Western Constr. Co. v. Commissioner , 14 T.C. 453 ( 1950 )

Western Construction Company, Petitioner, et al., ^{Western Constr. Co. v. Commissioner}

Docket Nos. 15495, 15496, 15497, 15498, 15499, 15500, 15586, 15588

United States Tax Court

14 T.C. 453; 1950 U.S. Tax Ct. LEXIS 247;

March 22, 1950, Promulgated

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Decisions will be entered under Rule 50.

Petitioner Western Construction Co. was created as a limited partnership under the laws of the State of Washington in 1942 and again in 1943. The certificate of formation of the partnership included petitioners J. A., George, and Albin Johnson as the general partners and their several adult sons and daughters as the limited partners. Held, on the evidence, petitioner Western Construction Co. does not resemble an association in corporate form and is, therefore, not taxable as such ( Glensder Textile Co., 46 B. T. A. 176, followed); held, further, the Western Construction Co. is a bona fide partnership composed of the three Johnson brothers and their several children as set out in the certificate of formation of the partnership and is recognized as such for tax purposes ( John A. Morris, 13 T. C. 1020, followed).

Ralph B. Potts, Esq., for the petitioners.

Wilford H. Payne, Esq., for the respondent.

Black, Judge. Turner, J., dissents. Opper, J., dissenting. Leech, Hill, Disney, Harron, and LeMire, JJ., agree with this dissent.

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BLACK

In these consolidated proceedings, the Commissioner determined deficiencies in Federal taxes of petitioners for the years and in the amounts as follows:

Petitioner	Docket No.	Year
Western Construction Co	15495	1942
		1943
		1944
		1945
Albin Johnson	15496	1943
		1944
		1945
Ellen M. Johnson	15497	1943
		1944
		1945
Huldah M. Johnson	15498	1943
		1944
		1945
George J. Johnson	15499	1943
		1944
		1945
J. A. Johnson	15500	1943
		1944
		1945
Roberta M. Johnson	15586	1943
		1944
		1945
Lloyd W. Johnson	15588	1943
		1944
		1945

Petitioner	Tax	Deficiency
Western Construction Co	Income tax	$ 4,085.00
	Declared value excess profits tax	49,390.07
	Excess profits tax	255,736.68
	Income tax	4,703.95
	Declared value excess profits tax	43,432.61
	Excess profits tax	223,777.92
	Income tax	3,152.71
	Declared value excess profits tax	6,677.60
	Excess profits tax	27,574.04
	Income tax	4,401.33
	Declared value excess profits tax	18,253.17
	Excess profits tax	87,647.08
Albin Johnson	Income tax	93,780.81
	Income tax	6,717.05
	Income tax	23,177.99
Ellen M. Johnson	Income tax	26,624.73
	Income tax	2,312.86
	Income tax	6,529.81
Huldah M. Johnson	Income tax	30,745.52
	Income tax	2,385.74
	Income tax	6,681.15
George J. Johnson	Income tax	29,872.23
	Income tax	2,320.75
	Income tax	6,635.52
J. A. Johnson	Income tax	29,111.03
	Income tax	2,262.40
	Income tax	6,529.81
Roberta M. Johnson	Income tax	1,285.07
	Income tax	604.05
	Income tax	333.50
Lloyd W. Johnson	Income tax	1,284.76
	Income tax	604.05
	Income tax	333.50

The deficiencies result from several adjustments to petitioners' net incomes as disclosed by their returns for the years in question. By appropriate assignments of error petitioners contest these adjustments. The parties agreed by stipulation to an adjustment of most of the issues involved, and effect will be given these stipulations in a recomputation under Rule 50. The stipulations leave for our consideration only two issues:

The first issue is whether petitioner Western Construction Co. is taxable as a corporation. This was explained in a statement attached to the deficiency notice of petitioner Western Construction Co. as follows:

It is held that for income tax, declared value excess profits tax and excess profits tax purposes the Western Construction Company under the so-called limited partnership agreements of February 24, 1942 and June 30, 1943 constitutes an association taxable as a corporation as prescribed by Section 3797 (a) (3) of the Internal Revenue Code and Section 29.3797-5 of Regulations 111.

Section 3797 (a) (3) of the Internal Revenue Code*250 and section 29.3797-5 of Regulations 111 *251 are printed in the margin.

The second issue is in the alternative, if Western Construction Co. is held not to be taxable as a corporation, then whether Western Construction Co. constituted a bona fide partnership consisting of the general partners and the several limited partners for the taxable years 1942 to 1945, inclusive, or whether it was a partnership consisting only of the three general partners. This was explained in a statement attached to the deficiency notice of petitioner George J. Johnson as follows:

In the computation of your net income for each year mentioned it is held that you and your spouse are each taxable upon one-sixth of the net income of the business conducted under the name of Western Construction Co. It is held that for income tax purposes your children, Lloyd W. Johnson, Bernice Wallin, Lorraine Ellingson and Rachel Gustafson were not bona fide partners in the business conducted under the name of Western Construction Co. during the taxable years mentioned.

A similar explanation was given in the deficiency notices of petitioners in Docket Nos. 15496, 15497, 15498, and 15500.

FINDINGS OF FACT.

The facts which were stipulated are so found. Other facts are found from the evidence.

Petitioner Western Construction Co. was created as a limited partnership under the laws of the State of Washington and filed partnership returns for the taxable years 1942 to 1945, inclusive. Petitioners J. A. Johnson, George Johnson, and Albin Johnson are the three general partners of petitioner Western Construction Co. Petitioner Huldah Johnson is the wife of George Johnson and petitioner Ellen Johnson is the wife of J. A. Johnson. Their cases are here solely because of their community property status with their husbands and do not require any separate consideration by the Court. Petitioner Lloyd Johnson is a limited partner of Western Construction Co. and petitioner Roberta Johnson is his wife. They have stipulated to an adjustment of their deficiencies. If it is held that the limited partnership can not be recognized for Federal tax purposes, petitioners Lloyd and Roberta Johnson will be entitled to a refund due to the fact that they have included in their tax returns their share of the profits of Western Construction Co.

Petitioners J. A. Johnson, George Johnson, and Albin Johnson are brothers, and as young men they emigrated from Sweden and later became naturalized United States citizens. They settled in Seattle, Washington, and each reared a family of several sons and daughters. These brothers were later to become the general partners and their children the limited partners of petitioner Western Construction Co. The brothers were carpenters by trade, and in 1909 George and J. A. formed a partnership, known as Johnson Brothers, to engage in the general construction business. In 1934 Albin was admitted to the partnership under an oral agreement making him an equal partner with his two brothers. The partnership operated under the name of the Western Construction Co., with offices at Seattle, Washington. At first the partnership built small homes, but gradually expanded into larger lines of construction as their capital increased; however, the business was always run as a family affair. The sons of the partners worked for the company from their early teens during school vacations, and the daughters worked as clerks or stenographers prior to the taxable years involved herein.

In 1935 the partnership suffered a large loss in connection with a contract for the construction of bridge piers at the Grand Coulee Dam in the State of Washington. The loss was approximately $ 100,000, which was all the money the partners had saved during the many years before. While the partners were not forced into bankruptcy, they were deeply in debt, having pledged their homes and all they owned to the bank, and it was necessary that the bonding company complete the Coulee Dam contract. From 1936 to 1940 the Western Construction Co. partnership did not actively engage in the construction business. It was not dissolved, however, but was kept alive for the purpose of paying off creditors and prosecuting its claims against the Federal Government.

To enable the partners to continue in business, obtain necessary loans, and pay off their indebtedness, the bank and the bonding company advised that they do business as a corporation. On October 9, 1935, a corporation was organized under the name of "Western Construction Co., Inc.," and the construction work during the years 1936 to 1940 was conducted by that corporation. The bank insisted that the incorporators and officers of the corporation be Roy Johnson, son of J. A. Johnson; Lloyd Johnson, son of George Johnson; and Lucille Easterbrook, the bookkeeper. In accordance with the agreement the stock was issued to them, but the beneficial owners of the stock were the three Johnson brothers, and it was so understood by all the parties. The corporation operated by the three brothers succeeded in obtaining various construction jobs, and after a period of about five years, from 1936 to 1941, George, J. A., and Albin prospered sufficiently to pay off the entire indebtedness which the Western Construction Co. and the three brother partners thereof had incurred as a result of the Coulee Dam project. It was then decided to dissolve the corporation and revert to the partnership form of business. Prior to the dissolution, the incorporators turned over their stock to the three brothers, who then became the officers of the corporation. The dissolution was completed in 1942.

While the corporation was still in existence, J. A., George, and Albin also did some business as general partners of the Western Construction Co. In 1940 they secured a very large contract, known as the West Park Housing project, at Bremerton, Washington. This contract was performed as a joint venture composed of the three partners and another individual because the partners did not have the financial backing themselves to secure the necessary bond. It was later discovered that the other joint venturer was of no real financial help to the partnership; however, in spite of this lack of financial assistance, the agreement required a split of the profits. In 1941 the partnership also received the contract for the Rainier Vista project. When work was first started on this job it was thought that there might be difficulties with the weather, possibly resulting in a large loss as in the case of the Coulee Dam project. The contract, however, was a financial success and was completed by Western Construction Co., the limited partnership and a petitioner herein.

Early in 1941 and prior thereto there were discussions among the three brothers, who had no formal engineering training, and their three sons concerning the formation of a partnership consisting of fathers and sons. Lloyd, George's son, and Roy, the son of J. A., were graduate engineers, with considerable experience with other firms. Winston, Albin's son, had attended engineering school for three years and, except for a short period of military service, has worked for his father and the other Johnson brothers in the construction business. On January 6, 1941, articles of copartnership naming the six individuals as partners were prepared and executed by them. That agreement contemplated preserving in the three fathers the value of the assets then owned by the old partnership and allowing the sons to participate, without any capital investments on their own part, only in the increase in the value of the new partnership from the date of that agreement. That agreement also provided that each of the six partners should actively work for the partnership; that salaries would be determined and paid the six of them based upon their services; and that thereafter the partnership profits would be divided equally among the six partners. That partnership, however, never actively operated and no books or accounts were ever set up for it.

The Johnson brothers were anxious to bring their children into the business, especially their sons, who had the engineering training the brothers lacked. One of the big problems that confronted the brothers was that, largely because of their limited finances, they were unable to obtain bonds in order that they might secure the large and more lucrative Government contracts. They endeavored to persuade other companies to join them on bids, but the West Park project at Bremerton indicated that this was not a satisfactory solution. They also tried unsuccessfully to get outsiders to invest in the partnership. Faced with the desire to include their children in the business and with the need of additional financial backing, the brothers decided to form a limited partnership in which the brothers would be the general partners and their adult children the limited partners. This decision was made without discussion with tax counsel, accountants, or attorneys as to whether it would be cheaper to do business as a partnership rather than as a corporation. The proposed partnership contemplated that each of the Johnson brothers would have a capital investment of $ 20,000 and the children of each of the brothers a like capital investment of $ 20,000, divided equally among the children becoming limited partners. On February 24, 1942, they formed a limited partnership, Western Construction Co., a petitioner herein, consisting of three general partners, the Johnson brothers, and seven limited partners, being their three adult sons and four of their adult daughters. The agreement was as follows:

Certificate of Formation of a Limited Partnership

State of Washington

County of King

ss.

We, J. A. Johnson, George Johnson, Albin Johnson, Roy W. Johnson, Lloyd W. Johnson, Winston A. Johnson, Eleanor J. Rector, Evelyn L. Jorgens, Bernice J. Wallin and Elsie Kiel, the subscribers, having formed a limited co-partnership pursuant to the laws of the State of Washington, do hereby certify and state:

I.

That the name of the co-partnership is Western Construction Company.

II.

That the character of the business is general contracting.

III.

That the location of the principal place of business and office is in the Textile Tower, City of Seattle, County of King, and State of Washington.

IV.

That the name and residence of each member, general and limited partners being respectively designated, are as follows:

General Partners	Residing At
J. A. Johnson	1619 East 52nd Street, City of Seattle, County of
	King, State of Washington.
George Johnson	4558 55th N. E., City of Seattle, County of King,
	State of Washington.
Albin Johnson	2003 Boylston North, City of Seattle, County of King,
	State of Washington.
Limited Partners	Residing At
Roy W. Johnson	1520 Olin Place, City of Seattle, County of King,
	State of Washington.
Lloyd W. Johnson
Winston A. Johnson	901 East 71st, City of Seattle, County of King, State
	of Washington.
Eleanor J. Rector	220 North Portage Path, City of Akron, County of
	Summit, State of Ohio.
Evelyn L. Jorgens	N. 603 Walnut Road, City of Spokane, County of
	Spokane, State of Washington.
Bernice J. Wallin	, City of Seattle,
	County of King, State of Washington.
Elsie Kiel	, City of Seattle,
	County of King, State of Washington.

V.

That the term for which the partnership shall exist is for (10) years from January 2nd, 1942.

VI.

That the amount of cash contributed by each Limited Partner is as follows: $ 10,000.00 each, by each Limited Partner, except Roy W. Johnson, Eleanor J. Rector and Evelyn L. Jorgens who contributed $ 6,666.66 each.

VII.

The time when the contribution of each Limited Partner is to be returned, is agreed to be the end of said partnership as above stated, to-wit ten (10) years from January 2nd, 1942.

VIII.

The share of proceeds by way of income which each Limited Partner shall receive by reason of his contribution, is as follows: The General Partners, and each of them, are to receive a salary per year, to be fixed by them in a reasonable amount to cover their superintendence and management of the work and business, in proportion to the amount of work done by them, each year, taking into account the amount of the net profit of the partnership each year, never to exceed the sum of $ 15,000.00 a year salary to any one of the General Partners.

After the payment of said salaries to said General Partners and deduction of all other expenses of the partnership, the net income or proceeds shall be divided among the partners both general and limited on the basis of their financial interest in said partnership, as shown by the books of the partnership.

IX.

The General Partners are hereby given the right to admit additional Limited Partners in the future upon the agreement of the General Partners hereto, but in no event other than upon a cash contribution to the partnership, and upon the same terms as herein expressed.

X.

The entire management of the partnership shall be vested in the three General Partners and the right is hereby given to the remaining General Partners to continue the business upon the death or retirement of a General Partner, and the right is also given to the General Partners to continue the business upon the death or retirement of any of the Limited Partners hereto.

XI.

It is understood and agreed between all of the partners that a Limited Partner shall not receive out of partnership property any part of his contribution until all liabilities to the General Partners and Limited Partners on account of their contribution, have been paid or their [sic] remains property of the partnership sufficient to pay them.

XII.

The interests of all the Limited Partners herein may be transferred upon the approval of the General Partners to accept a new assignee as a Limited Partner in this co-partnership, and not otherwise.

XIII.

No General Partner shall demand or receive any property other than cash in return for his contribution and each General Partner's interest in this partnership shall be fixed as of the date of January 2nd, 1942 by the books of the co-partnership.

In Witness Whereof the partners have hereunto set their hands this 24th day of February, 1942.

[Signed]	J. A. Johnson	[Signed]	Eleanor J. Rector
	Geo. Johnson		Evelyn L. Jorgens
	Albin Johnson		Roy W. Johnson
			Lloyd W. Johnson
			Bernice J. Wallin
			Elsie Keil
			Winston A. Johnson

The partners and their capital accounts were as follows:

General Partners:
Albin Johnson	*264 $ 15,000.00
George Johnson	15,000.00
L. A. Johnson	15,000.00
Limited Partners:
Albin's Children:
Winston Johnson	10,000.00
Elsie Keil	10,000.00
George's Children:
Bernice Wallin	10,000.00
Lloyd Johnson	10,000.00
J. A.'s Children:
Roy Johnson	6,666.66
Eleanor Rector	6,666.66
Evelyn Jorgens	6,666.66

The limited partners made their cash capital contributions to the partnership with money they borrowed from their respective fathers. The fathers drew checks on moneys they had to their credit on the books of Western Construction Co. and delivered these checks to their children. In return each child gave his or her promissory note payable to the father. Each limited partner then gave the limited partnership a check in the amount of the loan in payment of his or her limited partnership interest. The partnership itself did not thereby increase its assets; however, each of the general partners had in his possession $ 20,000 worth of notes signed by his children. These notes were never pledged as collateral for any loan, but they were listed as personal assets of the general partners in applications for construction bonds. On July 30, 1942, an additional $ 50,000 was borrowed from a bank.

Each of the children knew and understood he was signing a note which was unconditionally payable and which represented a bona fide obligation on his part. They did not take on these obligations lightly as there was considerable discussion about the notes before signing them. While none of the husbands of the Johnson daughters signed any of these notes given to the general partners, generally speaking, the notes were signed by the wives with the knowledge and consent of their husbands. Rachel Gustafson, the daughter of George Johnson, was invited to participate in the first limited partnership. However, she declined to do so as both she and her husband did not desire to sign a note for $ 5,000. They knew that the construction business is subject to heavy losses, as well as handsome profits. Rachel had seen firsthand the Coulee Dam fiasco, with its resulting damaging effects to the partnership. Her husband had changed his course of study at the university from premedical to engineering at the urging of his father-in-law. When he graduated there was no work available in engineering, so he entered the meat business and at present is the owner of a butcher shop.

Those notes did not provide that they were payable solely from business profits, but, on the contrary, there was a general understanding among the limited partners that they were entering a normal business transaction upon the signing of the notes. The financial situation of the limited partners of the 1942 partnership was good, and each had sufficient assets to cover his or her liability on the notes. This was especially true of the three sons of the respective general partners. Two of the sons had already achieved considerable prominence and success in the business world. Though the sons-in-law did not sign the notes, they treated these obligations as resting on their community property. An example of all the notes which were given by the limited partners to their fathers is the note of Eleanor J. Rector given to her father, J. A. Johnson. It reads as follows:

$ 6,666.66

Seattle, Wash.,

April 21st, 1942.

One year after date, without grace, for value received I promise to pay to the order of J. A. Johnson Six Thousand Six Hundred Sixty-Six Dollars and Sixty-Seven Cents Dollars, in Lawful Money of the United States of America, of the present standard value, with interest thereon in like Lawful Money, at the rate of 4 per cent. per annum from date until paid. Interest to be paid at maturity and if not so paid, the whole sum of both principal and interest to become immediately due and collectible at the option of the holder of this note. And in case suit or action is instituted to collect this note or any portion thereof I promise and agree to pay in addition to the costs and disbursements provided by statute such sum as the court may adjudge reasonable as attorney's fees in said suit.

Due April 21st 1943

[Signed] Eleanor J. Rector

On June 30, 1943, a new limited partnership was formed on substantially the same basis as the former one, excepting that three additional daughters were brought into the partnership as limited partners. The additional limited partners consisted of Rachel Gustafson and Betty Lorraine Ellingson, daughters of George Johnson, and Vedola Johnson (now Mrs. Vedola Kent), daughter of Albin Johnson. The capital of the general partners remained at $ 20,000 each. The capital of the limited partners was changed by consent of all parties as follows:

Albin's children:
Winston Johnson	$ 6,666.66
Elsie Keil	6,666.66
Vedola Johnson	6,666.66
George's children:
Bernice Wallin	5,000.00
Lloyd Johnson	5,000.00
Betty Ellingson	5,000.00
Rachel Gustafson	5,000.00
J. A.'s children:
Roy Johnson	6,666.66
Eleanor Rector	6,666.66
Evelyn Jorgens	6,666.66

None of the new partners made a direct contribution of capital to the partnership. Rachel Gustafson and Betty Lorraine Ellingson each obtained a division of the interests which had been held in the names of their sister and brother, Bernice Wallin and Lloyd Johnson. This was accomplished by the unpaid notes of the latter partners being returned to them by their father and new notes in the amount of $ 5,000 being given by each of the four children to their father. Vedola Johnson (daughter of Albin) was taken in as a limited partner in the same way as Rachel Gustafson and Betty Lorraine Ellingson, daughters of George, were taken in. She executed her note for $ 6,666.66, payable to her father. Her brother Winston and her sister Elsie Keil had their notes for $ 10,000 each returned to them and each executed a note for $ 6,666.66, payable to their father. When these new limited partners found that their brothers and sisters had done so well in the 1942 partnership they too wanted to acquire an interest for themselves. The interests of the three Johnson families were always kept equal in the various partnerships. The moneys which these adult children borrowed from their fathers and used to invest in the limited partnership were bona fide loans. The general partners had minor children, but they were not taken into the partnership because they wanted notes from adults, fully responsible for payment. The notes were negotiable, bore interest, and were all for short terms not exceeding two years, except the first two notes of Lloyd Johnson and his sister Bernice Wallin to their father George Johnson for $ 10,000 each. These notes were installment notes, payable in yearly installments of not less than $ 3,500 in any one payment. Some of the notes given by the limited partners were paid in 1945. Lloyd paid his note in 1946; Winston and Elsie paid their notes in 1947. Rachel has not paid her note, as no demand has been made for payment from her by her father.

The limited partnerships were very successful and made large net profits, which were credited each year to the partners on the basis of their capital accounts. In determining net profits there was first subtracted $ 15,000 for each general partner as salary. The 1942 profits were several times more than the expectations of the general partners, and the crediting of profits to each partner was more than three and one-half times his capital account; however, the construction business represents a hazardous financial risk and it is possible to lose heavily, as well as to realize large profits.

The partnership reported its profits for tax purposes upon a completed contract basis. This was true of the Quartermaster and Rainier Vista contracts, which were under way by the time the first partnership was created. Gross profits were realized upon the Quartermaster and Rainier Vista contracts in the respective amounts of $ 234,866.20 and $ 201,754.39, which were reflected in the 1942 return of the limited partnership. Division of such profits was made with the limited partners on the basis of their stated partnership interests.

The limited partnership was not the result of an impulse set off by the desire to minimize taxes, but rather the result of many years of thought by the general partners, who were anxious to have their sons, daughters, and sons-in-law come into the business so that it would continue after the general partners retired or died. Just prior to the formation of the partnership it appeared that Lloyd and Roy were drifting away from the business to other attractive jobs. Their talents and training were in demand by others. For some years prior to 1942 Lloyd had worked for various individuals and companies other than Western Construction Co. In 1941 Lloyd, contrary to his father's wishes, formed a construction partnership with Max J. Kuney of Spokane, Washington, in which each had a one-half interest. When the Kuney-Johnson partnership was formed there was no plan for its being a permanent association, but that partnership opened offices in Seattle, Washington, and has been successfully active in the construction business from that time down to the present. Lloyd did not work as an employee of the limited partnership, but he did perform important services for the firm. He was a graduate engineer, with a great deal of experience. In 1942 and 1943 he was consulted by the general partners on matters relating to pricing and estimating pricing jobs, figuring bids, and helping them get scarce materials such as nails, which were almost impossible to get. Pricing was a very important work during the war years because prices changed so fast. The partners telephoned Lloyd a great deal on business matters of the company. He also did a great deal of night work helping the general partners on matters relating to engineering, bids, and estimates. He did not receive any compensation for this work, but he devoted a considerable amount of his time because of his interest as a limited partner. It was of great value to the partnership.

Roy Johnson was engaged for many years prior to 1942 in businesses other than that of the Western Construction Co. He rendered no regular services to the limited partnership until January, 1943, when he devoted full time to its affairs. In 1942 he assisted the partnership by advising it on estimates and by performing engineering work for it. From January, 1943, until June, 1944, Roy worked full time for the partnership and was paid a salary of $ 2.05 an hour. During this period he worked as an engineer designing layout foundations, excavating footings, roads, buildings, arches, and superintending both large and small jobs. He estimated various projects and did some difficult engineering work which the general partners could not do. In June, 1944, Roy went to Alaska to assist with a hydroelectric project. He remained there until the fall of 1947, working on this project, which had no connection with the Western Construction Co.

Winston Johnson, son of Albin Johnson, worked for the partnership at all times after March, 1942, when he was released from the Army. Winston, who had three years of college training as a civil engineer, did various types of work for the firm. He worked in the office, estimated jobs, obtained materials, arranged subcontracts, represented the partnership before the Navy on problems relating to contracts, and supervised jobs. His pay for this work was $ 80 or $ 90 a week, which was somewhat below the standard for estimators, some of whom earned $ 30,000 a year working on a salary plus bonus basis.

The daughters did not render any services to the limited partnership of any substantial consequence.

With the exception of Harold Ellingson, Betty's husband, none of the sons-in-law worked for the limited partnership, and Ellingson worked as a carpenter for only three months of the taxable years here involved. The general partners hoped that some day most of the sons-in-law would be associated with the partnership.

The partnership profits were regarded by all of the limited partners and their spouses as community property and in the filing of their returns for the years 1942 to 1945, inclusive, such profits were divided in the returns of the spouses on a community property basis the same as other income. Substantially all of the returns of the limited partners and their spouses for the years 1942 to 1945, inclusive, were prepared at the office of the Western Construction Co. by the accountant who handled the affairs of the partnership.

Partnership checks representing distribution of profits were sometimes made out to the limited partners and sometimes to the spouses of the limited partners, depending upon which one requested the money. It was regarded as a family business and no distinction was made as between limited partners or his or her spouse when it came to distributing the profits. There were no profits credited to the accounts of the limited partners and no withdrawals by them until after the close of the taxable year ended December 31, 1942. The limited partners were entitled to withdraw their share of the profits as they pleased and the share of the profits credited to the individual partners' accounts were in no way considered to be anything but their own property. No limited partners ever withdrew any profits and turned them over in any way to the father, the general partner. No limited partner was in any way dependent upon his or her father, the general partner, for support either at the time of the formation of the partnership or later.

The freedom of withdrawals by the limited partners without consulting the general partners is illustrated by the various uses they made of their profits. Roy Johnson in 1945 withdrew $ 40,000 to invest in his own construction project in Alaska. At one time he overdrew $ 6,600 for working capital in his Alaskan project, which he returned when the bookkeeper notified him of that fact. Winston Johnson withdrew $ 2,333.50 to pay for an engagement ring, the cost of his honeymoon, his mother's funeral expenses, and personal items. He also withdrew $ 2,700 to purchase a lot for his home and later $ 36,509.79 to invest in the stock of another company. Lloyd Johnson withdrew $ 9,000 of his profits to invest in a restaurant. The greater portion of his withdrawals were for uses other than the payment of income taxes. Elsie Keil used some of her profits to pay personal bills and also withdrew $ 45,976.52 to buy stock in another company. Vedola Johnson withdrew $ 6,586 of her profits to purchase stock in another company. Evelyn Jorgens invested $ 8,500 of her profits in a chicken ranch. Rachel Gustafson made withdrawals only to pay income taxes, as she had no other need for the money. Bernice Wallin withdrew $ 5,000 of her profits to invest in a real estate business and made a number of other personal withdrawals. Betty Ellingson used some of her profits for personal expenses.

The three general partners managed the limited partnership in the same manner that they had the business which preceded the limited partnership. As general partners, the management and direction of the business was in their hands and all their personal assets, including the notes of the limited partners, were subject to possible loss in the event the limited partnership failed. The sons who were limited partners worked under the direction of the general partners. Only the general partners could sign checks or notes for Western Construction Co.

There was no delegation of authority by the limited partners to the general partners. The limited partners held no meetings regarding such delegation of authority, elected no officers and representatives, and received no certificates or other evidence of their contribution as limited partners, other than the partnership articles.

The limited partnerships were not operated with any of the usual formalities of a corporation or association. There were no officers, no regular or formal meetings, no bylaws, board of directors, seal, or minute books. The Western Construction Co. held itself out to the public as a true limited partnership. The parties to the limited partnership agreements here involved formed a bona fide partnership and truly intended to join together for the purpose of carrying on the business as a partnership. It was not an association taxable as a corporation. Proper statutory notice of the formation of both limited partnerships was given. The limited partnership agreements provided that the general partners could admit additional limited partners and continue the business upon the death or retirement of a general or limited partner. Those rights could be exercised only by agreement among the general partners.

It was orally stipulated at the hearing that Lloyd Johnson and his wife Roberta are entitled to additional community expense deductions over those allowed in the defiency notice issued to them for the years and in the amounts as follows:

1942	$ 1,200
1943	1,200
1944	1,200
1945	600

OPINION.

There are two issues presented in these proceedings; however, they are in the alternative. The first issue is whether petitioner Western Construction Co. is an association taxable as a corporation. If it is held that Western Construction Co. is not taxable as a corporation, but is instead a partnership, then we must decide the second issue, namely, the composition of the partnership for tax purposes. The respondent concedes that he has made inconsistent determinations in determining that Western Construction Co. was an association taxable as a corporation and then also determining that the same business during the same period was a general partnership composed of three members. He concedes that both determinations can not stand.

Issue 1. -- Respondent first contends that petitioner Western Construction Co. resembles an association in corporate form and is, therefore, taxable as a corporation. Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344, is cited by respondent as the basic authority for taxing Western Construction Co. as a corporation, but petitioners also rely upon the Morrissey case to sustain their argument that Western Construction Co. is taxable as a partnership. In the Morrissey case the Court said: "The inclusion of associations with corporations implies resemblance; but it is resemblance and not identity." Therefore, it is for us to determine whether Western Construction Co. resembles a corporation to a sufficient extent as to make it taxable as such.

Petitioner Western Construction Co. was created as a limited partnership under the laws of the State of Washington, the pertinent sections of which are printed in the margin. ^*281 This designation as a partnership is not conclusive of its being such for tax purposes. To ascertain whether Western Construction Co. is taxable as a corporation or as a partnership, it is necessary to find what the rights and duties of the partners are as between themselves and the public. Therefore, we must examine the statutes of the State of Washington, by virtue of which Western Construction Co. exists as a limited partnership in Washington, and the certificate of the formation of the partnership filed with the county auditor.

The certificate of formation of the limited partnership Glensder Textile Co., 46 B. T. A. 176, is indistinguishable from the instant proceedings, except that Glensder Textile Co. was a limited partnership formed under the Uniform Limited Partnership Act of the State of New York, whereas the limited partnership here was organized under the laws of the State of Washington. There seems to be no substantial difference between the two statutes. In the Glensder Textile Co. case we held that the limited partnership did not resemble a corporation, but was more closely akin to a general partnership. See also J. A. Riggs Tractor Co., 6 T.C. 889">6 T. C. 889; George Brothers & Co., 41 B. T. A. 287. In the Glensder Textile Co. case, after discussing in considerable detail the several provisions of the limited partnership agreement there present which were similar in character to those of the limited partnership agreement in the instant case, we said:

We must conclude, therefore, after an examination of the organization and legal powers and liabilities of the members of the limited partnership before us, that it does not bear such a resemblance to an association or operate effectively as such so as to justify our inclusion of it in that category for tax purposes. Although a limited partnership, it was still a partnership, and should be treated as such under the statute. The statute provides a category for individuals doing business in partnership and deriving income thus; and we may not disregard it where the likeness to an association is no plainer than it is here.

In the Glensder Textile Co. case we set out in the margin the applicable statute and the Treasury regulations with reference to limited partnerships. They are also set out in our footnotes 2 and 3 herein and it is unnecessary to reprint them here. Following our decision in that case, we hold that petitioner Western Construction Co. was not an association taxable as a corporation. On this issue petitioner is sustained.

Issue 2. -- As we have held that Western Construction Co. is a partnership for tax purposes, we must now determine the composition of that partnership.

Respondent contends that if Western Construction Co. is held to be a partnership for Federal tax purposes, it consists solely of the three general partners. Petitioners contend that Western Construction Co. is a partnership for tax purposes and includes all the limited partners. Both parties cite the cases of Commissioner v. Tower, 327 U.S. 280">327 U.S. 280, and Lusthaus v. Commissioner, 327 U.S. 293">327 U.S. 293. Since the hearing of these proceedings and the filing of briefs, the Supreme Court has decided the case of Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733. From these cases it is apparent that in order to determine the issue it is necessary for us to find whether Western Construction Co. is a bona fide business partnership, and upon such finding the tax consequences rest.

Respondent argues that the formal documents executed in 1942 and 1943 creating a limited partnership under the laws of the State of Washington are nothing more than a reallocation of the income attributable to the general partners, and that there was no real intent to create a partnership for business purposes. Petitioners argue that the partnership is a result of a bona fide intent of the general and limited partners to join together for the purposes of carrying on the construction business and to share in the profits and losses. Their intention in this respect is a question of fact, to be determined from the agreement and by their conduct in its execution and in the subsequent operation of the business. As was said in Commissioner v. Culbertson, supra:

* * * The question is not whether the services or capital contributed by a partner are of sufficient importance to meet some objective standard supposedly established by the Tower case, but whether, considering all the facts -- the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent -- the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. * * *

At this juncture it seems appropriate to point out that the Commissioner himself in his determination of the deficiencies against Western Construction Co. determined that Western Construction Co. should be recognized as a bona fide organization in which the members of it joined together for a business purpose. He contends, however, that the organization should be treated as an association taxable as a corporation and not as a limited partnership. That is his first and main contention. Failing in that, he contends, in the alternative, that the partnership should be held a general partnership, with no recognition given to the limited partners.

The record shows that prior to the formation of the limited partnership the general partners were having difficulty in getting the larger and more lucrative Government contracts because of their inadequate financial backing. This lack of capital made it extremely difficult to get the necessary construction bonds. To obviate this difficulty, the partners attempted to get outside capital, but were unsuccessful, and the one time a joint venture was attempted to obtain the necessary bond Western Construction Co. came out on the short end of the bargain. In bringing in the children as limited partners, $ 60,000 was added to the individual assets of the general partners by reason of the personal notes given by the children to their respective fathers. This was a factor of considerable importance to the financial status of the general partners and, through them, to the limited partnership.

The evidence convinces us that these notes were not given as a part of a scheme to avoid taxes, but were given to increase the financial strength of the partnership. Cf. O. H. Delchamps, 13 T.C. 281">13 T. C. 281. In the Delchampscase, two brothers and their sister, equal partners in a chain grocery business, admitted the brothers' wives as partners, each brother contributing two-fifths of his interest to his wife and the sister a one-fifth of her interest to each wife. The admission of the wives as partners was necessary for the purpose of securing bank credit for the business. Under those circumstances we held that the partnership was formed for a valid business purpose, with a bona fide intention to form a business partnership. We think the Delchamps case supports the validity of the partnership agreement here involved. It is true that these notes were never used as collateral by the partnership, but shortly after its formation the limited partnership borrowed an additional $ 50,000 from a bank and the notes were listed with bonding companies as a part of the personal assets of the general partners. There was no plan whereby these notes would be payable only out of profits -- it was a business transaction in which the adult children participated with full knowledge of the attending responsibilities in signing these notes, and with the consent of the sons-in-law.

Profits were distributed as in any normal partnership and the limited partners had the right to withdraw their shares of the profits at any time and use them for whatever they might desire. The majority of the limited partners did not withdraw a great deal of their profits; however, they had the right to do so and some of the limited partners withdrew a considerable portion of their distributive shares and used the funds as they saw fit. Cf. John A. Morris, 13 T.C. 1020">13 T. C. 1020. The Morris case involved a limited partnership organized under the laws of the State of New York, as was the limited partnership in the Glensder Textile Co. case, supra. In the Morris case we held that Edna B. Morris, wife of the taxpayer, John A. Morris, was a partner in the limited partnership there involved, even though the capital which she contributed to the partnership came from a prior gift which she received from her husband and she did not render any services or participate in the management of the business. We based our holding that she was a limited partner on a finding which we made from the evidence that "Petitioner, his wife, and the other members of the brokerage firm formed a bona fide partnership and really and truly intended to join together for the purpose of carrying on the business as a partnership." We relied as our chief authority for the holding upon Commissioner v. Culbertson, supra.

We think that the evidence shows that the three Johnson brothers had a real desire to have their children become partners in the Western Construction Co. The sons not only gave their notes, but also contributed their engineering skill which the general partners lacked. Their services were of substantial value to the partnership. All of the limited partners were conscious of the fact that the partnership was real and the promissory notes given their respective fathers were binding obligations.

Looking at the evidence as a whole, we think that petitioner Western Construction Co. was intended and created as a valid business partnership, including all the limited partners, and must, therefore, be recognized as such for tax purposes. John A. Morris, supra.

The parties have stipulated that each of the three general partners expended $ 1,200 "for each of the years 1942, 1943, and 1944 in excess of that determined and allowed by respondent in the deficiency notices, as business expenses, covering depreciation, insurance and operating expenses of automobiles, and also entertainment and travel expenses." From the stipulation it is apparent that a total of $ 3,600 for each of these years was expended as additional ordinary and necessary expenses of the business. These expenses are not allowable as a deduction from the personal returns of the general partners, as they are partnership expenses and are so deductible. Hiram C. Wilson, 17 B. T. A. 976. In a recomputation under Rule 50, these expenses should be deducted in computing partnership net income for each of the years 1942, 1943, and 1944.

Decisions will be entered under Rule 50.

OPPER

Opper, J., dissenting: The two issues before us can not be neatly severed, so that we can separately deal with the reality of the partnership and its resemblance to a corporation. For the first time since Tower, Lusthaus, and Culbertson, this case raises the question whether a family enterprise cast in the form of a limited partnership, just because it truly represents an actual form of doing business, is not in reality more nearly like a corporation than any other business organism. The very aspects upon which petitioners rely to strengthen their claim of a valid partnership and yet to explain the relation to the business of the "limited partners" are in fact and in essence the Morrissey^{Glensder Textile Co., 46 B. T. A. 176, decided before Tower and Lusthaus , the Board was not confronted by the juxtaposition of a developed family partnership rule with the similarity of limited family partnerships to corporations, and hence it can not be regarded as controlling this question. It is for that reason, at least, less persuasive than a more recent decision of this Court holding certain family limited partnerships to be taxable as corporations. *293} Giant Auto Parts, Ltd., 13 T.C. 307">13 T. C. 307.

Without placing undue reliance on relevant provisions of local law, it can not altogether lack significance that the Constitution of the State of Washington, in the article referring to "corporations," provides that: "All laws relating to corporations may be altered, amended, or repealed by the legislature at any time, and all corporations doing business in this State may, as to such business, be regulated, limited, or restrained by law," art. 12, sec. 1; that "the term 'corporations,' as used in this article shall be construed to include all associations and joint stock companies having any powers or privileges of corporations not possessed by individuals or partnerships * * *," art. 12, sec. 5; and that the Supreme Court of the State has declared that "Under constitutional provisions similar to Section 5, article 12, supra, it is almost uniformly held that joint-stock companies and limited partnerships organized under statutory authority are in fact corporations." State ex rel. Range v. Hinkle, 126 Wash. 581">126 Wash. 581; 219 Pac. 41, 42. (Emphasis added.)

And while nomenclature is not, of course, decisive, it may nevertheless be added that the Washington statutes under which petitioner "company" was formed refer to the capital of the enterprise as "common stock" and "capital stock," and that in one instance it is provided: "* * * no part of the capital stock thereof shall be withdrawn, nor any division of interests be made, so as to reduce such capital stock below the sum stated in the certificate of partnership * * *." Remington's Revised Statutes, Washington, vol. 10, secs. 9967, 9972. In fact, if the general partners are thought of as common stockholders, and the special partners as holders of participating preferred stock, the entire arrangement would be identical in all respects with a corporate structure, except for the unlimited liability of the general partners. Since it is similarity and not identity which constitutes the test, Morrissey v. Commissioner, ^*296 and since it is the interest of the special partners, and not that of the general partners, which raises the real present issue on both alternative contentions, it seems to me inescapable that this arrangement fails, on the one hand, to bear any resemblance to a true and actual partnership of all the participants, see Hill, J., dissenting in John A. Morris, 13 T. C. 1020, but that, on the other, it does resemble and almost duplicates a corporation, and that reality thus requires the tax to be imposed upon it as a corporation and not as a partnership.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: Albin Johnson; Ellen M. Johnson; Huldah M. Johnson; George J. Johnson; J. A. Johnson; Roberta M. Johnson; and Lloyd W. Johnson.↩

• 2. SEC. 3797. DEFINITIONS. [As amended by secs. 120 (f) and 511, Revenue Act of 1942.]

  (a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof --

  (1) Person. -- The term "person" shall be construed to mean and include an individual, a trust, estate, partnership, company, or corporation.

  (2) Partnership and partner. -- The term "partnership" includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term "partner" includes a member in such a syndicate, group, pool, joint venture, or organization.

  (3) Corporation. -- The term "corporation" includes associations, joint-stock companies, and insurance companies.↩

• 3. Sec. 29.3797-5. Limited Partnerships. -- A limited partnership is classified for the purpose of the Internal Revenue Code as an ordinary partnership, or, on the other hand, as an association taxable as a corporation, depending upon its character in certain material respects. If the organization is not interrupted by the death of a general partner or by a change in the ownership of his participating interest, and if the management of its affairs is centralized in one or more persons acting in a representative capacity, it is taxable as a corporation. For want of these essential characteristics, a limited partnership is to be considered as an ordinary partnership notwithstanding other characteristics conferred upon it by local law.

  The Uniform Limited Partnership Act has been adopted in several States. A limited partnership organized under the provisions of that Act may be either an association or a partnership depending upon whether or not in the particular case the essential characteristics of an association exist.↩

• 4. Through a bookkeeping error the general partners' capital accounts were shown as $ 15,000 each. This was corrected to $ 20,000 each on June 30, 1943, when the second limited partnership was formed. Profits for 1942 were distributed on the book basis of 15/105 for each general partner, but should have been on the corrected basis of 20/120. In a recomputation under Rule 50, effect should be given the additional profits attributable to the three general partners because of this bookkeeping error.

• 5. See footnotes 2 and 3, supra↩.

• 6. Remington's Revised Statutes of Washington, Ann., vol. 10.

  "§ 9966. Limited partnership may be formed. Limited partnership for the transaction of mercantile, mechanical, or manufacturing business may be formed within this state, by two or more persons, upon the terms and subject to the conditions contained in this chapter.

  "§ 9967. Of whom composed, and liability of members. A limited partnership may consist of two or more persons, who are known and called general partners, and are jointly liable as general partners now are by law, and of two or more persons who shall contribute to the common stock a specific sum in actual money as capital, and are known and called special partners, and are not personally liable for any of the debts of the partnership, except as in this chapter specially provided.

  * * * *

  "§ 9970. Renewal of limited partnership. A limited partnership may be continued or renewed by making, acknowledging, filing, and publishing a certificate thereof, in the manner provided in this chapter for the formation of such partnership originally, and every such partnership, not renewed or continued as herein provided, from and after the expiration thereof according to the original certificate, shall be a general partnership.

  * * * *

  "§ 9973. Suits by and against limited partnership -- Parties. All actions, suits, or proceedings respecting the business of such partnership shall be prosecuted by and against the general partners only, except in those cases where special partners or partnerships are to be deemed general partners or partnerships, in which case all the partners deemed general partners may join therein; and excepting also those cases where special partners are severally liable on account of sums or amounts received or withdrawn from the capital stock, as provided in the last preceding section.

  "§ 9974. Dissolution, how may be accomplished. No dissolution of a limited partnership shall take place, except by operation of law, before the time specified in the certificate of partnership, unless a notice of such dissolution, subscribed by the general and special partners, is filed with the original certificate of partnership, or the certificate, if any, renewing or continuing such partnership, nor unless a copy of such notice be published for the time and in the manner prescribed for the publication of the certificate of partnership.

  "§ 9975. Liabilities and rights of members of firm↩. In all cases not otherwise provided for in this chapter, all the members of limited partnerships shall be subject to all the liabilities and entitled to all the rights of general partners."

• 7. Findings of fact, page 6, supra↩.

• 8. Id., arts. V and VII.↩

• 9. Id., art. IX.↩

• 10. Id., art. X.↩

• 11. Id., art. X.↩

• 12. Id., art. XII.↩

• 13. Id., art. XIII.↩

• 1. See footnote 4, infra↩.

• 2. "* * * namely, centralized control and management, limited liability, transferability of interests, title to property held in the name of the business entity, continuity of enterprise, and sustained operation of the business for profit. * * *" ( Giant Auto Parts, Ltd., 13 T.C. 307">13 T. C. 307, 315↩.)

• 3. "It is true that the ownership of the business was confined to a few members of an intimate family group, that no regular or formal meetings were held, that no minutes were kept, and that no election of officers was held after the original execution of the partnership agreement. The petitioner's failure to observe the formalities in respect to meetings and elections and the fact that it was owned by a small number of persons have no bearing upon its classification as a corporation or partnership. * * *" ( Giant Auto Parts, Ltd., supra↩.)

• 4. 296 U.S. 344:

  "The inclusion of associations with corporation implies resemblance; but it is resemblance and not identity. * * * Thus an association may not have 'directors' or 'officers,' but the 'trustees' may function 'in much the same manner as the directors in a corporation' for the purpose of carrying on the enterprise. The regulatory provisions of the trust instrument may take the place of 'by-laws.' And * * * it cannot be considered to be essential to the existence of an association that those beneficially interested should hold meetings or elect their representatives. Again * * * the test of an association is not to be found in the mere formal evidence of interests or in a particular method of transfer.

  * * * *

  "It is no answer to say that these advantages flow from the very nature of trusts [here limited partnerships]. * * * The suggestion ignores the postulate that we are considering those trusts [family partnerships] which have the distinctive feature of being created to enable the participants to carry on a business and divide the gains which accrue from their common undertaking, trusts that thus satisfy the primary conception of association and have the attributes to which we have referred, distinguishing them from [ordinary] partnerships. In such a case, we think that these attributes make the trust sufficiently analogous to corporate organization to justify the conclusion that Congress intended that the income of the enterprise should be taxed in the same manner as that of corporations." (Emphasis and bracketed language added.)