Harkness v. Commissioner , 13 T.C. 1039 ( 1949 )

Molly A. Harkness, Petitioner, v. Commissioner of Internal Revenue, Respondent. Floyd J. Harkness, Petitioner, v. Commissioner of Internal Revenue, Respondent

Harkness v. Commissioner

Docket Nos. 16407, 16408

United States Tax Court

13 T.C. 1039; 1949 U.S. Tax Ct. LEXIS 5;

December 22, 1949, Promulgated

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Decisions will be entered under Rule 50.

On the facts, held, that when sole proprietorship was converted into a family partnership in 1943, neither petitioners nor their son and daughter intended to join together in the present conduct of the business, and, therefore, the partnership was invalid for tax purposes in that year. Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733.

Philip S. Ehrlich, Esq., R. J. Hecht, Esq., and Le Roy H. Guntner, Esq., for the petitioners.

T. M. Mather, Esq., for the respondent.

Hill, Judge.

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HILL

The above entitled cases were consolidated for hearing. Respondent determined a deficiency in the income tax liability of petitioner Floyd J. Harkness in the amount of $ 65,367.27 for the calendar year 1943 and a deficiency in the income tax liability of petitioner Molly A. Harkness in the amount of $ 64,781.64 for the same year. The only issue raised in this proceeding is whether a valid family partnership existed between petitioners and their children, Floyd J. Harkness, Jr., and Harriet H. Colgate, in the operation of United Packing Co. in 1943.

FINDINGS OF FACT.

Part of the facts were stipulated and are so found.

Petitioners Floyd J. Harkness and Molly A. Harkness are individuals, residing in Fresno, California. They filed their separate income tax returns for 1943 with the collector of internal revenue for the first district of California. Petitioners were married July 14, 1915, and have made their home in California ever since. They have two children, Floyd J. Harkness, Jr., and Harriet Harkness Colgate, born in 1918 and 1920, respectively.

Harkness, Sr., has been a grower and shipper of fruits and vegetables since 1918. Prior to 1937 he engaged in this occupation first as an employee of various concerns and then as a member of two successive partnerships operating under the name of United Packing Co. In January 1937 petitioner bought out his partner and commenced operating the business as a sole proprietorship under the same name. Molly Harkness, as his wife, owned the assets of the business in community with him. The company specialized in packing and shipping cantaloupes, carrots, peaches, plums, nectarines, and grapes. Some commodities were raised by the company itself, while others were bought from farmers on a cash basis. Still other produce was packed and shipped by the company on a commission basis. For the purposes of its business, United Packing Co. operated ranches and packing houses, and manufactured and stocked packing materials. Its main office was located in Fresno, but its operations covered a large area in the San Joaquin Valley, extending northward 138 miles to Lodi and southward 127 miles to Arvin. At the close of 1942 the gross proceeds and net income earned by United Packing Co. amounted to $ 1,468,119.64 and $ 141,790.95, respectively.

During the years up to 1942 petitioners' two children were occupied primarily in obtaining an education, though each performed some services in their father's business. Harkness, Jr., attended schools until June 1941, when he graduated from college with a major in commerce. From 1934 until 1941 he worked in his father's business during summer vacations and in 1937 he quit school for six months to help his father launch the sole proprietorship. From June 1941 until January 1942 he devoted his full time as an employee of United Packing Co., working as a "regular field man" at a salary of $ 150 per month plus a 5 per cent bonus of approximately $ 910. During this six-month period he also earned four to five thousand dollars in independent deals in the fruit and vegetable business. On January 12, 1942, he entered the United States Air Corps as a private. At the close of 1942 petitioners' son still had a credit on the books of the sole proprietorship of $ 1,412.05 for prior services performed. He owned no substantial property outside of these earnings at that time.

Harriet Harkness finished her schooling in June 1942, when she graduated from college. During summer vacations she had occasionally performed secretarial services in her father's business. Harriet worked full time as a secretary at United Packing Co. from June until August 1942, at which time she married William H. Colgate, Jr., who was then serving in the United States Army. Following her marriage she spent her time housekeeping for her husband at various military posts in the United States until October 1944. She owned no significant amount of property at the time of her marriage.

Harriet's husband, William Colgate, had resided in Fresno County, California, all his youth and had been an acquaintance of the Harkness family for a number of years prior to his marriage in 1942. He attended college, majoring in commerce, and during summer vacations was employed by Peerless Pump Co., the largest supplier of irrigation pumps in the San Joaquin Valley. Colgate later quit school and worked full time for this company for nine months before enlisting in the United States Army in March 1941. This was in keeping with his desire to devote his career to agricultural pursuits in the Valley. As an assistant foreman aiding in the installation of extensive irrigation systems, Colgate acquired considerable knowledge of the mechanics of irrigation. After his marriage to Harriet, they were stationed at Columbus, Ohio, during the latter part of 1942 and throughout 1943.

In the fall of 1942 Harkness, Sr., became convinced that it would be advantageous to convert the operation of his fruit packing and shipping business from a sole proprietorship to a partnership composed of his wife, himself, and his two children in the coming year. Many reasons dictated that decision. Primarily, he desired to obtain the services of his son and son-in-law in the business. He felt that, as a result of their college education and the practical experience they had gained pursuing agricultural employment in the Valley, they would make skilled, competent supervisors, capable of overseeing the widespread operations of the company. Secondly, from his experience in the fruit- and vegetable-packing industry, Harkness believed that it was essential to increase the capital investment in the company by allowing annual profits to remain in the business. This was necessary not only to permit payment of extensive operating expenses, to allow for expansion of company facilities and equipment and to develop new business, but also to meet the exigencies of bad crop years when the company's income declined drastically. Furthermore, in 1942 fruit packers were anticipating a decline in profits due to labor shortages, low transportation priorities for their produce, and the probability that prices would tumble as in World War I. These circumstances only increased the need for increasing the capital reserve of United Packing Co. Yet it had been Harkness' experience in past years that to hold qualified supervisory personnel it was necessary to pay them large bonuses or percentages of profits, which they invariably withdrew from the business and often used to set themselves up in competition with him, thus draining the company's capital. He felt the only way to retain profits in the company was to bring into the business persons who felt as he did. Through long discussions with Harkness, Jr., and William Colgate petitioner knew that they agreed with him that only a reasonable amount of the profits should be withdrawn from United Packing Co. and the rest of the net income should be allowed to accumulate in the business.

While Harkness, Sr., was well aware that neither Floyd, Jr., nor William Colgate would be available to serve United Packing Co. for the duration of the war and he would be the only active partner in the meantime, yet he desired them to acquire an interest in the company at this time to guarantee their future help in running the business after their release from the Army.

Furthermore, formation of the partnership accorded with the wish of Harkness, Sr., to give his children an opportunity to make good. Even when Floyd, Jr., was a boy he and his father planned for the day when the former would be a full-fledged partner. After graduation from college in 1941 Harkness, Jr., had pressed his father to give him the status of a partner in the business, and, while Harkness, Sr., had too many financial commitments to do so in that year, yet he promised his son he would make provision for him to purchase an interest in the business. Now petitioner desired to fulfill that promise. It was long understood that if one child was given an opportunity to participate in the business the other would be given an equal opportunity. Offering Harriet an opportunity to become a partner in his business not only fulfilled this pledge, but was a long step toward securing the eventual services of her husband, which petitioner so greatly desired.

While Harkness, Sr., consulted a lawyer concerning the feasibility of converting his business into a partnership and was thus aware of the tax-saving possibilities inherent therein, yet this fact was only a secondary consideration with him, and he would have entered into this arrangement regardless thereof.

During the fall of 1942 Harkness, Sr., held lengthy conversations with his son, who was stationed at a nearby airfield, regarding the proposed partnership. Harkness, Jr., eagerly accepted the chance to buy an interest in United Packing Co., for this had been his great desire for many years, and it assured him of full participation in the business on his return from the service. Petitioners and young Harkness then definitely planned to convert the business into a partnership, starting in 1943.

Over the same period of time Harkness, Sr., also corresponded with his daughter and offered her either the opportunity to invest in United Packing Co. or some other enterprise. Furthermore, it was understood that, if she decided to come into her father's business, her husband, William Colgate, would be allowed to participate in the partnership following his release from the Army. Harriet and William Colgate debated at length whether it was advisable for her to buy an interest in her father's business or to invest elsewhere. Finally Harriet exercised her option to procure an interest in United Packing Co. after her husband determined he wanted to be associated with United Packing Co. upon his return from the service.

Thus by November 1942 petitioners and both their children generally agreed to the formation of a partnership for the operation of United Packing Co. in the coming year, though the details of the partnership relationship had not been worked out. A "Certificate of Co-Partnership Transacting Business under Fictitious Name" was executed on November 12, 1942, which petitioners and young Harkness signed on that date and Harriet signed on November 28. It stated that the four were copartners, carrying on business under the name of United Packing Co., and that Harkness, Sr., was the general manager, in full charge of all business operations. This certificate was published in a local paper and later filed with the county recorder of Fresno County.

On December 31, 1942, "Articles of Partnership," providing the detailed terms of the proposed partnership, were drafted and met the approval of all but Harriet Colgate, who refused to sign until provisions as to control of the business and as to purchase of a deceased partner's share were modified.

On January 1, 1943, petitioners transferred to United Packing Co., a partnership, most of the assets and some of the liabilities of United Packing Co., sole proprietorship, existing on December 31, 1942, resulting in a net worth of $ 138,241.61 for the partnership on that date. Harkness, Jr., and Harriet Colgate each bought a one-fourth interest in the partnership for $ 34,560.41, equivalent to one-fourth of its net worth. To pay Harkness, Sr., for his share in the partnership the son used $ 1,392.05 of the credit he had earned as compensation for prior services rendered the sole proprietorship and on January 2, 1943, signed a promissory note for the remaining $ 33,168.35, with interest at 4 per cent per annum. Harriet Colgate purchased her partnership interest from her father with a promissory note dated January 2, 1943, for $ 34,560.40, with interest at 4 per cent per annum. William Colgate joined her on the note as comaker. No collateral was required on either note.

These transactions were reflected on the books of United Packing Co., copartnership, as of January 1, 1943. It showed assets of $ 142,861.03 and liabilities of $ 4,619.92 and a net worth of $ 138,241.61. Capital of the partnership was stated to be $ 138,241.61, resulting from contributions of $ 34,560.41 each from the three Harknesses, and Harriet Colgate.

On January 4, 1943, pending acceptance by Harriet Colgate of the articles of partnership drafted on December 31, 1942, Harkness, Sr., Molly Harkness, Harkness, Jr., and Harriet Colgate signed a supplemental agreement fixing compensation and distribution of partnership profits among the partners. The salary of Harkness, Sr., as general manager of the partnership, was fixed at 75 per cent of the first $ 100,000 of the partnership net income. There was no provision for salaries for the other partners. The remainder of the first $ 100,000 of partnership net income was to be divided equally among the partners, as were any profits over that amount. Paragraph three of this supplemental agreement stated:

It is understood and agreed that the payment of the 75% of the net income as provided for, is being made to first party on account of the fact that he is the only active co-partner in said business at this particular time and will continue as such during the duration of the present war.

During January 1943 Harkness, Sr., discussed with the Colgates the modifications sought by Harriet Colgate in the partnership agreement drafted on December 31, 1942. Harriet withdrew her objections when the original draft was altered to meet her demands. The reformed partnership agreement was signed by the three Harknesses on February 27, 1943, and by Harriet Colgate on March 10, 1943. The terms of this agreement were as follows:

These Articles of Co-Partnership, made and entered into this 31st day of December, 1942, by and between Floyd J. Harkness, first party, Molly A. Harkness, second party, Floyd James Harkness, Jr., third party, and Harriet Harkness Colgate, fourth party, the first, second, and third parties being residents of the County of Fresno, State of California, and fourth party being a resident of Columbus, Franklin County, Ohio:

WITNESSETH:

That the said parties hereto for themselves, their heirs, executors, administrators and assigns agree to become co-partners in the business of carrying on a general business of growing, packing, shipping and distributing of fresh fruit and vegetables in the State of California, including the purchasing and selling of any and all kinds of real and personal property necessary in carrying on and conducting said business, and said business shall be conducted under the firm name and style of "United Packing Co." from January 1st, 1943 until such time as the said co-partners shall mutually agree to dissolve said co-partnership, or the said co-partnership shall be otherwise as hereinafter provided dissolved, and that the terms upon which the said parties have entered into said co-partnership are hereinafter stated as follows, to-wit:

That the said business of growing, packing, shipping and distributing of fresh fruit and vegetables and any other business which shall be incidental and necessary thereto, shall be carried on in the State of California and that the principal place of business of said co-partnership shall be in the Rowell Building in the City of Fresno, County of Fresno, State of California or at any other place or places as the partners shall hereafter determine and that the firm name and style of said co-partnership business shall be United Packing Co., with real and personal property belonging thereto located in the Counties of Kern, Tulare, San Joaquin and Fresno, State of California.

It is understood and agreed by and between the parties hereto that said first party has been conducting the above mentioned business individually under the firm name and style of United Packing Co., and that he and Molly A. Harkness, his wife, second party herein, have been the owners of all the real and personal property, equipment and materials that are now used in carrying on said business, together with such moneys as may now be on deposit in the name of the said United Packing Co. and together with any and all outstanding accounts owing as of this date, the said Floyd J. Harkness and Molly A. Harkness, first and second parties herein, do by these presents, sell, convey and set over, an undivided one-fourth partnership interest in and to all of the partnership property of the United Packing Co. to each of the third and fourth parties, namely, Floyd James Harkness, Jr., and Harriet Harkness Colgate, and from this date on each of the said co-partners above named, shall be and become the owners of an undivided one-fourth interest of all of the property of the said co-partnership doing business under the firm name and style of United Packing Co. and that the real and personal property which shall compose the capital of the said co-partnership and belong to the newly organized co-partnership is described in a Schedule marked Exhibit "A" and attached hereto and made a part of this agreement as if herein fully set out, and that there shall also belong to said co-partnership any and all other assets which now belong to said co-partnership and are not herein described as well as any and all other assets which may hereafter belong to said co-partnership; that all thereof shall belong equally to all of the partners herein named and in consideration of said first party conveying all of said real and personal property to said co-partners being conducted under the firm name and style of the United Packing Co., and which is agreed to be of the net value of $ 138,241.61, that the said third and fourth party shall each execute in favor of first party a promissory note in the sum of $ 34,560.40, payable in the manner as therein set forth to first party, and which sum shall be the purchase price for their undivided one-fourth interest in and to all of the assets of said co-partnership.

It is understood and agreed by and between the parties hereto that the said first and second parties are husband and wife and that all of the property which said first party is on this date conveying to the newly formed co-partnership, in which all of the above named parties are equal partners, has been accumulated by first and second parties during their married life and is the community property of first and second parties and that one-half thereof, by reason thereof, is the property of said second party and that the said second party does herewith join first party in the conveying of all of the said assets herein described to the said co-partnership so that from this date on, all of the said property now belonging to the said United Packing Co. and any and all other property which may hereafter belong to said co-partnership shall be owned equally by all the said co-partners.

It is understood and agreed by and between the said co-partners that said first party shall be, and is from this date on made the general manager of said co-partnership, and that he shall be in full charge of all business operations of said co-partnership and that he shall have the full right to conduct the business of said co-partnership in such manner as he may desire, including the selling of any and all of the partnership assets and the purchasing of such other property as he may desire in the name of said co-partnership together with the right to borrow such money as he may deem necessary to carry on said business and in consideration thereof it is understood and agreed that first party is to receive for his said services a certain percentage of the net profits of said business to be agreed upon between all of the partners herein from time to time as they may agree upon between themselves, and that the balance of the net income of said co-partnership shall be equally divided between all of the co-partners herein at such time or times as they may agree upon, provided however, that any profits which third and fourth parties are entitled to receive shall be paid to first party and applied by him first, to any payment which first party may have advanced to third and fourth parties, together with interest thereon and the balance thereof, if any, shall be applied by first party in the payment of the promissory notes which the said third and fourth parties have executed in favor of first party for the purchase price of their share in said co-partnership business.

It is understood and agreed that the said first party as general manager, and anyone of the other co-partners acting together shall have the right to bind the said co-partnership in such manner or form as they may deem necessary, in order to carry on the business of the said co-partnership, and that no other co-partner shall have the right to in any manner bind the said co-partnership, and that no co-partner shall have the right to in any way sell, assign, set over, transfer or hypothecate his undivided one-fourth interest in said co-partnership without first obtaining the written consent of two other co-partners.

It is understood and agreed that said first party as general manager of said co-partnership shall devote such portion of his time and attention to the conducting and carrying on of said business, as he shall deem necessary and proper but that he will at all times use his own good judgment and best efforts and experience in carrying on said business for the best interests of all parties concerned and that second, third and fourth parties shall shall not devote any time or attention in carrying on said business unless hereafter agreed upon by and between any three of said co-partners and at that time it shall be agreed upon by and between any three of said partners as to what the compensation shall be for the services which third or fourth partner may contribute towards the carrying on of said co-partnership business.

It is understood and agreed that there shall be kept at all times a complete set of books of account wherein there shall be entered any and all records and transactions of said business and that the said first party shall have complete charge thereof and that said books shall be under his immediate supervision and that the said first party shall have the full charge of the collections and expenditures of all of the moneys received and taken in, in the carrying on of said business, and that all of the business transactions of said first party in carrying on said business shall be binding on all of the said co-partners.

It is understood and agreed in this connection that first party will render on the 1st of each year a true and full statement and account of the profits or losses of said business and all other matters and transactions done and performed in connection with said business.

It is understood and agreed by and between the parties hereto that upon the consent of the managing partner and two of the remaining partners that the capital of the partnership may be increased to such sum as may be determined by them, and that thereafter each of the partners shall contribute their respective share of the capital increase. In the event the managing partner and two of the other partners desire to reduce the capital of the partnership or withdraw profits, then such determination shall become binding upon all the partners hereto.

It is further understood and agreed by and between the parties hereto that each one of the partners will not, without the previous consent in writing of the other partners, enter into any bond or become bail or security for any person or persons or do or suffer to be done anything whereby the capital or property of the co-partnership may be taken by execution and that each partner shall punctually pay his own separate debts and should anyone of the said co-partners become financially involved in outside interests so that his share in the said co-partnership business shall become involved, and should anyone of said co-partners in any manner so become involved then the other co-partners shall have the right to acquire such insolvent partner's right, title and interest in said co-partnership at the book value thereof without any consideration of the good will of the said co-partnership and upon such transfer, such insolvent partner shall have no further right, title and interest in and to the capital assets of the said co-partnership.

It is understood and agreed that in the event that anyone of the said co-partners desire to sell or in any way dispose of their interest in the said co-partnership business, that then the remaining co-partners shall have the right to purchase such partner's interest interest in said co-partnership and then the selling co-partner shall convey all of his right, title and interest in and to the said co-partnership property to the remaining co-partners, and shall receive for such conveyed interest the book value of such interest at said time without any consideration of the goodwill of the co-partnership and that the amount which the selling co-partner shall receive may be paid in cash by the remaining co-partners, but if the remaining co-partners do not desire to pay cash for the selling partner's interest, then they shall have the right to pay such amount by the application of the profits from the business of such selling partner's share and that the same shall continue to be paid in this manner until the said purchase price of such selling partner's interest in said co-partnership shall have been paid in full, and then such selling partner shall execute in favor of the remaining co-partners a Bill of Sale conveying all of his right, title and interest in and to the said co-partnership business and assets to the remaining co-partners.

It is understood and agreed by and between the parties hereto that should anyone of the partners become deceased, that then the remaining co-partners shall have the right to purchase such deceased partner's share in said business at the book value at the time of the death of such co-partner without any consideration of the good will of the partnership and such deceased partner's interest in said business shall be paid to the legal representative of such deceased partner and then the legal representative of such deceased partner's estate shall convey all of the deceased partner's right, title and interest in and to the said co-partnership property to the remaining co-partners and the legal representative of such deceased partner shall receive for such conveyed interest the purchase price for such deceased partner's interest which may be paid in cash by the remaining co-partners or if the remaining partners do not desire to pay cash for such deceased partner's interest, then they shall have the right to pay such amount by the application of the profits from the business of such deceased partner's interest and that this method of payment shall continue until the said purchase price of said deceased partner's interest shall have been paid in full and that upon such payment in full of the purchase price of said deceased partner's interest in said co-partnership the legal representative of such deceased partner shall execute and deliver to the remaining co-partners a Bill of Sale conveying all of the said deceased partner's interest in the said co-partnership business and assets.

It is also agreed by the co-partners that in the event of any misunderstanding between the co-partners concerning the matter of conducting and carrying on of said business that then the partners shall, between themselves adjust the same; it is however understood in this connection that the decision of the general manager and one other partner hereto shall determine any question which may arise between them and in the event that anyone or more of said co-partners should be dissatisfied with such decision then they shall have the right as given them by the laws of the State of California to bring proceedings in court for the purpose of either dissolving the said co-partnership or obtaining such relief as they are entitled under the terms of this co-partnership.

It is further understood and agreed that this co-partnership business is entered into on the proposition that each partner has an equal interest therein and is entitled to an equal share in all gains, profits and increases which shall come, grow or arise from, or by means of said business so long as such partner or partners shall not be in default in any of the terms of this agreement and that each partner shall be entitled to his one-fourth share of the said profits and that each partner shall likewise share equally in any losses which the said partnership may sustain and that each partner shall in the event it becomes necessary to furnish additional funds by reason of any losses which the said partnership may sustain, then each partner shall furnish and pay into the said business his equal share which may be necessary in order to continue on with the said co-partnership business. It being agreed that the decision of the managing partner and any two of the remaining partners shall be final as to the matter of the division of the profits and the amount which may be paid in by each partner in the event it becomes necessary to do so on account of losses sustained by the said co-partnership.

That at the end or sooner determination of their co-partnership, the said co-partners, each to the other, shall and will make a true, just and final accounting of all things relating to their said business, and in all things truly adjust the same; and that all and every stock and stocks, as well as the gains and increase thereof, which shall appear to be remaining, either in money, goods, wares, fixtures, debts or otherwise, shall be divided between them, share and share alike.

In Witnesseth Whereof, the above named partners have hereunto set their hands and signatures the day and year first above written.

In February 1943 an undivided one-half interest in a 300-acre vineyard and orchard was acquired by Harkness, Sr., Molly Harkness, Harkness, Jr., and Harriet Colgate, as tenants in common. The other half interest in the ranch was acquired by Chris Sorenson and his wife. Sorenson was a supervisory employee of the United Packing Co. All funds for purchase of the vineyard were supplied by United Packing Co. and the amount loaned to Sorenson was repaid to the company by him. The 50 per cent interest acquired by the Harknesses and Harriet Colgate was included as an asset of United Packing Co. and subsequent income therefrom was included in its net income. Previously, on January 16, 1943, by a bill of sale the personal property on the River Ranch had been conveyed to Chris A. Sorenson and Katharine Sorenson, his wife, and "Floyd J. Harkness, Molly A. Harkness, Harriet Harkness Colgate and Floyd J. Harkness, Jr., co-partners, doing business under the firm name and style of United Packing Co., a co-partnership." Prior to these purchases, all the partners were consulted with respect to them, and Harkness, Jr., who was familiar with the land, approved the transactions.

During the year 1943 there was no change in the operation of United Packing Co. over prior years. The business was still completely under the control of Harkness, Sr. Harriet and William Colgate were absent from Fresno until his discharge from the armed services in October 1944, so consequently she performed no services for United Packing Co. during the year 1943, nor did she participate in the management of its affairs. Throughout the year 1943 until December, Harkness, Jr., was stationed at Hamilton Field, California, approximately six hours traveling time from Fresno, and frequently visited the company's office and packing plants on week ends. While he was unable to participate in the business activities, yet he discussed its problems with his father on these occasions. In December 1943 Harkness, Jr., went overseas with the Air Corps and did not return to Fresno until January 1946.

In 1943 United Packing Co. earned gross proceeds of $ 2,572,905.53 and a net income of $ 361,582. In accordance with the terms of the supplemental agreement Harkness, Sr., was paid a salary of $ 75,000 and Harkness, Sr., Molly Harkness, Harkness, Jr., and Harriet Colgate each were credited with $ 71,645.50 as their respective shares of the profits.

Harriet's credit on the partnership books was first applied to pay off the principal and interest on her promissory note to Harkness, Sr., in the amount of $ 35,942.82, and to offset prior withdrawals from her capital account, consisting of cash in the amount of $ 112.97 and sums of $ 1,070.89 and $ 31,423.67 paid to the collector of internal revenue. The balance of $ 3,095.15 which she left in the business at the close of 1943 was withdrawn in 1944 to pay for taxes and personal expenditures. Of the $ 71,645.50 credited to Harkness, Jr., $ 34,495.08 was turned over to his father to pay the principal and interest on his promissory note. Of the remaining $ 37,150.42 which he left in the business in 1943, young Harkness expended $ 331.58 for his own use in 1944.

United Packing Co. filed a partnership return for the year 1943, reporting a net income of $ 361,582, compensation of $ 75,000 paid to Harkness, Sr., and the distribution of $ 71,645.50 from profits to each of the three Harknesses and to Harriet Colgate.

Harkness, Sr., and Molly Harkness filed separate income tax returns in 1943. As residents of a community property state, each reported one-half of the total income of $ 218,291 they together received from United Packing Co. in 1943, or $ 109,145.50.

In his notices of deficiency sent to petitioners respondent determined that the net income of United Packing Co. for 1943 was $ 361,823 and that each petitioner realized one-half of this amount, or $ 180.916, as community property income. The notice of deficiency sent to Harkness, Sr., stated in part:

(a) On December 31, 1942, you and your wife, Molly A. Harkness, together with your two children, Floyd James Harkness, Jr., and Harriet Harkness Colgate, executed an instrument purporting to create a family partnership. Since Floyd James Harkness, Jr., and Harriet Harkness Colgate contributed no capital originating with themselves, rendered no services to the business, and were not required to participate in the control and management of the business under the terms of the alleged partnership agreement, it is held that they did not acquire valid partnership interests in the United Packing Company. Accordingly, profits from the above-named organization are reallocated to you and your wife on a community property basis, thus increasing your taxable income by $ 71,770.50 as shown below.

Total net profit of United Packing Company	$ 361,832.00
Your community one-half share	180,916.00
Amount reported on return	109,145.50
Adjustment -- Increase	$ 71,770.50

Similar language was contained in the notice of deficiency received by Molly Harkness.

The three Harknesses and Harriet Colgate had no intent to join together in conducting the business of United Packing Co. as bona fide partners in 1943 and thus their partnership was not valid for tax purposes in that year.

OPINION.

The only question for our determination in this case is whether a partnership, valid for tax purposes, existed between petitioners and their children, Harkness, Jr., and Harriet Colgate, in 1943. Petitioners contend that a valid partnership was formed between petitioners and their children on January 1, 1943, for the conduct of business under the name of United Packing Co., which continued in existence throughout the year. There is no contention on their part that William Colgate was a partner during this period. Respondent argues that all the net income of United Packing Co. in 1943 was community income of petitioners because no bona fide partnership existed in that year. Since this case arises in a community property state, California, and there is no serious contention denying the wife's interest in United Packing Co., our consideration is directed to the alleged participation of the children in the business as partners.

In determining whether a bona fide partnership existed between the three Harknesses and Harriet Colgate in 1943, the basic question is, as the Supreme Court stated in :

* * * 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. [Italics supplied.]

While some of the evidence in this proceeding is indicative of a valid family partnership, yet, after careful study of the purposes which motivated the formation of a partnership for the conduct of United Packing Co., the circumstances existing at the time of this decision, the partnership agreement and the supplementary agreement thereto, and the actual conduct of the business throughout the year 1943, we are convinced that there was no intent on the part of the four alleged partners to join together in the present conduct of United Packing Co. in 1943.

Both the purposes stated by Harkness, Sr., for converting the sole proprietorship into a partnership and the circumstances existing at the time of this decision in the fall of 1942 plainly show it was not contemplated by any of the parties that the Harkness children would contribute substantial capital or vital services to the conduct of the business in 1943 or play any active part in its management. The evidence is clear that Harkness, Sr., offered his son and daughter an opportunity to acquire an interest in United Packing Co. in 1943 primarily to obtain the future services of his son and his son-in-law, William Colgate. He did not thereby expect to acquire either capital or services from Harriet at any time, but wished to provide her with an opportunity for investment and lay the foundation for future participation in the company's affairs by her husband. His testimony shows that the year 1943 was chosen for conversion of the sole proprietorship into a partnership in order to guarantee the services of young Harkness and William Colgate after their return from the war, rather than to secure their present services.

Q. You knew at the time you organized the company both your son and son-in-law were in the service, and you knew, naturally, that they couldn't render any service at the time. Why did you create the partnership knowing that they could not render any service until they were released from the Army?

A. I wanted to be sure of their services * * *

The circumstances existing in the fall of 1942 also make it obvious that no vital services or contributions of original capital could have been expected from the Harkness children in 1943. Harkness, Jr., had been in the Army since January 1942, and there was little likelihood of his return to Fresno for the duration of the war. He owned no substantial property at this time and his prospective earnings were low while in the Army. Harriet had left California to accompany her husband across the country in his various stateside Army assignments in August 1942 and there was no certainty when he would be released. At the time of her marriage she had no independent means of her own and the evidence does not reveal the capital resources of her husband.

In keeping with economic status, neither Harkness child made any substantial contribution of new capital to United Packing Co. when the partnership was formed in 1943. Harriet acquired her one-fourth interest in the partnership solely by means of a promissory note, which was paid entirely out of the company's profits accruing from the business at the close of the year. Young Harkness gained his interest in United Packing Co. by using a credit of $ 1,392.05 owed him by his father for prior services and by signing a promissory note for $ 33,168.35, which was paid out of company earnings for 1943. Since this credit was but a tiny fraction of the company's total capital of $ 138,241.61 on January 1943, we must conclude that neither Harkness, Jr., nor Harriet Colgate contributed any substantial capital not already available to the company within the meaning of .While such lack of a capital contribution originating with themselves is not in itself determinative of the partnership status of the Harkness children, yet the presence or absence of such a capital contribution is a significant test of whether the parties intended to form a bona fide partnership. ;.

Turning to the partnership agreement, it also refutes an intent by the signatories to join together in the present conduct of the affairs of United Packing Co., but rather shows an intent that Harkness, Sr., continue to control the conduct of the business as in prior years, when he was sole proprietor. The parties therein agreed that neither Harriet, young Harkness, nor Molly Harkness would devote any time to carrying on the business unless thereafter agreed upon, but that Harkness, Sr., would be general manager thereof in full charge of all business operations which he might conduct as he chose. Harkness, was given full charge of the books of accounts of the partnership and of the collection and expenditures of money taken in. His consent was necessary to bind the partnership in any business transaction and to lower or raise partnership capital. His participation was necessary in the adjustment of any misunderstanding between the partners as to the conduct of the business and in the determination of the proper allocation of profits and losses among the partners. Furthermore, the Harkness children had no unhampered enjoyment of their share of the profits, for net income accruing to them was first to be turned over to Harkness, Sr., and applied to any payments he may have advanced to them and the balance was then to be applied on the promissory notes executed in his favor. Thus by the terms of the partnership agreement Harkness, Sr., retained a controlling position over the company's activities and the income therefrom.

The supplementary agreement of January 4, 1943, also contradicts any intent on the part of the alleged partners to join together their services in the conduct of United Packing Co. in 1943. By its provisions Harkness, Sr., alone was to receive compensation for services because he was to be the only active partner in the business for the duration of the war.

Finally, the actual conduct of the business of United Packing Co. in 1943 makes it clear that the parties intended for Harkness, Sr., to operate it as a sole proprietor for the duration of the war. Young Harkness and Harriet Colgate rendered no vital services, nor did they participate in the management of the business during that year. Harriet was absent from Fresno the entire time. While by chance young Floyd was stationed in California during almost all of 1943 and frequently visited the company's plant on week ends to talk over business conditions with his father, yet such visits hardly bespeak an active role in the conduct of the company, but rather a continuing interest therein by a prospective participant. The evidence reveals only one transaction, the purchase of River Ranch, where the approval of his children was sought by Harkness, Sr. Nor was Floyd, Jr.'s, intent to perform future services for United Packing Co. on his return from the war sufficient to give him a partnership status in 1943. As the Supreme Court said in :

* * * The intent to provide money, goods, labor, or skill sometime in the future cannot meet the demands of §§ 11 and 22 (a) of the Code that he who presently earns the income through his own labor and skill and the utilization of his own capital be taxed therefor. The vagaries of human experience preclude reliance upon even good faith intent as to future conduct as a basis for the present taxation of income.

Harkness, Sr., frankly admitted in his testimony that the conduct of the company's business was not altered in 1943, but remained essentially the same as in 1942, when he operated United Packing Co. as a sole proprietor. We conclude that he continued to dominate all phases of the company's life as before, and that the children acquiesced in such control of the business by their father. The evidence is decisive that the income of United Packing Co. for 1943 was earned by the efforts of Harkness, Sr., and that the capital was contributed by both petitioners rather than from the services or capital contributions of the son and daughter.

Nor were Harkness, Jr., and Harriet Colgate entirely free to enjoy the fruits of their respective interests in the partnership at the close of 1943. In accordance with the partnership agreement Harkness, Sr., had first call on their shares of the company's net earnings for the year to offset the credit he had advanced to Harriet's capital account and to pay off the principal and interest on both their promissory notes which he held. Only after these obligations had been met were the children allowed to exercise control over their shares of the profits of United Packing Co.

On the basis of all the evidence, we believe that the three Harknesses and Harriet Colgate had no present intent, but rather an indefinite future plan, to operate United Packing Co. as a genuine partnership when the partnership papers were drawn up, and thus we conclude, and have found as a fact, that the Harkness children were not bona fide partners in 1943 within the meaning of We therefore hold that one-half of United Packing Co.'s net income for 1943 should be taxed to each of the petitioners as owners of the business in community. Due to the fact the amount of the company's net income for 1943 determined by respondent is at variance with the amount stated in the stipulation of facts, the deficiencies in the income tax liabilities of petitioners must be redetermined.

Decisions will be entered under Rule 50.