*77 Decision will be entered under Rule 155.
In 1973, petitioner-husband, a partner in a business in which both capital and services are material income-producing factors, received from the partnership both distributions which are treated for the purposes of this case as guaranteed payments, within the meaning of
*828 OPINION
Respondent determined a deficiency in the amount of $ 39,773 in petitioners' Federal income tax for 1973. The issue for decision is whether earned income, for the purposes of the 50-percent maximum tax prescribed by
*81 The facts, all stipulated, may be briefly summarized.
At the time their petition was filed, petitioners Daniel S. Kampel and Clarisse Kampel, husband and wife, were legal residents of New York, N.Y. They filed their joint Federal income tax return for 1973 with the Internal Revenue Service Center, Andover, Mass.
During 1973, petitioner Daniel S. Kampel (Daniel) was a partner and the Pension Fund Department manager of L. F. Rothschild & Co. (the company), a brokerage firm operated in partnership form and engaged in a trade or business in which both personal services and capital were material income-producing factors. The company's articles of copartnership, effective January 1, 1973, provided in part for payment to the general partners of amounts characterized as "salary or compensation." In 1973, Daniel received or had credited to his account compensation for personal services rendered in his capacity as manager of *829 the company's Pension Fund Department. This compensation, which totaled $ 379,000, was determined with reference to the productivity of Daniel and of the Pension Fund Department and without regard to the income of the company.
Before petitioner became a partner*82 in the company, he received compensation from the company as an employee for personal services rendered in managing the company's Pension Fund Department. After he became a partner, the services he rendered managing the company's Pension Fund Department were substantially similar to those rendered before he became a partner; the compensation for such services was determined in a substantially similar manner before and after he became a partner.
Daniel also received or had credited to his account a distributive share of the company's income, gains, losses, and deductions totaling $ 45,772.26, as well as interest payments totaling $ 32,095.60 on capital contributed to the company. Daniel had nonreimbursed business expenses of $ 10,947 in 1973.
On their 1973 joint income tax return, petitioners reported for purposes of the maximum tax on earned income, earned income and earned net income in the amount of $ 381,785, computed as follows:
| Compensation for services rendered | |
| in the Pension Fund Department | $ 379,000 |
| Earned income portion of distributive | |
| share of company's income, gains, | |
| losses, and deductions ($ 45,772.26 X 30%) | 13,732 |
| 392,732 | |
| Less: Nonreimbursed business expense | 10,947 |
| 381,785 |
*83 The amount of Daniel's distributive "net profits of the trade or business" for the purpose of computing "earned income" subject to the maximum tax is $ 456,867.86, computed as follows:
| Salary, interest, and ordinary income (loss) | $ 284,176.06 |
| Additional first-year depreciation | (503.32) |
| Dividends qualifying for exclusion | 7,704.71 |
| Short-term capital gain | 149,213.95 |
| Long-term capital gain | 10,896.20 |
| Contributions -- 50-percent limitation | (678.93) |
| Political contributions | (77.08) |
| Nontaxable income | 10,452.41 |
| Interest paid to earn nontaxable income | (4,316.14) |
| 456,867.86 | |
| Nonreimbursed business expenses | (10,947.00) |
| 445,920.86 |
*830 Thirty percent of the excess of his share of net profits of the trade or business over allocable expenses, or $ 133,776, constitutes petitioners' "earned net income" under
*84 According to petitioners, the 50-percent maximum tax rate prescribed by
*85
under regulations prescribed by the Secretary, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income. 5
See also
a reasonable allowance as compensation for the personal services actually rendered by the individual shall be considered earned income, but the total amount which shall be treated as the earned income of the individual from such a trade or business shall in no case exceed 30 percent of his share of the net profits of such trade or business (which share shall include any guaranteed payment (as defined by
By its express terms, the final parenthetical clause of this regulation includes in the partner's share of net profits "any guaranteed payment," as defined in
Maintaining that
Petitioners argue, alternatively, that
We think the regulation embodies a reasonable interpretation of
*91 To strengthen their argument that the regulation is invalid, petitioners point to the
*92 Yet, as the committee reports discuss, one purpose for treatment of salary-type payments to partners not as part of the distributive share was to eliminate accounting complexities existing under prior law. Before enactment of the 1954 Code, salary-type payments were considered to be part of the distributive share of partnership income. When such payments exceeded partnership income, they were nontaxable to the extent that they represented a return of the recipient's capital. To the extent that they exceeded his basis, they were attributed to the capital accounts of other partners, taxable to the recipient and deductible by the partners to whose accounts the payments were charged. H. Rept. 1337, supra at 68. According to several commentators, the elimination of this complex and unrealistic approach was the reason for enactment of
*94 Moreover, petitioners' argument fails to take into account *835 Conf. Rept. 2543, 83d Cong., 2d Sess. 59, which makes the following comment with respect to
Both the House provisions and the Senate amendment provide for the use of the "entity" approach in the treatment of the transactions between a partner and a partnership which are described above. No inference is intended, however, that a partnership is to be considered as a separate entity for the purpose of applying other provisions of the internal revenue laws if the concept of the partnership as a collection of individuals is more appropriate for such provisions. An illustration of such a provision is section 543(a)(6), which treats income from the rental of property to shareholders as personal holding company income under certain conditions.
We think the concept of a partnership as a collection of individuals is appropriate for the application of
To further support their contention that the regulation is invalid, petitioners rely upon
*836 Because they involve not
It is true that both the Carey and Miller courts held that the
*98 In support of their argument that the reasoning of Miller and Carey applies to
*99 Finally, petitioners argue that the result we reach violates horizontal equity by affording to a partner who receives a guaranteed payment less favorable tax treatment than that accorded a salaried employee performing similar services for the partnership. In many cases, however, the guaranteed payment will be no less subject to
To reflect the foregoing,
Decision will be entered under Rule 155.
Footnotes
1. All section references are to the Internal Revenue Code of 1954, as in effect during the tax year in issue, unless otherwise noted.↩
2. In the notice of deficiency, the Commissioner determined that total 1973 income from the company is $ 284,176 and applied the maximum tax to 30 percent of this amount, or $ 85,253. Respondent concedes that this determination is incorrect.↩
3. Alternatively, respondent challenges petitioner's position that the compensation he received as Pension Fund Department manager constitutes a guaranteed payment within the meaning of
sec. 707(c) . We find it unnecessary to reach this argument. For if the management compensation is not a guaranteed payment, all amounts received from the partnership are part of petitioner's distributive share of partnership income and thus subject to the 30-percent limitation. If it is a guaranteed payment,sec. 1348↩ , as we read it, compels a holding for respondent. Thus, the result is unchanged whether or not the compensation qualifies as a guaranteed payment.4.
Sec. 1348(a) and(b)(1) is as follows:SEC. 1348 . FIFTY-PERCENT MAXIMUM RATE ON EARNED INCOME.(a) General Rule. -- If for any taxable year an individual has earned taxable income which exceeds the amount of taxable income specified in paragraph (1), the tax imposed by
section 1 for such year shall, unless the taxpayer chooses the benefits of part I (relating to income averaging), be the sum of --(1) the tax imposed by
section 1 on the lowest amount of taxable income on which the rate of tax undersection 1 exceeds 50 percent,(2) 50 percent of the amount by which his earned taxable income exceeds the lowest amount of taxable income on which the rate of tax under
section 1 exceeds 50 percent, and(3) the excess of the tax computed under
section 1 without regard to this section over the tax so computed with reference solely to his earned taxable income.* * * *
(b) Definitions. -- For purposes of this section --
(1) Earned income. -- The term "earned income" means any income which is earned income within the meaning of * * *
section 911(b)↩ * * *5. Pub. L. 95-600, 95 Stat. 2779, included in
sec. 1348(b)(1)(A) the following sentence: "For purposes of this subparagraph,section 911(b)↩ shall be applied without regard to the phrase, 'not in excess of 30 percent of his share of net profits of such trade or business.'" Due to this amendment, the issue presented in this case will arise only in taxable years beginning on or before Dec. 31, 1978, the effective date of the amendment.6.
Sec. 1.707-1(c), Income Tax Regs. , is as follows:(c) Guaranteed Payments. Payments made by a partnership to a partner for services or for the use of capital are considered as made to a person who is not a partner, to the extent such payments are determined without regard to the income of the partnership. However, a partner must include such payments as ordinary income for his taxable year within or with which ends the partnership taxable year in which the partnership deducted such payments as paid or accrued under its method of accounting. See
section 706(a) and paragraph (a) ofsection 1.706-1 . Guaranteed payments are considered as made to one who is not a member of the partnership, only for the purposes ofsection 61(a) (relating to gross income) andsection 162(a) (relating to trade or business expenses). They do not constitute an interest in partnership profits for purposes ofsections 706(b)(3) ,707(b) , and708(b) . For the purposes of other provisions of the internal revenue laws, guaranteed payments are regarded as a partner's distributive share of ordinary income. Thus, a partner who receives guaranteed payments for a period during which he is absent from work because of personal injuries or sickness is not entitled to exclude such payments from his gross income undersection 105(d) ↩. Similarly, a partner who receives guaranteed payments is not regarded as an employee of the partnership for the purposes of withholding of tax at source, deferred compensation plans, etc. * * * [Emphasis added.]7.
SEC. 707 . TRANSACTIONS BETWEEN PARTNER AND PARTNERSHIP.(c) Guaranteed Payments. -- To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of
section 61(a) (relating to gross income) andsection 162(a)↩ (relating to trade or business expenses).8. The following excerpt from the Senate committee report supports this view (S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591) 83d Cong., 2d Sess. 94 (1954)):
"In the case of guaranteed salary payments your committee followed the House bill but made it clear that such income is to be reported for tax purposes at the end of the partnership year in which it is paid and that this treatment is only provided for purposes of the reporting of the income by the partner and the deducting of the payments by the partnership. Your committee also extended this treatment to guaranteed interest payments on capital. [Emphasis added.]"
The reference to "this treatment," as we interpret it in the context of this case, means "treatment other than as part of a distributive share." Such an interpretation strengthens the theory that, as the "but only" phrase and
sec. 1.707-1(c), Income Tax Regs. , indicate, guaranteed payments are to be treated as part of the distributive share for the purposes of Code sections other thansecs. 61(a) and162(a)↩ .9. In
Armstrong v. Phinney, 394 F.2d 661">394 F.2d 661 , 664 n. 10 (5th Cir. 1968), the phrase "but only for the purposes ofsection 61(a) * * * andsection 162(a) " was construed as inCarey v. United States, 192 Ct. Cl. 536">192 Ct. Cl. 536 , 427 F.2d 763">427 F.2d 763 (1970), andMiller v. Commissioner, 52 T.C. 752">52 T.C. 752 (1969). Reading the sec. 119 exclusion into the reference tosec. 61(a) , the Fifth Circuit stated in dictum that a partner may exclude under sec. 119 the value of meals and lodging received as a guaranteed payment. The opinion in Armstrong v. Phinney has received criticism from commentators who have suggested that it not be relied on as authority for treating a partner as an employee for the purposes of other Code sections. E.g., A. Willis, Partnership Taxation, sec. 16.02 (1971). This Court inMiller v. Commissioner, supra at 763 , expressly noted that its holding was not based on Armstrong v. Phinney↩.10. In
Cagle v. Commissioner, 63 T.C. 86 (1974) , affd.539 F.2d 409">539 F.2d 409 (5th Cir. 1976), the taxpayer argued that thesec. 707(c) words "but only for the purposes of * * *section 162(a) " indicate that guaranteed payments are automatically deductible by the partnership. The Court held that deductibility is subject to usual standards, including that of not being described in sec. 263. To affirm the Cagle↩ holding, Congress inserted the words "subject to section 263" in the statute. General Explanation of the Tax Reform Act of 1976 (H.R. 10612, 94th Cong., 2d Sess.), 1976-3 C.B. (Vol. 2) 101-102.