McKnight v. Commissioner , 13 B.T.A. 885 ( 1928 )

R. C. MCKNIGHT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

McKnight v. Commissioner

Docket No. 10804.

United States Board of Tax Appeals

13 B.T.A. 885; 1928 BTA LEXIS 3153;

October 10, 1928, Promulgated

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Held, that during the taxable years petitioner, his wife, and his mother were members of a partnership engaged in coal mining and should be taxed as such.

D. Curtis Reed, Esq., and Thad H. Brown, Esq., for the petitioner.

J. Arthur Adams, Esq., for the respondent.

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VAN FOSSAN

This proceeding is brought to redetermine deficiencies in income tax of the petitioner asserted by respondent in the sum of $46,649.14 and $9.81 for the years 1920 and 1921, respectively.

The sole question in controversy is whether the coal mining operations which resulted in the income found by the respondent to have been earned in the years under consideration, were conducted by the petitioner individually or by a partnership composed of himself, his mother and his wife. Certain adjustments were made by the respondent which increased the income of the business for the year 1920 and decreased it for the year 1921, but both the petitioner and the respondent have agreed to such adjustments.

FINDINGS OF FACT.

Prior to October, 1917, M. C. Hobart and M. J. Sauer were engaged in a partnership coal-mining operation near Pomeroy, Ohio, under a lease covering about 300 acres of partially exhausted coal lands. Hobart was responsible for the financial and business part of the enterprise, while Sauer directed the mine operations. At that time only one opening, known as the "Dabney Mine," was being worked.

In October, 1917, Hobart's one-half interest in the partnership of Hobart and Sauer was purchased by the petitioner who, with his wife, Marie L. McKnight, lived at the home of his mother, Margaret McKnight. The purchase price, $5,000, was paid by the conveyance of two small houses owned by Margaret McKnight. The amount so paid by Margaret McKnight constituted a loan by her to her son, R. C. McKnight, and interest was paid quarterly thereon during the continuance of the partnership of McKnight and Sauer, or until about April 15, 1918, but no interest was paid thereafter. McKnight and Sauer adopted the firm name of "Pomeroy Mining Company" and opened books. Only the simplest forms of journal entries were used. The bank account was carried under R. C. McKnight's name and checks for the partnership disbursements were signed "Pomeroy Mining Company, by R. C. McKnight." The petitioner's personal deposits were credited to the same account. No one connected with the enterprise from its operation by Hobart and Sauer to its sale to the Kenova Mining Co., hereinafter mentioned, was familiar with accounting methods or adept in bookkeeping. No capital account or other such normal entries were made on the books of the Pomeroy Mining Co. at any time.

The partnership of McKnight and Sauer continued until about April 15, 1918, when the conduct of Sauer, his inability to manage the personnel at the mine, and his consequent failure to produce a proper tonnage therefrom, compelled the petitioner to discontinue the relationship. The situation was discussed thoroughly by the petitioner, his mother and his wife and it was agreed to form a partnership. McKnight agreed to contribute his interest in the former partnership of McKnight and Sauer; Margaret McKnight offered to contribute the $5,000 which had been paid by her conveyance of the two houses to Hobart; Marie L. McKnight offered to contribute about $300 in cash - all she possessed - and to take charge of the clerical part of the business, which was then being conducted in a room of their home. Later she contributed an additional $200 for the benefit of the enterprise. The partnership arrangement was so effected and about April 15, 1918, the partnership interest of Sauer was purchased by the payment to him of $1,258.40 and the assignment to him of McKnight's interest in the lease of the Dabney Mine, while McKnight received from Sauer the assignment of his interest in the lease on the "White Mine," which had been opened by McKnight and Sauer a short time before and was located about four miles distant from the home of the petitioner.

During the remainder of the year 1918 and the year 1919 the petitioner withdrew $24 (later $25) per week to cover the joint living expenses of himself, his mother, and his wife. Whatever profits were derived from the business were utilized to purchase additional equipment for the White Mine and to provide for an enlarged out-put. In addition Margaret McKnight mortgaged the home in which all three partners lived for $3,000, to purchase a small steam plant, electric machines and other equipment needed for the mine. At times during 1918 and 1919 the venture was almost at the point of failure, but succeeded in surviving until 1920, when the period of increased coal prices enabled the firm to make a large profit.

During 1920, with the advice and consent of Margaret and Marie L. McKnight, the petitioner opened stock brokerage accounts in Parkersburg, W. Va., and Columbus, Ohio, for the benefit of the partnership. In the spring of 1921 a distribution of $20,000 was made to each of the partners. Margaret and Marie L. McKnight received their shares in municipal bonds, which they retained in their own possession and owned at the time of the hearing. R. C. McKnight received $10,000 in such bonds and utilized the remaining $10,000 of his share in his dealings in stocks. At various times further distributions were made in equal amounts to the three partners by the assignment of stocks or in cash withdrawals. Some of these transactions were carried on in the name of the petitioner in order to facilitate their expeditious handling. Unfortunate experiences in trading in stocks on margin and in the outright purchase of securities, together with the failure of a brokerage house, resulted in serious losses to the partnership, all of which were borne equally and jointly by all three members thereof.

In January, 1921, the assets of the Pomeroy Mining Co. were sold to the Kenova Mining Co. for the consideration of $50,000, of which sum $35,000 was paid in cash, and a mortgage retained for the balance. Later the partnership was forced to foreclose that mortgage and the White Mine with its equipment is now owned by the said partnership.

No written agreements were entered into relating to the partnership status of Hobart and Sauer, McKnight and Sauer, the Pomeroy Mining Company, or the firm of R. C. McKnight, Margaret McKnight and Marie L. McKnight. No partnership returns were filed by the Pomeroy Mining Co. or the firm composed of the petitioner, his mother and his wife until 1921. Failure to do so was caused by ignorance of these taxpayers concerning the nature of a partnership return and the necessity of filing it. The employment of an auditing company in connection with the sale to the Kenova Mining Co. occasioned the first filing of a partnership return, covering the year 1920.

On many occasions prior to, at, and subsequent to the purchase of the interest of Sauer in the partnership of McKnight and Sauer on or about April 15, 1918, the petitioner, McKnight, Margaret Mc,Knight, and Marie L. McKnight represented to strangers that the partnership of the said three individuals was about to be or had been formed for the purpose of acquiring the interest of the said Sauer. At times when transactions were carried on in the nme of R. C. McKnight as a matter of convenience, it was disclosed and they were for the benefit of the partnership composed of himself, his mother and his wife.

OPINION.

VAN FOSSAN: In the State of Ohio a husband and wife may enter into any contract which either might if unmarried. General Code of Ohio, section 7999. It is also fundamental that a partnership may be created by an oral agreement. The sole question with which we are concerned is whether or not the petitioner, R. C. McKnight, his mother, Margaret McKnight, and his wife, Marie L. McKnight, actually formed a partnership which conducted a coal mining business and operated the White mine from about April, 1918, to January, 1921, and continued partnership transactions later in that year.

Chancellor Kent defined a partnership as follows:

A contract of two or more competent persons to place their money, effects, labor and skill, or some or all of them in lawful commerce or business, and to divide the profit and bear the loss in certain proportions.

A further definition is contained in :

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 property or services, and having a community of interest in the profits.

In , we said:

Several of the well recognized tests of the existence of a partnership are sharing of profits and losses, mutual agency and community of interest.

The evidence in this case discloses that petitioner was engaged in a partnership venture in coal mining with one Sauer, which had proved unprofitable, and petitioner determined to terminate the relationship. This was accomplished by the payment to Sauer of $1,258.40 in cash and the assignment to him of all of McKnight's interest in the Dabney mine and the assignment to McKnight of all of Sauer's interest in the lease on the White mine. The situation was fully discussed by McKnight, his mother and his wife and it was agreed that a partnership should be formed. McKnight agreed to contribute his half interest in the partnership business of McKnight and Sauer and proposed to superintend the mining and production of coal at the White mine. The mother, Margaret McKnight, agreed to contribute the sum of $5,000 by canceling the loan previously made to her son which had been used to purchase the interest of M. C. Hobart and form the partnership of McKnight and Sauer, while petitioner's wife, Marie L. McKnight, agreed to contribute the sum of $300 and to manage the office of the business, including the taking of orders, checking mine reports, making up pay rolls, etc. Each of the three partners was to share equally in profits and losses. The three partners carried out their respective agreements and the partnership was formed.

During 1918 and 1919 no profits were made and only a small amount was withdrawn from the partnership for living expenses, all three partners living together under the same roof. During this time Margaret McKnight borrowed $3,000 additional by mortgaging her home to purchase additional equipment. In 1920 and 1921, however, the profits were large and in so far as any distributions were made such distributions were in equal proportions to the three partners, and the surplus was used for the benefit of the partners jointly in attempts to make money in the stock market.

The partnership relation existing between the three persons above mentioned was a matter of general knowledge in the community. Various witnesses testified that at the time of the formation of the partnership and on other occasions the three partners had represented to them that such a partnership existed and was conducting its business under the name of the Pomeroy Mining Co. These representations were made long prior to the time when, for tax purposes, an advantage might have accrued to the partners by reason of the filing of a partnership return rather than individual returns.

The evidence is uncontradicted and convincing that a partnership consisting of petitioner, his wife and his mother was formed on or about April 15, 1918, and continued during the years 1920 and 1921. The action of the respondent in determining the deficiencies in this case is disapproved. ; .

Judgment will be entered under Rule 50.