Brown v. Commissioner , 10 B.T.A. 1036 ( 1928 )

JAMES BROWN ET AL., ^{v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.}

Brown v. Commissioner

Docket Nos. 11161-11165, 11224, 15610.

United States Board of Tax Appeals

10 B.T.A. 1036; 1928 BTA LEXIS 3974;

February 28, 1928, Promulgated

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">*3974 1. The distributive shares of the taxable income of the continuing partners in a partnership (exclusive of salary adjustment on account of deceased partner) were not affected by the retirement at the end of the year of one partner and death during the year of another partner where the articles of copartnership provided for the same distribution to the retiring partner and to the estate of the deceased partner as if retirement and death, respectively, had not occurred.

2. The unpaid balance of a deceased partner's salary which accrued as a liability of the partnership at his death, held to be an additional distributive share of the profits of the partnership as it existed prior to his death and to constitute an asset in the hands of the estate, the receipt of payment of which would not be taxable income.

3. Since the petitioner and respondent are agreed that the estate of the deceased partner was not a member of the partnership as it existed after the deceased partner's death, the amount distributable to the estate, which was on a cash basis, was not taxable income to the estate until received by it, either actually or constructively, which in this case is held not to">*3975 have occurred in 1920.

4. When a sale is made by a partner to a partnership of which the partner is a member for the express purpose of establishing a deductible loss, the burden is on such a partner of showing that the sale is bona fide in character, in order to enable him to receive the benefit of such a deduction. The evidence in this proceeding is insufficient to warrant the allowance of the loss claimed.

5. An amount paid by one Bache, the majority stockholder in the Kali Inla Coal Co., to petitioner James Crosby Brown in order to induce Brown to acquire the minority stock of the Kali Inla Coal Co., held by the estate of one Jackson, being offered for sale, and which stock Bache desired should not be purchased by one unfriendly to him, was a reduction of the cost of the stock to Brown and, therefore, not taxable income to him.

6. Deduction for a debt determined to be worthless and charged off, allowed.

Sanford Robinson, Esq., for the petitioners.

Henry S. Drinker, Jr., Esq., for James Crosby Brown.

M. N. Fisher, Esq., and Shelby Faulkner, Esq., for the respondent.

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LITTLETON

">*1037 These cases were consolidated">*3976 for hearing and decision for the reason that the question of the extent to which the various parties are liable to the tax upon the income from the partnership of Brown Brothers & Co. for 1920 is involved in each proceeding. The deficiencies involved are as follows: James Brown, 1920, $31,422.55; Thatcher M. Brown, 1920, $26,647.90; J. H. Hammond, 1920, $13,684.99; Louis Curtis, 1920, $17,773.36; Moreau Delano, 1920, $15,246.74; James Crosby Brown, 1920, $27,205.94 and 1921, $12,447.57; Moreau Delano and William A. Delano, executors, estate of Eugene Delano, deceased, period April 2, 1920, to December 31, 1920, $20,024.61. In the last-named proceeding petitioners not only ask that the deficiency be disallowed, but also claim that there has been an overpayment of $44,672.10, for which claims for refund have been filed.

FINDINGS OF FACT.

Petitioners, with the exception of Moreau Delano and William A. Delano, executors of the estate of Eugene Delano, deceased (hereinafter sometimes referred to as the "Delano Estate"), were, during the entire year 1920, and for many years prior thereto, partners in the firm of Brown Brothers & Co., engaged in the banking business, and in dealing">*3977 in securities, with principal office in New York City. Eugene Delano was a member of the partnership from January 1, 1920, to April 2, 1920, the date of his death, and also for some time prior to January 1, 1920. The firm has been engaged in such business for more than 100 years.

The articles of copartnership in effect throughout the year 1920, were dated January 1, 1918, and were signed and executed on or about that date. The paragraphs material to a decision of the question here in issue are as follows:

SIXTH: Subject as aforesaid, no partner holding ordinary shares shall whilst the capital standing to his credit in the books of the concern shall not amount to the sum which by these presents he is required to provide and keep in the ">*1038 concern, except with the approval of partners owning not less than seventy-five per cent. (75%) of ordinary shares, draw from the concern in any year any larger sum than shall be required for his ordinary personal and family expenses and donations, and the sum so allowed to be drawn in any year together with salary and interest on such partners paid up capital shall not in any case exceed One Dollar and fifty cents ($1.50) for every">*3978 ordinary share held by such partner plus the pro rata share of such partner in any taxes on the business or profits of the firm for that year and plus the amount of any income tax or tax of the like nature on his share of the profits of the business which such partners shall in either case be obliged to pay during such year.

NINTH: Except by special arrangement between all the partners interest upon personal accounts kept by the partners with the firm in its general ledger is to be debited at five per cent. (5%) per annum or credited at four per cent. (4%) per annum as the case may be with annual rests but the aggregate balance of all personal accounts kept by any partner with the firm shall not if a credit balance at any time exceed twenty per cent. (20%) of his paid up capital for the time being, nor if a debit balance at any time exceed One dollar and fifty cents ($1.50) for every ordinary share held by such partner.

SIXTEENTH. At each annual settlement in ascertaining the net profits of the concern interest on capital with all incidental expenses including salaries to partners and taxes on the business or profits paid during the year shall be deducted and the assets shall">*3979 be valued so as to make full allowance for all actual or contingent losses or profits upon outstanding transactions and engagements and upon all contingent liabilities up to and including the 31st December in each year and in case any difference of opinion shall arise as to such settlement or the accounts or valuations relating thereto the same shall be determined in the manner provided in Article Thirty-seventh hereof.

Taxes on the profits of business shall be charged as an expense of the business in the accounts of the year in which they are paid. A retiring partner or the estate of a deceased partner shall be liable for such partner's proportion of any taxes payable on the business or profits of the firm for the period up to the thirty-first December following his death or retirement so long as any amounts payable to him or them remain unpaid to the extent only of such amounts remaining unpaid; but there shall be no liability for such taxes on any retiring partner or on the estate of any deceased partner in excess of funds remaining payable hereunder. The proportionate part of the taxes or any additions to or increases thereof chargeable against such retiring partner or the">*3980 estate of such deceased partner shall be charged against the next installment payable to such retiring partner or representative of deceased partner after such taxes or additions or increases thereto shall have been imposed or assessed or if that installment be not sufficient against any succeeding installment.

TWENTY-FIRST: Any partner may retire from the concern on the 31st December in any year on giving by writing, delivered or posted on or before the previous 30th June to the firm at its principal office in New York, notice of his intention to do so. Such notice when given shall be irrevocable, except on consent of remaining partners holding not less than three-quarters of the shares. Any partner retiring as provided in this Article or in Article Twenty-second shall upon such retirement cease to have any interest in the name or good will of the firm. His share of the capital and of the profits shall be paid as herein specifically provided. The salary of any partner who shall ">*1039 retire, as provided in this Article, shall however continue until the 31st December next following the date of such retirement; but the salary of any partner who shall retire, as provided">*3981 in the Twenty-second Article, shall cease on the date of his retirement.

TWENTY-FOURTH: On the death of any partner during any current year of the partnership his interest in the name and good will of the concern shall forthwith terminate, but his salary and his interest in the profits and losses of the concern shall continue for account of his estate to the thirty-first December next following. Save as expressly provided in this agreement his estate shall have no other interest in the shares, assets or profits of the partnership.

TWENTY-FIFTH: On the retirement of any partner pursuant to Article Twenty-first of this agreement, or on the death of any partner such retiring partner or the legal representative of such deceased partner shall be at liberty to draw from the concern up to the thirty-first December on which such retirement shall take place or in case of death then up to (but excluding) the first January next following such death (interest being charged at the same rate as is provided in the case of personal accounts of partners) such sums for the necessary and ordinary requirements of such retiring partners or of the family of such deceased partner as such retiring">*3982 or deceased partner if continuing or surviving might have drawn during the same period and between such thirty-first December and the thirty-first March then following such retiring partner or the legal representatives of such deceased partner shall be entitled to receive for the purposes above mentioned in respect of that portion of the capital of such retiring or deceased partner in the concern, which under this clause would become payable by the concern on the thirty-first March next following such thirty-first December on which such retirement shall have taken place, on which shall occur next after such death, such an amount as shall be determinedin the manner provided in Article Thirty-seventh hereof, interest at the rate of six per cent (6%) per annum being charged on the amount so paid, and the balance of the sum which in the said annual account above mentioned shall appear to be due to such deceased or retiring partner from the concern after deducting the sums paid in accordance with this Article shall be paid by the continuing or surviving partners to the retiring partner or to the representatives of the deceased partner as the case may be after deducting his share of any">*3983 taxes on the business or profits and any indebtedness of such partner to the firm in manner following, namely, any surplus of the sum appearing due to such partner over the amount of the capital required by these presents to be provided by such partner shall unless provided otherwise by some special agreement be paid to him or his representatives on the rendering of the said annual account and the balance of the amount so appearing to be due to him or them shall be paid in manner following, that is to say, by five equal annual installments payable on the 31st March in successive years, the first such annual installment falling due on the 31st March next following the 31st December on which such partner shall have retired, of which 31st December shall next follow the death of the deceased partner, and interest on the sum for the time being due to such retiring or deceased partner at the rate of six per cent (6%) per annum to be calculated from the 31st December on which such retirement shall have taken place or next following such decease shall be paid by equal half-yearly payments on the thirtieth June and the thirty-first December in each year. Payments provided in this Article may">*3984 be anticipated on sixty (60) days notice, such notice to specify which of the payments is anticipated.

">*1040 THIRTIETH: In the case of the retirement or death of any partners or partner, or of the determination of the partnership as to any partner or partners pursuant to Article Twenty-second of this agreement the partnership shall not thereby be determined as regards the continuing or surviving partners, but shall continue as a partnership between them on the terms of these Articles.

THIRTY-FIFTH: In the event of the retirement (whether voluntary or compulsory) of any partner from the firm under any of the provisions of these articles (including his noncontinuance as a member of the firm under the provisions of Article Thirty-third of this agreement) or of the death of any partner the liability of each then continuing or surviving partner or his estate in respect of any payments to be made or obligations incurred to such retiring or deceased partner or his representatives shall be limited to such payments as shall become due and payable or such obligations as shall mature before the first January next following his own retirement or death or in case of any periodical">*3985 payments to such proportion thereof as may have accrued (though the same may not have become actually payable) up to the same date: it being the intention that neither the retiring partner or (as the case may be) the representatives of the deceased partner directly, nor the other partners by way of contribution, shall have any claim against such then continuing or surviving partner or his estate, except for such payments or proportion of payments or obligations as aforesaid. And any bond or other security which may be given to the retiring partner or the representatives of the deceased partner shall be in such form that the obligation of each continuing or surviving partner thereunder shall be limited in * * * manner aforesaid PROVIDED ALWAYS that nothing in this Article contained shall affect or diminish the liability towards the retiring partner or the representatives of the deceased partner of the partners for the time being in the firm or in any firm in succession thereto who shall also procure that any person who may subsequently be admitted as a partner in the firm or in any firm in succession thereto shall bind himself so as to become liable jointly with and in the same manner">*3986 as the other partners to such retiring partner or such representative of a deceased partner as aforesaid AND PROVIDED ALSO that in the event of the firm or any firm in succession thereto being would up or ceasing to carry on business the provisions of this Article shall not apply to or affect the liability towards such retiring partner or such representative of a deceased partner as aforesaid, or any person who shall be a partner at the date of such winding up or cessation of business.

THIRTY-SEVENTH: Seniority of partners wherever referred to herein shall be determined by the order in which the names of the partners holding ordinary shares appear in these presents.

Any questions arising under these Articles with reference to the business of the concern, the settlement of accounts valuations amounts payable on death or retirement of partners or as to any other matters unless otherwie provided herein shall be decided by majority vote of the two senior partners and one other partner to be elected from time to time by the majority in number of the other partners, such partner to serve until his successor is elected and the decision of a majority of them shall be final and conclusive">*3987 upon all parties and their representatives. In case of absence or inability to act of either or both of the two senior partners the partners next in order of seniority as prescribed in this Article shall act in his or their place.

Since 1913 and for many years prior thereto, it has been the uniform practice to determine the annual profits of the partnership for distribution among the partners and for accounting to the estates of ">*1041 deceased partners on the basis of inventorying at market value at the end of the year all securities and other assets held by the firm, irrespective of the cost of such assets. This method was followed in 1920 and the income so determined is herein referred to as "business income" as distinguished from "taxable income."

The accounting year of Brown Brothers & Co. is and was during the calendar year and the Federal tax returns for the taxable years of the partnership and the partners were made on the calendar year basis. The accounts, for the purpose of making returns of income subject to Federal income taxes for the year 1920, were kept on the basis of inventorying the securities on hand at the beginning of and at the end of the year at">*3988 cost or market whichever was the lower. This method was also followed in 1921. In 1922, the Commissioner authorized inventories by dealers in securities to be made on the basis of market value as well as on the basis of cost, or on the basis of cost or market whichever is lower, and in 1922 the partnership changed its method of accounting for income subject to Federal income taxes by inventorying the securities on hand at the end of 1922 at market value, as authorized by the Commissioner. The 1920 Federal income-tax return of the partnership disclosed that it was made on the basis of inventorying securities on hand at cost or market, whichever was lower, and it was made on that basis. All the securities were inventoried by the same method. The audit made by the Commissioner of the 1920 partnership return was also made on the basis of inventorying securities at cost or market whichever was lower, and all deficiency notices upon which these proceedings are predicated, are on this basis. During the taxable years the partnership kept its accounts on an accrual basis and the individual partners made their tax returns on the cash basis. On January 1, 1920, the partners were James">*3989 Brown, James Crosby Brown, Thatcher M. Brown, Louis Curtis, Eugene Delano, Moreau Delano, George H. Frazier, and John Henry Hammond. On April 2, 1920, Eugene Delano died and on December 31, 1920, George H. Frazier retired. The books of the partnership were not closed on April 2, 1920, or as of any intervening date, but were closed on December 31, 1920.

The total gains and profits from partnership operations subject to Federal income tax for 1920 on the basis of inventorying securities on hand at cost or market, whichever is lower, but before deducting the amounts paid to the estate of Eugene Delano, deceased, and to George H. Frazier amounted to $709,410.15, which the partnership income-tax return allocated to the surviving and continuing partners and the estate of the deceased partner in the amounts stated in the following schedule:

">*1042

Members of partnership
1. Name and address of each as shown on individual tax returns	2. Interest in partnership	3. Interest on tax-freecovenant bonds included in Item 5, Schedule A	4. Dividends	5. Interest on obligations of the United States issued since Sept. 1, 1917, and War Finance Corporation bonds (Item 4, Schedule A)	6. Other income	Total
	Percent
a. James Brown 59 Wall Street, New York	14.7284	26,319.05	55,431.17	10,803.22	44,241.86
b. James Crosby Brown, 4th & Chestnut Streets, Philadelphia, Pa	12.8011	22,875.04	48,177.67	8,327.48	1 41,929.46	37,450.73
c. Thatcher M. Brown, 59 Wall Street, New York	11.6791	20,870.07	43,954.96	7,427.20	1 38,318.69	33,933.54
d. Louis Curtis, 60 State Street, Boston	3.2524	16,533.66	34,821.94	7,427.20	1 30,375.41	28,407.39
e. Eugene Delano, 59 Wall Street, New York	12,9881	23,209.20	48,881.45	10,128.06	173,933.86	256,152.57
f. Moreau Delano, 59 Wall Street, New York	10.7415	19,194.62	40,426.25	7,427.20	1 35,258.72	31,789.35
g. George H. Frazier, 4th & Chestnut Streets, Philadelphia	16.1657	28,887.44	60,840.53	11,028.36	142,782.25	243,538.58
h. John H. Hammond, 59 Wall Street, New York	11.6437	20,806.81	43,821.73	7,427.20	1 38,159.61	33,896.13
Total	100	178,695.89	376,355.70	69,995.92	84,362.64
Total partnership income, line 26, Schedule A, Form 1065						709,410.15

">*3990

The percentages appearing in column 2 of the foregoing statement, showing the interest of the respective partners in the partnership, are the percentages of the business income accruing to each partner, or in the case of Eugene Delano, deceased, the amount that would have accrued to him had he lived to December 31, 1920.

The distribution of the income of the partnership as made by the respondent for the calendar year 1920, was as follows:

Name and address	Percent	Interest on tax-free bonds	Cash dividends	Interest on United States obligations	Other income	Total
James Brown, 59 Wall Street, New York City	14.7284	26,319.05	55,431.17	10,803.22	11,931.32	104,484.76
James Crosby Brown, Fourth and Chestnut Streets, Philadelphia, Pa	12.8011	22,875.04	48,177.67	8,327.48	11,432.11	90,812.30
Thatcher M. Brown, 59 Wall Street, New York City	11.6791	20,870.07	43,954.96	7,427.20	10,600.50	82,852.73
Louis Curtis, 60 State Street, Boston, Mass	9.2524	16,533.66	34,821.94	7,427.20	6,854.67	65,637.47
Eugene Delano, 59 Wall Street, New York City	12.9881	23,209.20	48,881.45	10,128.06	9,920.18	92,138.89
Moreau Delano, 59 Wall Street, New York City	10.7415	19,194.62	40,426.25	7,427.20	9,153.22	76,201.29
George H. Frazier, Fourth and Chestnut Streets, Philadelphia, Pa	16.1657	28,887.44	60,840.53	11,028.36	13,924.79	114,681.12
John H. Hammond, 59 Wall Street, New York City	11.6437	20,806.81	43,821.73	7,427.20	10,545.85	82,601.59
	100.00	178,693.78	376,355.70	69,995.92	84,362.64	709,410.15

">*3991 ">*1043 The total amount due and accrued to Eugene Delano and to the estate of Eugene Delano, deceased, for the calendar year 1920 out of the partnership profits for the year, determined under the articles of copartnership, was $209,788.09, of which $48,556.19 was drawn by Eugene Delano between January 1, and April 2, 1920, and $161,231.90 was credited on the partnership books to the estate of Eugene Delano, deceased, as of December 31, 1920. Such partnership profits for the year 1920 were made up in part of wholly tax-exempt interest received by the partnership upon state and municipal bonds, and in part of unrealized appreciation accrued during the year upon securities owned by the partnership. Of such wholly tax-exempt interest, 12.9881 per cent amounts to $49,902.69 and of such unrealized appreciation 12.9881 per cent amounts to $68,810.18. Delano's proportion of unrealized appreciation upon securities on December 31, 1919, was $107,767.17.

Frazier received $261,114.85 as his distributive share of the profits of the partnership for the year 1920, which included his shares of wholly tax-exempt interest on state and municipal bonds amounting to $54,319,89, and his share">*3992 of unrealized appreciation accrued during the year upon securities held by the firm amounting to $85,644.92. Frazier took certain securities in kind upon his retirement from the firm, upon which the unrealized appreciation accrued during the year amounted to $82,409.60. Frazier's proportion of unrealized appreciation as of December 31, 1919, amounted to $134,133.22, of which unrealized appreciation amounting to $14,980 had accrued upon the securities taken in kind by him.

The amount due the estate of Eugene Delano by the partnership as of December 31, 1920, as determined by the annual accounting, or paid or credited to the decedent or his estate during the year 1920, was $995,528.94. Of this amount, $34,000 was so-called salary, of which $8,500 was paid to Eugene Delano during his lifetime and $25,500 was credited to his estate on or prior to December 31, 1920. Between January 1 and April 2, 1920, $48,556.19 was drawn by Eugene Delano against his share of the profits for the current year. To his estate was credited $161,231.90 at the time of the closing of the partnership books on the annual accounting for the year 1920. Eugene Delano's capital in the partnership at the beginning">*3993 of the year was $751,740.85 and this amount was paid to his estate in five annual installments, beginning March 31, 1921. The estate's interest in the partnership was appraised for the purpose of Federal estate tax at $831,327.82, and the Federal estate tax was duly paid upon an inventory of decedent's property, which included this item of decedent's capital at the date of his death. The annual accounting of the partnership for the calendar year ending December 31, 1920, was ">*1044 rendered on January 7, 1921, and the partnership books for 1920 were closed on January 7, 1921. The entries on the partnership books crediting the Delano estate with $161,231.90 were made on January 8, 1921.

The accounts of Eugene Delano and the accounts of his estate were kept on a cash basis, and the tax returns of both periods were made on a cash basis. The Delano estate paid a Federal estate tax amounting to $86,476.25 on September 26, 1921. The Commissioner held that the estate kept its books on a cash basis and disallowed this amount as a deduction in 1920.

Throughout the period from January 1, 1920, to the date of his death on April 2, 1920, Eugene Delano held 45,000 ordinary shares">*3994 of the firm of Brown Brothers & Co. at $20 each, amounting to $900,000, being the sum which the articles of copartnership required him to provide and keep in the partnership, and throughout this period the paid-up capital standing to Delano's credit on the books of the partnership was $751,740.85, and less than said $900,000 by $148,259.15.

The amount of Delano's Federal income tax for the year 1919 payable in the year 1920, was $15,164.82. This amount was paid in 1920 by the credit for 1918 taxes to which Delano was entitled. In subsequent years the Treasury Department credited the 1918 tax against 1920 tax payable in 1921, and collected the 1919 tax in full. Delano's New York State income tax for 1919, paid in 1920, amounted to $1,496.98. He was not obliged to pay any other income tax or tax of a like nature in 1920. The partnership of Brown Brothers & Co. did not pay and was not liable for any taxes on the business or profits of the firm during or for the year 1920.

During 1921 petitioner, James Crosby Brown, made two purchases of stock of the Anhydrous Food Products Co., as follows:

February 10, 1921, 900 shares at $50 and accrued interest	$45,457.50
August 6, 1921, 100 shares	10,029.00

">*3995 The purchase of August 6, 1921, was from his sister and was made in pursuance of an agreement to the effect that in case the sister desired to sell the stock, he (James Crosby Brown) would pay the price which he did pay on August 6, 1921.

On December 17, 1921, Brown sold the aforementioned 1,000 shares of stock to Brown Brothers & Co., a partnership, hereinbefore referred to, and in which he held approximately a one-seventh interest, for $4,996. On November 23, 1922, Brown repurchased the same stock at the same price at which he had sold it to the partnership. In December, 1922, Brown sold the 1,000 shares of stock and an unsecured note of $2,000 to Brown Brothers & Co. for $100. In his return for 1921, J. C. Borwn claimed a loss on account of the foregoing ">*1045 transaction of $50,490.50, this being the difference between the total cost of $55,486.50 and $4,996, the amount realized in the sale to Brown Brothers & Co. The Commissioner disallowed the loss on the ground that this was not a bona fide sale.

During 1920, and for some time prior thereto, one Franklin Bache was president and principal stockholder of the Kali Inla Coal Co., (hereinafter referred to as">*3996 the "Coal Company"). Upon the death of J. T. Jackson, who held the remainder of the stock, the estate of Jackson offered the stock for sale. At this time there were suits pending in connection with the Coal Company and Bache was desirous that this minority interest should not be purchased by persons hostile to the Coal Company. Bache, not having funds to purchase the entire minority interest, urged petitioner, James Crosby Brown, to purchase the stock, but Brown was reluctant to make the purchase for the reason that he considered the price asked of $125 per share excessive. At this time and for some time prior thereto, Bache had been serving the Coal Company at a low salary and there was an understanding that when the condition of the Coal Company would warrant such action, Bache would be paid a substantial amount as back salary. In order to induce James Crosby Brown to purchase some of the stock at the price offered, Bache agreed with Brown that if he (Brown) would purchase a certain amount of the stock at the price offered, he (Bache) would give him (Brown) 15 per cent of the aforementioned back salary when received. Accordingly, in February, 1920, Brown purchased 90 shares">*3997 of the Coal Company stock at $125 per share from the Jackson estate. During 1920, Bache received certain back salary and made payments to Brown of $2,200.14 on August 30, 1920, and $1,050 on October 19, 1920. Brown made book entries on account of the foregoing amounts as payments to reduce the cost of the Coal Company stock. The Commissioner included the payment of August 30, 1920, as a part of Brown's gross income for 1920.

During 1919 and 1920, petitioner, James Crosby Brown, made four loans totaling $2,500, to the Musical Art Club of Philadelphia, a corporation organized for the advancement of music and social contact with music lovers. At this time Brown was a member of this club and had served as its president. The club became involved in financial difficulties and, in 1921, claims against its property which were prior in right to that of Brown exceeded the value of the property. Attempts by Brown in 1921 to enforce collection would have availed him nothing. In 1921, Brown determined the debt to be worthless and charged it off. In January, 1922, he signed an agreement releasing the club from any liability on account of this loan, a promise to execute such release having">*3998 been made by him in 1921.

">*1046 In March, 1909, James Crosby Brown received from his father's estate, 232 shares of Wall & Hanover Street Realty Co. stock, appraised at the time of his father's death at $90 per share. On March 1, 1913, this stock was valued at $90 per share. On April 2, 1913, Brown purchased 50 shares of Wall & Hanover Street Realty Co. stock at $80 per share, making a total investment of $24,880. On August 15, 1920, he sold the 282 shares of stock for $125 per share, less stamp tax, or $35,238.72, on which transaction a profit of $10,358.72 was realized, though petitioner reported this profit in the amount of $10,262.48. The Commissioner erroneously considered that this petitioner reported his profit only to the extent of $8,032.48.

OPINION.

LITTLETON: The principal issue in these proceedings and the one common to all of them is the amount of taxable income realized by the petitioners from the partnership of Brown Brothers & Co. At the beginning of 1920, the partnership was composed of eight partners, six of whom are petitioners in these proceedings. On April 2, 1920, one partner, Eugene Delano, died and the legal representatives of his estate">*3999 are likewise petitioners. Another partner, George H. Frazier, retired on December 31, 1920, but no petition on his behalf is involved in the present proceedings. The partnership income determined for ordinary business purposes under the articles of copartnership was greater than the taxable distributive income determined under the revenue acts and regulations then in force. The principal reason for the difference in the two incomes is that business income was determined by inventorying securities at the end of the year on the basis of market values, whereas taxable income, for the purposes of the partnership return to determine the distributive shares of the partners, was determined by inventorying securities on the basis of cost or market, whichever was lower. Settlement was made with the partner who retired and the estate of the partner who died on the basis of business income, and the petitioners who continued as partners contend that the entire amount paid to the estate of the decedent and to the retiring partner should be deducted from partnership taxable income in determining the taxable income distributable to each of the continuing partners. On the other hand, the respondent">*4000 centends that the retirement of the one partner had no effect upon the taxable income of the petitioners and that the amounts paid to the estate of the decedent were for his interest in the business and nothing should be deducted from the income distributable to the petitioners and to the partner who retired at the end of the year.

">*1047 First, we will dispose of the question raised as a result of the retirement of George H. Frazier from the partnership. Under the articles of copartnership, any partner was permitted to retire on December 31, of any year on giving proper notice at least six months prior to such date. On or before June 30, 1920, Frazier gave such notice and his retirement was effective December 31, 1920. The articles further provided that such retiring partner would receive the same share of partnership profits and the same salary for this last year's connection with the business that he would otherwise have been entitled to receive, and that upon retirement his interest in the good will or name of the partnership would forthwith terminate and that his share of the capital which he had invested in the firm and his share of the profits would be paid to him. ">*4001 We construe the articles of copartnership to mean with respect to a retiring partner, that to all intents and purposes he shall be a partner until the date of his retirement on December 31, when he will be dealt with by the continuing partners, with respect to the amount of salary and partnership income for the preceding twelve months, as if he had never contemplated retirement. At the end of the year the retiring partner was entitled to receive payment for his share of capital in the business and also his share of the partnership earnings for the year in which the retirement became effective.

Under such circumstances, we fail to see why the taxable distributive share of the partners should be affected because of the retirement of Frazier. The situation of Frazier in 1920 with respect to partnership income is the same as that of the continuing partners. The mere fact that the earnings of the partnership to which Frazier was entitled on retirement were determined on a basis different from that provided for the determination of taxable income distributable to the various partners, is not material. Under the articles of copartnership, a partner, upon retirement was entitled to">*4002 his share of the business income for the preceding twelve months, and also was entitled to be paid for the capital which he had invested in the partnership. That at the end of the year in which Frazier retired the continuing partners or continuing partnership was liable to make payment to him for the capital which he had in the business and also for his share of the partnership profits, as determined pursuant to the said articles of copartnership, does not affect the taxable income for the year of retirement. Under the revenue act in force for the year of retirement here in question, the manner of determining the net income of a partnership distributable to the partners and taxed in their individual returns is clearly defined (section 218, Revenue Act of 1918) and we fail to find anything therein which would permit a deduction of the character here claimed. In order for the continuing partners to have a ">*1048 partnership after December 31, 1920, in which no interest of the retiring partner would remain, not only must the retiring partner be paid for the capital which he had invested in the business, but also such retiring partner must be paid his share of the partnership">*4003 profits as determined under the articles of copartnership. In other words, there was a realization by the retiring partner on whatever interest he had in the partnership. This was a capital transaction in which the retiring partner was the seller and the continuing partners through the partnership were the purchasers. This has no effect upon the taxable income of the partnership for 1920, the distributive shares of which are to be taxed to the retiring and continuing partners. The action of the Commissioneron this point is accordingly sustained.

The first question raised by the petitioners, who continued as partners after the death of Eugene Delano, with respect to the payment to the Delano estate is whether the profits of the partnership credited to this estate and determined on the basis of the articles of copartnership should be deducted from the distributive taxable income of the partnership before making an allocation to each of the continuing partners of their respective shares of the partnership profits determined in accordance with the revenue act then in force.

In the determination as made by the Commissioner, the Delano estate was treated as a partner, but at the">*4004 hearing and in his brief filed after the hearing, the Commissioner conceded that this action was erroneous and that the petitioners' contentions to the effect that the estate was not a partner was correct. While from the mere fact that this is an estate with which we are concerned it does not necessarily follow that the estate could not, under any circumstances, be a member of a partnership (Rowley, Modern Law of Partnerships, vol. 1, p. 182; Ludley, Partnership (8 ed.), p. 86), but since the evidence is insufficient to make a finding in the matter, we shall proceed upon the basis of this agreement between the parties. The Commissioner also concedes the correctness of the petitioners' position that the death of Eugene Delano brought about a dissolution of the then existing partnership. This is in accordance with the laws of New York in effect for the year involved (ch. 408, sec. 62, Laws of 1919, New York). We are also of the opinion that while a dissolution of the partnership as it existed on April 2, 1920, was effected, immediately thereafter there came into existence a new partnership of which the continuing partners were members and in which, under the articles of copartnership, ">*4005 the continuing partners adopted the partnership agreement as it previously existed. When construed in the light of the law, no other interpretation fits the intentions and acts of the parties. There was to be no interruption to the business continuity of the firm, not even a settlement with the estate of the deceased ">*1049 partner, until the end of the year, but in the meantime the continuing partners were carrying on the business as heretofore, under a form of business which they had agreed to have so continued, and in conformity with the partnership agreement which they had agreed should fix their respective rights and obligations. See paragraph thirtieth, articles of copartnership.

But does the fact that the partnership of which Eugene Delano was a member was dissolved at his death on April 2, 1920, and that his estate was not a member of the new partnership which then came into existence, result in any change in the determination of the taxable profits distributable to the continuing partners when the Delano estate is to receive the same profits for the year to which Delano would have been entitled had he lived for the remainder of the year? From a careful consideration">*4006 of the evidence, particularly the intentions of the parties as evidenced by the partnership agreement, we are brought to the conclusion that the foregoing question must be answered in the negative. The plain intent of the partnership agreement was that regardless of the time during a year in which a partner might die, his estate would share in the partnership profits for the remainder of the year in the same manner as if he had lived throughout the year, and the capital which he had invested in the business would remain in, and at the risk of, the business until the end of the year. No settlement was to be effected until the end of the year, but during the remainder of the year the estate would be entitled to draw such sums for the ordinary and necessary requirements of the family of such deceased partner as such deceased partner, if surviving, might have drawn during the same period. After the end of the year, settlement was to be made with the estate not only on account of the profits for the year, but also for the capital which the deceased partner had in the business. While we must proceed on the theory that the estate was not a partner in the new partnership, the business">*4007 profits to which it was entitled were the same as if it had been a partner. An agreement to this effect was made by the eight partners prior to the death of the deceased partner in question and when it was uncertain which of them would die first. The profits of the partnership to which the surviving partners were entitled were not the total profits, but the total profits less the amount which all agreed should go to the estate of a deceased partner. There was not, therefore, receipt by these surviving partners of the total profits and then a distribution to the estate, but they were entitled in the first instance to receive only their share of the partnership profits and the remainder was a share of the profits which accrued to the Delano estate.

">*1050 It is, of course, true that as a result of this arrangement a contractual obligation arose under which the Delano estate must be paid its share of the business profits at the end of the year, but this is a transaction separate and apart from the profits, whether business or taxable, which resulted from the partnership operations during the year. By the satisfaction of the contractual obligation, there was a withdrawal of">*4008 the earnings of the partnership to which the estate was entitled. At the same time, the estate must be paid for the capital which the deceased partner had in the business. But the satisfaction of neither liability has any relation to the profits which were realized by the partnership in 1920. To say, as the petitioners contend, that the amount of the business profits which were paid to the estate was an expense incident to the use of the capital which the deceased partner left in the business, would not only be contrary to the intent of the partnership agreement, but would also be allowing the reduction of taxable income by an amount which is not expense, but rather an amount which must be paid in liquidation of the claims of the estate against the existing partnership. The fact that the amount that the estate was to receive was a share of the profits which, of course, would have been nothing had there been losses, and not an amount to be paid at all events, further indicates that this was not thought of by the parties as an amount to be paid for the use of capital.

In view of the foregoing, the Board is of the opinion that the business profits of the partnership, as it existed">*4009 from April 2, 1920, to December 31, 1920, which the Delano estate was entitled to receive under the articles of copartnership, should not be deducted from the distributive taxable income of such partnership before determining the distributive taxable income which is to be taxed to the continuing partners, but that only the distributive share of the taxable income to which the deceased partner Delano would have been entitled had he lived and remained a partner to the end of the year 1920, should be excluded.

The next question is the proper treatment, both from the standpoint of the partnership and the Delano estate, of the salary paid on account of Eugene Delano after his death. Had Delano lived throughout 1920, he would have been entitled to receive $34,000 as salary from the partnership for the year. The partnership agreement, however, provided that on the death of any partner during the year, his salary should continue for account of his estate to the end of the year. When Delano died on April 2, 1920, $8,500, or one-fourth of his salary had been paid to him, and the balance, or $25,200, was credited to his estate on, or prior to, December 31, 1920.

">*4010 The issue which then arises is: In determining the net taxable income of the old and new partnership which is to be taxed in the ">*1051 hands of the respective partners, what effect is to be given to the foregoing salary item of $25,500? As we said in the , "An agreement between partners to pay salaries from profits is nothing more than the determination of a basis for dividing such profits." Since there is no apparent dispute between the parties that profits had accrued on April 2, 1920, sufficient to distribute profits as salaries in the amounts agreed upon, and since his proportionate part of such salary had been paid at this time, it would appear that by the time of his death on April 2, 1920, Eugene Delano had received $8,500 as his share of the profits to that date on account of services rendered. The agreement further provided that, "On the death of any partner during any current year of the partnership * * *, his salary * * * shall continue for account of his estate to the thirty-first December next following." That is, upon the death of Eugene Delano, the salary for the remainder of the year, or distribution">*4011 of profits to which he would have been entitled on account of services which he would have rendered for the remainder of the year, had he lived, accrued as a liability to the new partnership, and became an asset in the hands of the estate on April 2, 1920. The effect of this is that the profits of the old partnership for the first three months of the year which would accrue on account of Eugene Delano's connection with the partnership during this period was not only the amount paid for services rendered, $8,500, but also the additional amount of $25,500 which accrued at his death as well as his share of the profits which remained for distribution after these amounts and the salaries to the other partners had been deducted.

Since this amount, $25,000, represents additional profits of the old partnership which would accrue in favor of the Delano estate upon the death of Eugene Delano, the profits of the old partnership to which the other partners were entitled would be decreased on account of this additional amount which must be deducted before arriving at the distributive share to which each is entitled, exclusive of salaries. In so far as the new partnership is concerned, this">*4012 amount represented a liability which existed at the beginning of such new partnership on April 2, 1920. When, therefore, the profits of the members of the new partnership are determined, what each would be entitled to receive, exclusive of salary, would be proportionately greater, because the profits accruing in favor of the Delano estate would not include an allowance for salary, but would be the share of the profits to which Eugene Delano would have been entitled, exclusive of salary, whereas each member of the partnership would receive as his share whatever salary he was entitled to receive, plus a distribution of the profits after considering salaries of the partners. ">*1052 It also likewise follows that the receipt or payment of this amount of $25,500 is not taxable to the Delano estate in 1920. It constituted an asset which came into the hands of the estate on April 2, 1920, and was to be taken into account for estate tax purposes, or other purposes, as any other asset received at the time.

Another question in issue and which concerns only the Delano estate, is whether the amount of $161,231.90, credited to the estate on January 8, 1921, as the balance of the share">*4013 of the partnership profits to which Eugene Dalano would have been entitled had he lived to December 31, 1920, is income to the Delano estate in 1920.

Consistent with the agreement of the parties that the Delano estate was not a partner in the partnership of Brown Brothers & Co. from April 2, 1920, to December 31, 1920, section 218(a) Revenue Act of 1918, which provides for the taxation of a partner's share of profits in a partnership, whether distributed or not, would not be applicable. The estate was on a cash basis and so rendered its return. The amount in question was determined on January 7, 1921, credited to the estate on the following day, and had not previously been paid to the estate. This amount could not, therefore, be income to the estate in 1920 unless it can be said that, while not paid in 1920, it was unconditionally available to, and could have been withdrawn by, the estate prior to December 31, 1920.

A theory advanced by respondent in support of constructive receipt in 1920 is that such a conclusion follows from paragraph twenty-fifth of the articles oq copartnership, which states that "on the death of any partner such retiring partner or the legal representative">*4014 of such deceased partner shall be at liberty to draw from the concern up to the thirty-first December on which such retirement shall take place or in case of death then up to (but excluding) the first January next following such death (interest being charged at the same rate as is provided in the case of personal accounts of partners) such sums for the necessary and ordinary requirements of such retiring partners or of the family of such deceased partner as such retiring or deceased partner if continuing or surviving might have drawn during the same period."

The evidence show that the amount actually withdrawn, exclusive of the $161,231.90 here in question, was only slightly in excess of that which it was permissible under paragraphs sixth and ninth of the articles of copartnership for the deceased partner or his estate to have withdrawn prior to December 31, 1920. Only a small portion of the $161,231.90 would thus have been constructively received by the estate in 1920 and even as to this amount provision is made for charging interest on withdrawals. The interest provision would indicate that the amount withdrawn was not unconditionally made available to the estate, but rather">*4015 was an amount advanced in the ">*1053 nature of a loan which would unconditionally become the property of the estate when the partnership profits for the year were determined and if the estate's share of such profits were equal to or greater than the amount withdrawn. In view of the foregoing, we are of the opinion that since the amount of $161,231.90 had not been paid to the Delano estate in 1920 and was not unconditionally available to the said estate prior to January 7, 1921, such amount can not be considered as taxable income to the estate in 1920.

The remaining issues in these proceedings concern only one of the petitioners, namely, James Crosby Brown, and are whether certain items constitute proper deductions from this individual's gross income. The first question relates to a loss calimed on certain stock which this petitioner purchased in February and August, 1921, at a total cost of $55,486.50 and sold in December, 1921, to the partnership in which he held a one-seventh interest for $4,996, a loss being claimed in his individual return for 1921 of the difference between the purchase and sale price.

The only evidence we have as to this transaction is that furnished">*4016 by this petitioner who testified that in his opinion the stock in question was not worth in excess of the amount for which he sold it to the partnership in December, 1921, and that he made the sale for the purpose of establishing a deductible loss. He testified further that the corporation whose stock is in question was becoming seriously involved and that there was no market for the stock at the time. A part of his own testimony in this connection was:

Q. I will ask you if it is not a fact that the cause of this buying and rebuying, you did that to avoid the payment of a profit on the sale of that stock?

A. Profit? Q. Yes?

A. There was never any profit, no; if was for the purpose of establishing a real loss, and the stock wasn't listed, it had no market at all, and I found a complacent buyer, if you want to put it that way, and sold it.

Q. It was for the purpose of establishing a loss?

A. For the purpose of establishing a loss; absolutely, unquestionably. Everybody else was doing that.

The "complacent buyer" referred to above was, of course, the partnership of which petitioner was a member.

When asked as to the explanation of his repurchase of the same">*4017 stock approximately one year later at the same price at which he sold it to the partnership, the petitioner said:

I suppose Brown Brothers & Co. told me they were fed up holding it, and they couldn't find a buyer; so I bought it from them.

A few days after this transaction, the petitioner again sold the stock, together with an unsecured note, to the partnership for $100. Apparently, nothing took place between the dates of the last two ">*1054 transactions which would account for the reduction in value such as would be reflected by real sales, yet we are asked to say that when the petitioner was selling this stock to the partnership and repurchasing it, the parties were dealing at arm's length. We are not convinced that the evidence leads to this conclusion, but rather that these were sales of convenience which have not been shown to have been based on actual values. When a partner makes a sale to a partnership of which he is a member of the avowed purpose of establishing a deductible loss, certainly the burden of proof is on such a taxpayer to show that such a sale is bona fide and real. This we are not satisfied has been done in this case. In the ">*4018 , the Board said:

It can not be too much emphasized that alleged sales of property for the purpose of establishing losses must be real, valid transactions, definitely placing the legal and equitable ownership of the property alleged to have been sold out of the hands and out of the control of the seller. In the case of corporations sales to stockholders in all cases are subject to special scrutiny and their good faith must be unquestioned. The principle of corporate entity can not be used to cloak a transaction which is essentially a fraud upon the public revenue.

With even more reason, this same principle should be applied in the case of dealings between a partner and a partnership of which he is a member.

In view of the foregoing, the claim of the petitioner for a loss on the foregoing transaction in 1921 is denied.

The next question is whether the amount paid petitioner, James Crosby Brown, by one Bache to induce Brown to purchase certain stock of the Kali Inla Coal Co. is a reduction of the cost of the stock to Brown or whether it is to be treated as taxable income. The substance of the transaction is that">*4019 when the minority stock was offered for sale, Bache, the majority stockholder, was unable to purchase the stock himself and was desirous that the stock be purchased by some one friendly to the Coal Company as it then existed. Bache accordingly urged Brown to purchase the stock at the price offered, but Brown was reluctant to make a purchase at this price because he said he thought the price too high. Bache then agreed to pay certain amounts to Brown if he would purchase some of the stock. Our question is whether this is to be treated as a reduction of the cost of the stock to Brown, or whether it is taxable income to him.

On a consideration of the entire evidence connected with this transaction, the Board is of the opinion that the amount paid to petitioner by Bache does not constitute taxable income to him, but was a reduction of the cost of the stock. This amount was paid in furtherance of an understanding between petitioner and Bache under which petitioner made the purchase and, in the minds of both parties, represented a reduction of the investment by petitioner. Petitioner acquired ">*1055 the stock from the Jackson estate coupled with a contract that Bache would, ">*4020 in effect, make the cost to petitioner less than the agreed consideration between petitioner and the Jackson estate. When the two contracts are considered together upon the basis of the intent of the parties when made, and in the light of the results reached in their final consummation, we fail to see how the amount in question can be considered as taxable income. The action of the respondent in treating the amount paid by Bache to Brown as taxable income is accordingly reversed.

With respect to the loss claimed by James Crosby Brown on account of the loan of $2,500 to the Musical Art Club of Philadelphia, we are satisfied from the evidence that this was a bona fide loan when made and that it was properly determined to be worthless and charged off in 1921. The fact that a release of the club of any liability on account of the loan was not executed until 1922 is not considered material as the fact that a debt is determined to be worthless at one time will not prevent collection at a future date, should the debtor come into possession of funds upon which the creditor might levy. The contention of the petitioner on this point is accordingly sustained.

The final point in">*4021 the case relates to the profit of $10,358.72 realized by petitioner, James Crosby Brown, on the sale of certain stock of the Wall & Hanover Street Realty Co. The parties are agreed that the foregoing amount is the correct profit to be reported on this transaction and the recomputation with respect thereto should be made accordingly.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.

STERNHAGEN dissents in part.

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Footnotes

• 1. The following proceedings were consolidated for hearing and decision and the issues involved in all of the proceedings are decided herein: Thatcher M. Brown, Docket No. 11162; J. H. Hammond, Docket No. 11163; Louis Curtis, Docket No. 11164; Moreau Delano, Docket No. 11165; James Crosby Brown, Docket No. 11224; Moreau Delano and William A. Delano, Executors, Estate of Eugene Delano, Deceased,↩ Docket No. 15610.

• 1. Indicates amounts shown in red figures. ↩