Seidel v. Commissioner , 10 T.C. 1135 ( 1948 )

Walter F. Seidel, Petitioner, v. Commissioner of Internal Revenue, Respondent

Seidel v. Commissioner

Docket No. 13282

United States Tax Court

10 T.C. 1135; 1948 U.S. Tax Ct. LEXIS 155;

June 21, 1948, Promulgated

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Decision will be entered for the respondent.

Family Partnership. -- A wife is not recognized as a partner for tax purposes where a husband conveyed one-half of his established business to her and neither rendered services to the business during the taxable years.

Allin H. Pierce, Esq., for the petitioner.

Charles D. Leist, Esq., for the respondent.

Murdock, Judge.

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MURDOCK

The Commissioner determined a deficiency of $ 62,694.04 in the petitioner's income tax for the fiscal year ended January 31, 1944. The previous fiscal year must be considered because of the tax forgiveness provision.

The sole issue is whether the Commissioner erred in holding that the entire net income of Ad. Seidel & Son was taxable to the petitioner instead of to him and his wife in accordance with their partnership agreement.

FINDINGS OF FACT.

The petitioner filed his income tax return for the fiscal year ended January 31, 1944, with the collector of internal revenue for the first district of Illinois.

The business involved herein was the preparation and distribution on a nation-wide scale of bakery and institutional supply products. It was established by the petitioner's father in 1890, and the petitioner had been engaged in it since 1895. He became the sole proprietor in 1937. There were about 65 employees. The petitioner was active in the management of the business until 1937, at which time he underwent a surgical operation, and thereafter he was able to take little or no part in business affairs.

His son, who was experienced in the business, took over the management of the company at that time and was the general manager when he was ordered to active duty in the Army on January 10, 1942. The business was in a poor condition when he took over. The net profits increased from about $ 4,600 during his first year to over $ 23,600 for the year ended January 31, 1942.

The total assets at January 31, 1942, were shown on the books at about $ 176,000 and were offset by liabilities of about $ 110,000. Future prospects were uncertain, due to the war. Some of the employees had already been called into the service and the drafting of others was imminent.

The petitioner had about exhausted his credit. He was then 70 years of age. His wife Amy had advanced about $ 12,000 of her separate funds to pay his personal expenses, principally doctor and hospital bills. He had no assets aside from the business with which to repay her. She had been demanding an interest in the business ever since he became ill. The formation of a partnership was discussed late in 1941 and it was finally decided that the petitioner would convey a one-half interest in the business to Amy and henceforth they would be equal partners. This was done so that the business could be continued as a family business despite the petitioner's incapacity, so that Amy could sign necessary papers and act in emergencies after the son had left for the Army, so that Amy would have something in lieu of the money which she had advanced, and so that taxes might be reduced. Amy had $ 10,000 to $ 15,000 of her own outside of the business.

The petitioner executed a bill of sale on February 2, 1942, transferring a one-half interest in the business to Amy, partly as a gift and partly in consideration of the money which she had advanced in his behalf. They also executed a partnership agreement on the same day, under which they were to be general partners, sharing equally in the profits and losses and in the ownership of assets; subject, however, to the provision that the petitioner should devote all of his time and attention to the business, should not engage in any other business, and should receive an annual salary of $ 6,000 before the equal division of the remaining profits. There was no change in the name or place of business. All of the usual steps were taken to give notice of the formation of the new partnership. The partnership was to continue for 10 years, but actually a corporation was formed in 1946 in which some of the key employees had interests.

The business was conducted during the taxable years by three key employees, Stella Schwartz, Otis Larsen, and Edward Putzier. Schwartz and Larsen had long been connected with the business. Schwartz acted as purchasing agent and performed office duties. Larsen was chief chemist and in charge of production. Putzier came with the company in 1940, with 18 years previous experience in a similar business. He had been administrative assistant and in charge of accounts and records, but he became general manager in January 1942, when the son went into the Army. Putzier continued as general manager during the taxable years.

The taxable years were prosperous ones for the business, due to war conditions, such as shortages of meat and sugar, which created increased demands for the products of the business. New products were introduced which proved to be successful. There was a decided shift from bakery to institutional products. The profits were $ 74,260.18 for the first taxable year and $ 134,212.82 for the second taxable year. The net worth increased from about $ 66,000 to about $ 142,000 during those two years. The increase in the profits had not been anticipated at the time of the formation of the partnership.

The petitioner was unable to contribute, and did not contribute, any valuable services to the business during the taxable years. Amy did not render any valuable services to the business during those years. Amy and the petitioner conferred with the employees on occasion, but they did not make any important decisions during the period here involved. Amy had had no previous business experience of any consequence. She and the petitioner had confidence in the employees and found no need to interfere with the management of the business during the two years here in question.

The petitioner withdrew $ 91,009.76 from the business during the taxable years, of which $ 48,132.43 was for his income taxes. Amy withdrew $ 43,401.99 for income tax payments and $ 11,219.17 for her personal use.

Amy added $ 719.68 to her capital account on January 31, 1943, and $ 5,250 on January 31, 1944. The petitioner also added $ 5,250 to his capital account on January 31, 1944. These latter two amounts represented a transfer by the petitioner and Amy to the partnership of real estate used in the business. The petitioner had owned one-half of the real estate, and in 1939 he conveyed one-half of his interest to Amy. His sister, who owned a one-fourth interest in the real estate, gave it in equal shares to the petitioner and Amy in June 1942. Amy and the petitioner purchased the remaining one-fourth interest in October 1943, and the purchase price was charged equally to their accounts on the books of the partnership.

The Commissioner, in determining the deficiency, held that all of the income of the business was taxable to the petitioner. He explained that Amy was not recognized as a partner within the meaning of section 181 of the Internal Revenue Code and that all of the net income of the business was taxable to the petitioner.

OPINION.

The husband has been held taxable on all of the income in a number of cases in which it appeared that, after he had conveyed a part of his interest in the business to his wife, he continued to operate the business himself, while the wife contributed no important services. The leading cases are Commissioner v. Tower, 327 U.S. 280">327 U.S. 280, and Lusthaus v. Commissioner, 327 U.S. 293">327 U.S. 293. Here, as in those cases, the partnership began by the husband transferring a part of his interest in the business to his wife, following which she contributed no important services to the business. But, the present case differs somewhat from those cases and the differences in the facts favor the petitioner. There is evidence of a business purpose in that the wife's recognition as a partner was desirable so that she could act in any emergency while her husband was incapacitated. Also, some consideration passed from the wife to the husband for the transfer of a one-half interest in the business. But perhaps the principal difference is that the petitioner in this case was not active in the business during the taxable years, due to incapacity. This difference, as the petitioner argues, is not without significance, since the decisions in the Tower and Lusthaus cases were based to a considerable extent upon the fact that the husband really earned the income through the services which he performed during the taxable year. See, however, Camiel Thorrez, 5 T.C. 60">5 T. C. 60; affd., 155 Fed. (2d) 791, in which two of the partners were described as inactive, and Robert E. Werner, 7 T. C. 39, in which the petitioner gave his wife a business somewhat separate from his own.

The Supreme Court said in the Tower case that "a partnership is generally said to be created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses." It also said that the partners must really and truly join together for the purpose of carrying on a business if they are to be recognized as partners for income tax purposes. Amy and the petitioner contributed no labor or skill to this business during the taxable years. There was no change in the assets used in the business and no change in the management or operation of the business as a result of the execution of the instruments dated February 2, 1942. Apparently, the business went on under its own momentum, with the three key employees taking over the managerial duties. Yet, it must also be recognized that the petitioner, rather than Amy, was responsible for the income of the taxable years in view of his long connection with the business, during which time he helped to develop it and employed the persons who ran it for him. This case can not be distinguished satisfactorily from the cases cited above so as to reach a different result. The petitioner and Amy were not partners during the taxable years for tax purposes.

Decision will be entered for the respondent.