Damner v. Commissioner

Herbert L. Damner, Petitioner, v. Commissioner of Internal Revenue, Respondent

Damner v. Commissioner

Docket No. 2376

United States Tax Court

3 T.C. 638; 1944 U.S. Tax Ct. LEXIS 142;

April 18, 1944, Promulgated

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Decision will be entered under Rule 50.

1. The net worth of a business allocated between separate property of the petitioner and community property for the purpose of fixing the value of a gift to his wife by an agreement transmuting his separate property into community property.

2. A presumption of California law favoring community property does not relieve the taxpayer of the burden of overcoming the presumption of correctness of the Commissioner's determination.

3. A donor, who, under a mistaken conception of law, takes no part of the specific exemption in the gift tax return, is entitled to claim the exemption in a proceeding for redetermination.

H. F. Baker, C. P. A., and A. D. Schaffer, Esq., for the petitioner.

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

Arundell, Judge.

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ARUNDELL

This proceeding is for the redetermination of a deficiency in gift tax for the calendar year 1939 in the amount of $ 3,130.77, and a penalty in the amount of $ 469.62 for delinquency in filing a gift tax return. The primary questions involved are whether or not a gift was made by the petitioner to his wife when they entered into an agreement converting any separate property then held by either of them into community property, and, if so, the value of the gift. Also involved are the right of the petitioner to claim a specific exemption of $ 40,000, and the correctness of the delinquency penalty.

FINDINGS OF FACT.

The petitioner, Herbert L. Damner, is an individual residing in San Francisco, California, with his principal office at 146 Geary Street, San Francisco. The gift tax return for the period here involved was filed with the collector for the first district of California.

From the year 1927 until January 31, 1936, the petitioner was a member of the partnership of Damner Brothers, engaged in the manufacture and wholesale fur business. While a member of that firm he received a salary and a share of the profits of the business. The partnership was dissolved on January 31, 1936, and the petitioner received, as his distributive share of the partnership assets, merchandise and accounts receivable of a value of $ 27,365.44.

On September 23, 1929, the petitioner was married. His net worth as of that date is unknown. As of January 31, 1930, his net worth was $ 94,086.83. On January 31, 1935, his net worth had declined to $ 41,279.82, and on January 31, 1936, the date of dissolution of the partnership, it was $ 27,365.44.

When the partnership was dissolved the petitioner embarked upon a retail fur business, as an individual, operating as concessionaire the fur department of H. Liebes & Co., a San Francisco store. Subsequently, he took over the operation of the fur department in the Emporium, another San Francisco store. The net worth of this business increased as shown below:

Jan. 31, 1936	$ 27,365.44
Jan. 31, 1937	95,867.44
Jan. 31, 1938	101,126.17
Jan. 31, 1939	127,572.58

In the operation of the business during the period 1936 to 1939 the petitioner purchased merchandise, supplies, etc., on his own unsecured credit, in the aggregate amount of $ 1,334,362.43. In the same period he borrowed from banks the amount of $ 414,213.94 on his unsecured credit.

From the time of his marriage the petitioner maintained a single bank account, upon which he alone could draw checks and from which he paid both his business and personal expenses. No attempt was made to keep separate accounts of community income and separate income.

The petitioner filed his income tax returns on the community property basis, allocating annual profit between return on capital and income attributable to personal services. A certain percentage of annual average invested capital was deemed to be return on capital, and the balance recompense for services. Over the three-year period the aggregate amount so allocated to return on capital was $ 15,594.63. In the same period the aggregate amount shown on the returns as attributable to services was $ 106,897.90. For each of these years the petitioner entered into an agreement as to final determination of tax liability with the Commissioner. The basis for the computation for tax for the fiscal years ended in 1937 and 1938 is unknown, but the recomputation underlying the closing agreement for the fiscal year ended in 1939 did not alter the item of return on capital.

The petitioner's returns for those years consistently showed the capital investment in the business as his separate property. The return for the fiscal year ended January 31, 1939, showed as separate property the net worth of the business in the amount of $ 127,572.58. The closing agreement for that year, entered into May 1, 1941, fixed the tax due upon the basis of the petitioner's separate net worth of $ 127,572.58 as of January 1, 1939.

On January 17, 1939, the petitioner, in connection with the drawing of a new will, entered into an agreement with his wife, which agreement provided as follows:

First: That, save and except such property as is now owned by the parties in joint tenancy or the interest of either of said parties in any life insurance contract or policy, all property now owned by them, or either of them, whether real or personal or of whatever kind or nature, is the community property of said parties, and each thereof so hereby declare it to be.

Second: That, save and except such property as may be hereafter taken and acquired by the parties hereto as joint tenants or any hereafter acquired interest in any life insurance contract or policy, all property hereafter acquired by the parties, or either of them, whether earned by capital or by personal efforts or otherwise acquired, and irrespective of whether real or personal or whatever its nature, shall be deemed to be, and is hereby declared to be, the community property of the parties for all purposes.

Third: That, subject to the exceptions noted above, it is the intent hereof, irrespective of whether the fulfillment of such intent may presently involve gifts or conveyances between the parties hereto, that all property now held by them, or either of them, and all property to be hereafter acquired and accretions thereof or earnings of capital, or by the personal efforts of the parties, be deemed transmuted into community property of the parties, and so hereby declared to be the property of the community existing between them; -- it is not the intent hereof to alter the legal relation of the parties except as to such property.

On May 17, 1940, the petitioner filed a delinquent gift tax return in which he reported a gift to his wife in January 1939 of one-half of whatever separate property he then possessed, which return showed no tax due. The Commissioner determined that the separate net worth of the petitioner as of the date of the agreement was $ 127,572.58, and that the value of the gift was one-half of such amount, or $ 63,786.29, and determined a tax and penalty accordingly.

The separate net worth of petitioner at the time he made the gift to his wife in 1939 was $ 42,960.07. One-half of this amount, or $ 21,480.03, was the value of the gift made to Mrs. Damner through the transmutation agreement.

OPINION.

The basic question is the value of the petitioner's separate property, if any, on the date of the so-called transmutation agreement. If the petitioner was possessed of any separate property on that date, it is unquestioned that a gift of one-half of the value of that separate property was made, since the wife, by virtue of section 161 (a) of the California Civil Code, takes a "present, existing, and equal" interest in property coming into the community estate after the effective date of that statute, July 29, 1927.

The question is purely factual. The Commissioner has determined that the net worth of the petitioner's business at the time of the gift was approximately $ 127,000 and was the separate property of the petitioner. This determination was evidently based upon the income tax return for the fiscal year ended January 31, 1939, in which the income of the business was allocated between return on capital and compensation for services on the theory that the business was the separate property of the petitioner. He now contends that the return was erroneous in that respect and that $ 127,000 did not, in fact, represent his separate property.

Indicative of the plausibility of this contention is the fact that the business growth was due exclusively to the retention of profits in the business from year to year. Those profits were preponderately community property and were treated as such by the Commissioner in the final determination of tax liability each year from 1937 to 1939. Manifestly, to the extent profits representing community property were plowed back into the enterprise, it was not the separate property of the petitioner, but community property.

In the returns for each of the years in question the taxpayer apportioned the net profits of the business between income attributable to capital and income attributable to his services. The first, under the law of California, is his separate property and the latter represents community property. His method of allocation satisfied the Commissioner and is not here questioned. Over the three-year period a total amount of approximately $ 15,600 was thus allocated to separate income.

Closing agreements for all three years were entered into by the petitioner and the respondent. Only the agreement for the fiscal year ended January 31, 1939, discloses the actual recomputation of tax, and in this agreement the item representing income attributable to capital is left unaltered. From the comparatively small deficiencies agreed upon for the other two years, it is evident that there was, in those agreements, no substantial alteration of the separate income of the petitioner.

Thus, the aggregate separate income of the petitioner during the three-year period was not more than approximately $ 15,600. More than this, he could not separately have contributed to the expansion. The balance of the increase must be due to community earnings, which in this period totaled approximately $ 107,000.

Therefore, it seems inescapable that the petitioner's separate worth as of January 15, 1939, was not more than the sum of his separate net worth as of January 1936 and his separate income from that time to 1939, or approximately $ 42,960.07. One-half of this amount, or $ 21,480.03, was the value of the gift made to Mrs. Damner through the transmutation agreement.

A word concerning the contentions of the petitioner, which we have not chosen to adopt, may not be inappropriate. He has argued that he was possessed of no separate property as of the date of the transmutation agreement; first, because prior to that time there was an "understanding" between the spouses that all their property was held as community property; and, second, that in any event community property had been so commingled with the assets of the business as to make the whole community. In regard to the first contention, "the separate property of either or both spouses may be transmuted into community property and this may be done without the necessity of any written agreement providing the agreement or understanding to that effect is fully consummated." In re Sill's Estate, 9 Pac. (2d) 243. The only testimony on this point is to the effect that it was the intention of the husband that his wife should have an "equal partnership" in everything he possessed. Nothing shows that this intention was ever communicated to the wife; no discussion with reference to the property was ever had between them. We think that this evidence is inadequate to establish an understanding or agreement transmuting separate property into community property.

As to the second contention, the rule in California is to the effect that where separate and community property are commingled the burden is upon him claiming the separate property to establish the segregation. In the absence of the segregation, the whole will be treated as community. This is an extension of the general presumption favoring community property, and between litigants in the courts of California is undoubtedly controlling. However, in this proceeding the taxpayer is confronted with the presumption of correctness attaching to the Commissioner's determination. The conflict of presumptions resolves itself in favor of the respondent, and the petitioner retains the burden of proof. Shea v. Commissioner, 81 Fed. (2d) 937.

One further question remains. The petitioner, thinking that no taxable gift had been made, claimed in his return no deduction under section 505 (a) (1) of the Revenue Act of 1932, as amended by section 301 (b) of the Revenue Act of 1935, ¹ allowing a specific exemption of $ 40,000. He now claims the right to such deduction. It has been held that a donor who, under a mistaken conception of law, takes no part of the specific exemption in the computation of gift tax is entitled to claim the exemption in a proceeding for redetermination. Amy Hutchison Crellin, 46 B. T. A. 1152; Richardson v. Commissioner, 126 Fed. (2d) 562, affirming on this point 39 B. T. A. 927. The petitioner is entitled to the specific deduction of $ 40,000 by reason of which there is no taxable net gift and accordingly no deficiency.

Inasmuch as there is no deficiency in gift tax, the penalty must fall.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 505. DEDUCTIONS.

  In computing net gifts for any calendar year there shall be allowed as deductions:

  (a) Residents. -- In the case of a citizen or resident --

  (1) Specific exemption. -- An exemption of $ 40,000, less the aggregate of the amounts claimed and allowed as specific exemption for preceding calendar years.↩