidating dividends actually received by him, $13,419, or the sum of $4,919, was profit on liquidation and constituted capital gain. The record shows that*1250 decedent in 1925 reported $3,856 as received from these dividends, understating his capital gain by the difference between the latter two sums in the amount of $1,063. We are further of the opinion and hold that the $6,709.50 received by decedent as a liquidating dividend in 1924 was a return in part of the $8,500 investment and $1,790.50 of the liquidating dividend received in 1925 was likewise a return of invested capital, leaving subject to tax of 12 1/2 percent, in accordance with the provisions of section 208 of the Revenue Act of 1926, the sum of $4,919 as capital gain.
With respect to the ninth assignment of error, alleging the respondent erred in computing the earned income credit allowable for the years 1924, 1925, and 1926, it may be remarked that aside from the concession made by respondent that for each of those years he erroneously added $600 to the decedent's admitted annual salary of $6,000, *1252 there is no error insisted upon in petitioner's brief nor shown in the record relative to respondent's determination of the decedent's earned income or credit allowable on account thereof. A recomputation of earned income credit allowable, in our opinion, and we*1251 so hold, should be made and disposed of under Rule 50, after giving effect to our determinations herein.
Judgment of no deficiency will be entered as to the years 1921 and 1923, and under Rule 50 as to 1922, 1924, 1925, and 1926.
Footnotes
1. Deficit. ↩