Thorrez v. Commissioner

¶1concurring: Notwithstanding the many cases which have been decided involving claimed family partnerships, the line of demarcation between those in which such status has been recognized for tax purposes and those in which it has not been recognized is not clear. In the absence of pronouncement by the Supreme Court upon the subject, the judges of the various Circuit Courts of Appeal and of this Court have striven to find the correct rule. The result has not been entirely satisfactory, as is indicated by the divided opinion in this case. At the risk of increasing, rather than dispelling the fog of uncertainty, I respectfully state some of my views.

¶2Under the Revenue Act of 1917 tax was imposed directly upon the partnership. (40 Stat. 300, 303.) However, since 1918 the revenue acts1 have recognized the basic principle of partnership law: That a partnership is not, in any true sense, a separate entity, but, paraphrasing the language of Chancellor Kent, is the result of a contract of two or more competent persons to place their money, effects, labor, and skill, or some or all of them, in lawful commerce or business and to divide the profits and bear the losses in certain proportions. Cf. Meehan v. Valentine, 145 U. S. 611. Thus since 1918 each of the revenue acts has required what is usually spoken of as an “information” return and since 1921 each act has stated that “individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.”

¶3Under the Uniform Partnership Law, adopted in many of the states, business is a very comprehensive term, including “every trade, occupation or profession.” (See, e. g., New York Partnership Law, Consolidated Laws, ch. 39.) Without pausing to cite authorities, it may be stated that this is the view which has generally been taken of a partnership under the revenue laws.

¶4In most states a partnership may now exist among members of a family, including husband and wife, although at common law a husband and wife could not enter into such a relationship with each other. An infant’s contract of partnership is voidable; and if he affirms after attaining majority he will be bound. Whether one of tender years, purporting to have signed such a contract personally rather than through a guardian, as seems to have been the situation in the cases now before us, should not for that reason be considered to be a partner, may be passed. It is a circumstance, however, entitled to some consideration in determining the basic question, viz: Were all of the alleged partners “individuals carrying on business in partnership ?”

¶5One of the early, yet comparatively recent, cases decided by the Supreme Court is Burnet v. Leininger, 285 U. S. 136, which has been cited many times. In that case a written agreement confirmatory of a preexisting oral contract was entered into between the taxpayer and his wife, wherein it was acknowledged that she had been and was a full equal partner with him in his one-half interest in the Eagle Laundry Co., entitled to share equally with him in the profits and obligated to bear equally any losses. The wife took no part in the management of the business and made no contribution to its capital.

¶6In response to a contention by the taxpayer that the assignment to his wife was of one-half of the “corpus” of his interest and that this “corpus” produced the income in question,2 the Court said:

The characterization does not aid the contention. That which produced the income was not Mr. Leininger’s individual interest in the firm, hut the firm enterprise itself, that is, the capital of the firm and the labor and skill of its members employed in combination through the partnership relation in the conduct of the partnership business. There was no transfer of the corpus of the partnership property to a new firm with a consequent readjustment of rights in that property and management. If it be assumed that Mrs. Leininger became the beneficial owner of one-half of the income which her husband received from the firm enterprise, it is still true that he, and not she, was the member of the firm and that she had only a derivative interest. [Emphasis supplied.]

¶7In some of the cases decided since the Leininger case the emphasis has been placed solely upon the portion quoted above following the portion which I have taken the liberty of emphasizing. Thus the case has sometimes been construed to apply only to the situation adequately dealt with by the Court previously in Lucas v. Earl, 281 U. S. Ill, and discussed by it in the next subdivision of its opinion. Without expressing disagreement with this view, it seems to be entirely proper to consider in each case not only whether an assignment of an interest in the business had been made, but also whether the assignee had actually engaged in a firm enterprise — i. e., combined with others in the employment of the capital of the firm and the labor and skill of its members in the conduct of the partnership business. Under the present facts it is clear that the wives and children (with the exception of the one or two who worked in the business) furnished neither labor nor skill and that a substantial part of the income resulted solely from the labor and skill of their husbands and fathers. This brings us, then, to one of the tests which has sometimes been applied and which for want of a better term may be referred to as “personal service.”

¶8Numerous cases have been decided in which the existence of a partnership for income tax purposes has been denied because the income was derived, largely, if not exclusively, from the personal earnings of the husband. In this category are attorney fees (Tinkoff v. Commissioner, 120 Fed. (2d) 564); engineers’ fees (Schroder v. Commissioner, 134 Fed. (2d) 346); income from general insurance and real estate business (Mead v. Commissioner, 131 Fed. (2d) 323); commissions for writing insurance (Earp v. Jones, 131 Fed. (2d), 292); and commissions for selling shoes to dealers (Francis Doll, 2 T. C. 276; affd., 149 Fed. (2d) 239 (C. C. A., 8th Cir.). The difficulty is not so much in recognizing and applying this rule in appropriate cases. (But see Humphreys v. Commissioner, 88 Fed. (2d) 430.) The fallacy lies in adopting it as a postulate or major premise from which to start. In other words, the fact that the particular income under consideration may not be from practicing a profession or of the type mentioned in the cited cases, should not be accepted as a segment of a mold in which all partnership cases may be cast.

¶9To illustrate the thought which I have endeavored to bring out: Assume, e. g., a young graduate dentist, unable, for lack of finances, to establish himself in business. Recently married to one who has $10,000, the amount is put into fixtures and equipment under an arrangement to divide the profits. Shall it be said that no partnership existed because the income was derived solely from extracting and treating teeth ? The answer may be suggested by the reasoning of the court in Humphreys v. Commissioner, supra; but cf. Richardson v. Helvering, 80 Fed. (2d) 548 (estate tax). Whether it is correct is not now before us and is important only in examining one of the facets of the problem. Another, although not precisely like it, is the more familiar case where capital is essential (as in the plating business, which we have before us) but the skill of the guiding spirit is obviously the source of much of the income. The facts need not be repeated; but it is clear that capital played a less important part in the production of income than the skill of the taxpayers.

¶10Whether a more nearly correct answer to the problem posed could be reached by applying the rationale of Max German, 2 T. C. 474, 488, et seq., has not been suggested by either party. In that case it was obvious the wife had made a substantial contribution to the capital of the business. The record did not contain facts from which the profits of the business allocable to the wife could be determined with exactness. Nevertheless we felt it incumbent upon us “to determine the extent thereof as best we may on such facts as we do have.” We concluded that an allocation of 75 percent to the husband and 25 percent to the wife was reasonable and proper. Perhaps some such allocation could be made in the instant cases although it would of necessity be a mere approximation. Inferentially the Circuit Court of Appeals for the Eighth Circuit suggested such an allocation in the Doll case, supra, pointing out that the criterion for determining income tax liability is the “possession of attributes of ownership by the taxpayer.” However, the petitioners should have assumed their burden of showing how much of the income was derived from capital and how much from the labor and skill of the active partners; but they have made no effort to do so.

¶11Another segment of the mold, which some of the decided cases may tend to overemphasize, is whether a gift has actually been made by the one who established or breathed life into the business — usually, as in the cases at bar, the husband and father. Thus in the nine cases reported in the last bound volume of our reports, 3 T. C., which will be referred to seriatim, as well as in cases subsequently decided, including the present one, the circumstances surrounding the making of the alleged gifts have been referred to at length. In the Tower case3 it was held that there had been no unconditional gift by the husband to the wife of shares of stock in a corporation largely owned by him. The transfer had been conditioned upon the wife placing the corporate assets, which the shares represented, in a new partnership to be established by the husband, his wife and an individual who had owned 10 percent of the stock. The Circuit Court of Appeals for the Sixth Circuit, one judge dissenting, held that the gift was “both valid and complete” and that there was “no evidence upon which to base a conclusion that either the gift of corporate shares to the wife, or the organization of the partnership, was unreal and a mere artifice.” Accordingly it reversed our holding that the income of the business was taxable in toto to the husband. (Tower v. Commissioner, 148 Fed (2d) 388.

¶12The next case was the Lusthaus case,4 in which the husband undertook to vest one-half of his interest in two furniture stores in his wife, approximately half through a gift and half by purchase, the purchase being evidenced by a promissory note. Citing the Doll, Tower, and Schroder cases, supra, it was held that, even though the arrangement constituted a valid partnership under the laws of the state of domicile, it should not be given recognition for Federal income tax purposes. The Circuit Court of Appeals for the Third Circuit affirmed, although Judge Fake filed a vigorous dissent (Lusthaus v. Commissioner, 149 Fed. (2d) 232, basing its affirmance partially upon Dobson v. Commissioner, 320 U. S. 489. In answer to the taxpayer’s assertion that error had been committed by the Tax Court, the court pointed out that the cases5 “hold that the status must be genuine, with a change in economic interest.” It held that the circumstances surrounding the alleged gift of $50,000 could be construed as indicating that the taxpayer “had not divested himself irrevocably of the subject matter of the gift.” Whether the Tower and the Lusthaus decisions are in conflict with each other is not within our province and no opinion on that subject need be expressed.

¶13In the Lowry case 6 the taxpayers (Lowry and Sligh) transferred to their wives a portion of the stock of a furniture manufacturing company, most of the stock of which was owned by them. The corporation was then dissolved and an agreement was executed by the four, the husbands being designated general partners and their wives limited partners, the property of the corporation being transferred to the partnership. It was held that the wives had not received from their respective husbands “a complete economic interest in the portions of the property which purportedly went to them out of the. corporation, and from the wives into the partnership.” One of the circumstances relied upon was that the gifts had been made with full understanding that a plan devised by the husbands would be carried out which restricted the wives’ interests and required them to be limited partners rather than general partners, thereby preventing them from becoming absolute owners.

¶14In the Lorenz case 7 the taxpayer undertook to make a gift to his wife of a 50 percent interest in the tangible assets of an equipment company. It was pointed out that the “petitioner had not di vested himself … of the chief attribute of ownership of interests in property, namely, control over income.” Many of the outstanding cases wore analyzed and it was held that the facts failed to show that the wife exercised any control over the subject matter of (he alleged gift to her. The Circuit Court of Appeals for the Sixth Cii'cuit affirmed -per curiam,, partially on the authority of Dobson v. Commissioner, 320 U. S. 489.

¶15In the Scherer case 8 the owner of a profitable manufacturing business transferred to his wife, individually and as trustee for several named children, five-sixths of his interest. Although much of the success of the business was attributable to his ability, it was held, following Richard H. Oakley, 24 B. T. A. 1082, Justin Potter, 47 B. T. A. 607, and other cases, including J. D. Johnston, Jr., 3 T. C. 799, simultaneously promulgated, that the husband and father was engaged in a mercantile or manufacturing business and that he had made valid and completed gifts to his wife, individually and as trustee.

¶16Without criticising or attempting to justify the soundness of the conclusion reached, this circumstance may be alluded to. The Commissioner had determined very substantial deficiencies in gift tax in connection with the gifts which had been made and one of the issues submitted for determination was the value of the property transferred. In the income tax case, submitted contemporaneously, he was contending not that valid gifts had not been made, but that the income was taxable to the petitioner under the rationale of the Clifford case, supra (footnote 5). The inconsistency of the respondent’s con tentions in the gift tax case and in the income tax case furnished at least a modicum of justification for adopting the postulate that valid completed gifts had been made, especially in view of the fact that he was not contending otherwise.

¶17In the Johnston case9 the wife gave her husband an unsecured non-interest-bearing demand note, ostensibly in payment for one-half of his one-half interest in a partnership. A new partnership was then formed, which took over all the assets of the old and assumed its liabilities. The price paid by the wife was probably inadequate; but that was thought to be neutral, since the excess constituted a gift to her by her husband. It was held that the Commissioner erred in including all of the income from the 50 percent interest in the partnership in the taxpayer’s income.

¶18In the Zukaitis case10 petitioner and his wife, both before and after marriage, had jointly conducted a merchandising business. The business was carried on in the name of the husband. The parties executed a partnership agreement, the purpose of which was to make the wife an equal partner with the husband. It was held that, notwithstanding the fact husband and wife partnerships were not fully recognized under the laws of the state of domicile, nevertheless the wife, after the execution of the agreement, was entitled to one-half of the earnings of the business and that the husband was taxable only on the other half.

¶19In the Smith case11 petitioner executed a deed of gift to an undivided one-half interest in his lumber business. By accepting the gift the wife assumed equal and joint liability with her husband for the payment of all his debts and obligations. They then entered into a partnership agreement for the purpose of engaging in the lumber business. The deed of gift was held to be adequate to pass title to an undivided one-half of the assets of the business and the husband was held to be taxable upon only one-half of the income derived from its operation.

¶20In the Argo case12 the husband, an electrical engineer, undertook, by an oral agreement with his wife and through instructions to his bookkeeper, to divide the assets of a corporation, which had been distributed to him as its sole stockholder, among the members of the family. Decision that petitioner was taxable upon all of the income, notwithstanding the fact that he may have made bona fide gifts to his wife and children, was predicated largely upon the fact that the earnings of the business “were due mainly, though not entirely, to the personal activities and abilities of the petitioner as an electrical engineer under the principle applied in Earp v. Jones, …” cited supra, and other cases.

¶21The conclusion reached here may be contrary to that reached in the Scherer case; but it does not seem to be contrary to any of the other cases. The Argo case definitely supports the present decision. Whether the Scherer case and the other cases mentioned by Judge Black in his dissenting opinion “set a pattern” for all future cases, is debatable. Stare decisis, as the Supreme Court pointed out in Helvering v. Hallook, 309 U. S. 106, “is a principle of policy and not a mechanical formula for adherence to the latest decision, however recent and questionable, when such adherence involves collision with a prior doctrine more embracing in its scope, intrinsically sounder, and verified by experience.” If, therefore, the Scherer case can be construed as laying down a principle of law to be applied in resolving the difficult problem of fact arising in family partnership cases — which is doubtful — then perhaps it should be overruled. I view it, however, purely as a decision upon its facts. In that view, the possibility that it may have been contrary to the basic principle of Lucas v. Earl need not now disturb us.

¶22Some of my associates, for whose opinions I have the highest regard, seem to regard the cases as establishing the principle that if gifts of capital are made, followed by the execution of a document labeled a partnership agreement, the income is thereafter divisible unless the business is wholly “personal service.” That, it seems to me, is an unsound approach. The question always is: “Were the individuals actually engaged in carrying on business in partnership?” It can not be answered in every instance simply by looking at the capital investment. Take for example the minor daughter of the Miclmer’s, Elsie, in the case at bar. She was given an undivided one-third of the 25 percent interest of her father in the assets of the firm, the total value of which, as set out in the dissenting opinion of Judge Disney, was $109,464. Thus her interest in the assets was $9,122. During the taxable year she received $13,698.47. It taxes the credulity of the triers of facts to believe that Elsie’s capital, donated to her by her father, earned 150 percent per annum. It is far more reasonable to assume, as I think the facts clearly indicate, that a substantial portion of the amount resulted from the labor and skill of her father. In that view, Lucas v. Earl, supra, requires that the major portion of the income be taxed to him.

¶23My dissenting brethren are correct in their view that a citizen has a clear right to make a gift of property to his wife and children and to engage with them in “carrying on business in partnership.” His motive, even, is unimportant. But. while a taxpayer may assign capital to members of his family and permit them to have its fruits, he may not, through that guise, assign to them, tax-free, the income resulting from his own labor, skill, and industry. That, I am convinced by the record, is what occurred in the instant case. The suggestion that the taxpayers here, under the rationale of Helvering v. Taylor, 293 U. S. 507, may cast upon respondent the burden of proving how much of the income resulted from the capital investments and how much resulted from the labor and skill of the taxpayers is not sound, Respondent determined that the income was earned by the taxpayers. They have not proved otherwise. I therefore concur in the result reached by the majority.