Opinion
Docket Nos. 23940, 23941, 23942, 23943, 23944, 23945, 23946, 23947.
Promulgated September 19, 1952.
1. DEDUCTION — SALARY OF EMPLOYEE. — Amount allowed by respondent sustained, upon failure to show extent or value of services rendered.
2. PARTNERSHIP. — Held, that three wives became bona fide partners in a general partnership with their respective husbands and several other persons.
3. TRUSTS — SHARE OF PARTNERSHIP NET INCOME. — Certain members of a general partnership made transfers in trust by gifts of percentage interests in the partnership. The trusts were neither partners nor subpartners or joint venturers with the respective grantors. Each grantor retained dominion and control over the corpus of the trust. Held, that the grantors actually earned the partnership income in question and are taxable thereon.
Paul L. Martin, Esq., for the petitioners.
Frank M. Cavanaugh, Esq., for the respondent.
These consolidated proceedings involve income tax deficiencies for the calendar year 1943, determined against the respective petitioners in the following amounts:
Petitioners Deficiency
J. W. Boyt .............................. $149,371.95 A. J. Boyt .............................. 90,038.20 Estate of Paul A. Boyt, et al ........... 72,595.70 Barbaradina Boyt ........................ 1,088.37 Elizabeth M. Boyt ....................... 441.06 B. B. and Eva Quiner .................... 13,214.38 P. J. Kurtz ............................. 1,357.57 J. E. and Mearle N. Green ............... 1,102.86
The calendar year 1942 is also involved in each of these proceedings because of the forgiveness feature of section 6, Current Tax Payment Act of 1943.
In determining the deficiencies involved herein the respondent made numerous adjustments in the determination of the net income, for each of the years 1942 and 1943, of the general partnership of Boyt Harness Company and the net income of the Boyt Harness Company Limited Partnership, respectively. With respect to the effect thereof on the incomes of petitioners only one of such adjustments is assigned as error in each of these proceedings. Accordingly, the tax in controversy in each proceeding is less than the amount of the determined deficiency.
Paul A. Boyt initiated the proceeding in Docket No. 23492 and following his death the administrators of his estate were substituted as the petitioners in that proceeding.
One question presented and common to all the proceedings, is whether respondent in his determination of the net income of the general partnership for the year 1942, erred in disallowing $3,320 of a claimed deduction of $6,320 as compensation to an employee.
A second question presented and common to the proceedings in Docket Nos. 23940, 23941, and 23942, is whether the respondent erred for each of the years 1942 and 1943, in failing to recognize the respective wives of J. W. Boyt, A. J. Boyt, and Paul A. Boyt as partners in the general partnership taxable on their income therefrom and in taxing to each husband his wife's alleged distributive share of the net income of that partnership.
A third question presented and common to the proceedings in Docket Nos. 23940, 23941, 23942, and 23945, is whether the respondent erred for each of the years 1942 and 1943, in failing to recognize various trusts for the benefit of certain children as taxable on designated portions of the net income of the general partnership and in taxing such income to the grantors of the trusts, respectively.
FINDINGS OF FACT.
The stipulated facts are found accordingly and included herein by reference.
Each individual petitioner is a resident of Des Moines, Iowa. Their income tax returns for the periods involved were filed with the collector of internal revenue at Des Moines, Iowa.
The decedent Paul A. Boyt died intestate on July 20, 1951, a resident of Polk County, Iowa, and Dorothy F. Boyt and Fred H. Quiner are the duly qualified and acting administrators of his estate. The decedent's income tax returns for the periods involved were filed with the collector of internal revenue at Des Moines, Iowa.
The Boyt Harness Company, an Iowa corporation (hereinafter sometimes referred to as the Boyt Corporation), was organized in the latter part of 1933 and, at its place of business in Des Moines, Iowa, engaged in manufacturing harness, leather goods and kindred lines for farm use, until dissolved in 1941 as hereinafter mentioned. A predecessor corporation owned by members of the Boyt family had engaged in a similar line of business from 1901 until January 1934 when its assets were sold by a receiver to a group of persons consisting of the individual petitioners herein and Paul A. Boyt, now deceased. That group transferred such assets to the newly organized Boyt Corporation and received stock in proportion to their respective cash contributions for the purchase of the assets.
The stock of the Boyt Corporation so issued in 1934 in the names of J. W. Boyt, A. J. Boyt, and Paul A. Boyt was held by them on behalf of themselves and their respective wives, each of whom had made a substantial contribution, from her own funds, towards the venture. During the existence of the Boyt Corporation each of those wives rendered vital services to that company which had to develop new products if it was to remain in business because there was very little demand for harness. Mrs. J. W. Boyt performed various types of office work. Mrs. Paul A. Boyt assisted in advertising and selling. Mrs. A. J. Boyt experimented in designing and sewing new textile products such as horse and cow blankets, canvas covers, tractor seat and church pew cushions, etc., and estimated costs and selling prices. In 1940 the Boyt Corporation started bidding on comparatively small Government contracts for canvas and leather goods and the wives rendered vital services in connection therewith; namely, Mrs. J. W. Boyt handled the preparation of the numerous forms involved in the submission of bids, Mrs. A. J. Boyt helped develop the textile work contracted for and supervised the women engaged thereon, and Mrs. Paul A. Boyt interviewed all applicants for work in the then expanding business. None of the wives received adequate compensation for the long hours of services rendered.
During 1940 the Boyt Corporation did not have sufficient working capital or credit to finance large Government contracts and endeavored to interest Glen C. Herrick to that end, but he refused because it had assets of less than $50,000, and its machinery consisted mainly of heavy harnessmaking equipment. However, Herrick proposed the formation of a limited partnership between the corporation and himself to engage solely in the business of manufacturing certain types of canvas and leather military equipment.
On November 4, 1940, the Boyt Corporation as the general partner and Herrick as the limited partner entered into a limited partnership agreement, under the laws of Iowa, to conduct business at Des Moines, Iowa, under the firm name of Boyt Harness Company (hereinafter referred to as the Limited Partnership) to procure contracts with and manufacture products for the United States Government. Herrick agreed to contribute $500 as special capital, to procure the bidding and performance bonds, and to advance necessary funds for financing the contracts obtained, with such advances evidenced by the 4 per cent demand notes of the Limited Partnership. The Boyt Corporation agreed to contribute certain tools, equipment, machinery, etc., and also management. It was agreed that the Limited Partnership would purchase special dies, machinery and equipment; that it would pay the Boyt Corporation the actual cost of the manufacture of products contracted for, without allowance for the use of that company's machinery, equipment and premises or for salary to that company's officers; that it would not bid on work without Herrick's approval; and that its profits from completion of any contract would be divided between the general partner and the limited partner in the amounts of two-thirds and one-third, respectively, during the first year and thereafter three-fourths and one-fourth, respectively. It was agreed that the limited partner would not be liable for any losses in excess of his special capital contribution and further, that the Limited Partnership's books of account, funds, and disbursements would be maintained under the control of an employee of that partnership designated by Herrick. That agreement remained in effect until terminated in December 1944, except as modified with respect to the identity of the general partner as hereinafter mentioned. During the existence of the Limited Partnership it entered into and performed numerous contracts with several branches of the Armed Forces for production of items made from canvas, leather, and webbing, including haversacks, cartridge belts, gun covers, water tanks, pack saddles, pistol holsters, rifle slings, etc.
Entirely separate and apart from the Limited Partnership enterprises, the Boyt Corporation continued to engage in the production of certain civilian goods and maintained its own books of account and bank account, until its dissolution as of August 30, 1941.
During 1941 the stockholders of Boyt Corporation considered the dissolution of the company and the formation of a general partnership. Before any definite conclusion had been reached as to whether such a step could be carried out, in view of the limited partnership agreement, J. W. Boyt, A. J. Boyt, and Paul A. Boyt caused one-half of their respective shares in the Boyt Corporation to be issued to their respective wives. On August 1, 1941, the Boyt Corporation issued certificates of its capital stock to the wives as follows: Helen F. (Mrs. J. W.) Boyt 85 shares, Marjorie P. (Mrs. A. J.) Boyt 55 shares, and Dorothy F. (Mrs. Paul A.) Boyt 50 shares. Each of those transfers of stock was made in recognition of the wives' contribution to the original acquisition thereof in 1934 and of the valuable services rendered by them towards the success of the corporate enterprise. Those transfers were reported on gift tax returns to forestall any question as to the possibility of there being an indeterminate element of gift involved therein.
During the latter part of August 1941 and on advice of counsel, Herrick raised no question as to the proposed formation of a Boyt family general partnership provided it would assume and carry out the obligations of the Boyt Corporation.
On August 30, 1941, at a special meeting attended by all the stockholders of the Boyt Corporation, it was resolved that the corporation accept an offer to purchase its assets and assume its liabilities as of close of business on August 30, 1941, as made by a partnership composed of those stockholders. On August 30, 1941, eleven individuals, including petitioners and Helen, Marjorie, and Dorothy Boyt, executed an instrument providing that they, as sole stockholders entitled to the assets of the Boyt Corporation upon final distribution, direct the corporation to transfer all its assets to themselves as partners doing business under the firm name of Boyt Harness Company, a partnership, and further providing, that in consideration thereof "we do hereby as partners assume and agree to pay and discharge all debts and other obligations of said corporation and to perform all of its outstanding contracts as of the date of its dissolution."
On September 15, 1941, but as of August 30, 1941, the above-mentioned eleven individuals executed written articles of partnership under the firm name of Boyt Harness Company with principal place of business at Des Moines, Iowa (hereinafter referred to as the Boyt Partnership) providing, inter alia, that the partnership capital should consist of all the assets of the Boyt Corporation and should be owned by the partners in the proportions of J. W. Boyt 17 per cent; Helen F. Boyt 17 per cent; A. J. Boyt 11 per cent; Marjorie P. Boyt 11 per cent; Paul A. Boyt 10 per cent; Dorothy F. Boyt 10 per cent; Barbaradine Boyt 8 per cent; B. B. Quiner 6 per cent; Elizabeth M. Boyt 4 per cent; J. E. Green 3 per cent; and P. J. Kurtz 3 per cent; that the said partners should share in the profits and losses of the business in those proportions; that the partnership books and records should be open to examination of all partners and audited semiannually; that the partnership take over all assets and accounts of the Boyt Corporation and assume all its debts and liabilities and incompleted contracts as they existed on August 30, 1941; and that upon dissolution of the partnership and payments of debts, the surplus should be divided among the partners in accordance with their interests therein. The parties to the articles of partnership thereby intended in good faith to become partners for the purpose of carrying on a business to which they each contributed capital and the profits and losses of which they agreed to share in certain proportions.
Pursuant to the foregoing the Boyt Corporation was dissolved on August 30, 1941, and the Boyt Partnership took over its assets and assumed its liabilities as of that date. The Boyt Partnership was substituted for the dissolved corporation as the general partner in the Limited Partnership and thereafter carried out the terms of the November 4, 1940 limited partnership agreement. The Boyt Partnership was recognized as the general partner in the Limited Partnership in Government contracts obtained in the name of the Limited Partnership. J. W. Boyt had been president of the Boyt Corporation and as such had managed the affairs of Limited Partnership. He became the managing partner of the Boyt Partnership and as such continued as manager of the Limited Partnership.
The Boyt Partnership continued the production of civilian goods as an independent venture. Helen, Marjorie, and Dorothy Boyt rendered vital services to that partnership until about the end of 1942, at which time a large organization had been built up to handle the greatly increased volume of business. From August 30, 1941, and throughout the years involved Helen, Marjorie, and Dorothy Boyt each had separate capital and drawing accounts on the books of the Boyt Partnership. The respective partnership interests and withdrawals of those wives were not subject to any control or domination of their husbands. In his determination of deficiencies involved in Docket Nos. 23940, 23941, and 23942, the respondent refused to recognize those wives as partners in the Boyt Partnership and taxed their distributive shares of its net income to their respective husbands, namely, J. W., A. J., and Paul Boyt.
During the taxable years in question the Boyt Partnership employed John Boyt, who was the father of J. W. Boyt and who had been connected with the family harness business since 1901. He was a stockholder and officer in the prior corporation which went into receivership in 1933. He was not a stockholder in the Boyt Corporation nor a partner in the Boyt Partnership. During. 1942 John Boyt, then about 79 years of age, was paid the amount of $6,320 as a salary. He kept some books but mainly acted as a business adviser. In his determination of the deficiencies involved in each proceeding herein and more specifically in determining the net income of the Boyt Partnership for 1942, the respondent disallowed $3,320 of John Boyt's salary and allowed $3,000 as a deduction as reasonable compensation for the services rendered by him.
Under date of September 14, 1942, there were executed 17 declarations of trust, each identical in form, with the grantors thereof, the designated trustees, the beneficiaries who were minor children of the respective grantors, and the percentage of interest in the Boyt Partnership transferred in trust, respectively, as follows:
Percentage Grantors Trustees Beneficiaries Interest J. Walter Boyt J. Walter Boyt Robert Francis Boyt ..... 2 1/2 Helen F. Boyt James O. Boyt ........... 2 1/2 Kathleen M. Boyt ........ 2 1/2 Helen F. Boyt Helen F. Boyt Robert Francis Boyt ..... 2 1/2 J. Walter Boyt James O. Boyt ........... 2 1/2 Kathleen M. Boyt ........ 2 1/2 Arthur J. Boyt Arthur J. Boyt Arthur J. Boyt, Jr ...... 1 1/2 Marjorie P. Boyt Richard D. Boyt ......... 1 1/2 Christie Ann Boyt ....... 1 1/2 Marjorie P. Boyt Marjorie P. Boyt Arthur J. Boyt, Jr ...... 1 1/2 Arthur J. Boyt Richard D. Boyt ......... 1 1/2 Christie Ann Boyt ....... 1 1/2 Paul A. Boyt Paul A. Boyt Shirly Boyt ............. 2 1/2 Dorothy F. Boyt Dorothy F. Boyt Paul A. Boyt Shirly Boyt ............. 2 1/2 Dorothy F. Boyt B. B. Quiner B. B. Quiner Quentin B. Quiner ....... 1 Eva Jane Quiner ......... 1 David B. Quiner ......... 1 The trust instrument provided that:I, * * * [grantor], owner of a * * * [designated] per cent interest in the Boyt Harness Company, a partnership * * *, do hereby acknowledge and declare that as of June 1, 1942 I have established an irrevocable trust for the benefit of my minor * * * [name of son or daughter], in a * * * [designated] per cent subpartnership (with myself) interest in said partnership taken from my said * * * per cent interest therein, upon the conditions and for the uses and purposes hereinafter set forth.
The trust instrument further provided, inter alia, that:
No trustee, as such, shall participate in the management of said partnership, it being my intention hereby to establish the relation of subpartnership between myself and said trustees;
The instrument also provided that the trustees should have power to hold, accumulate, invest, sell, or exchange the trust fund and its accumulations; that the grantor directed the Boyt Partnership to segregate the interest therein transferred in trust and maintain book entries to show complete delivery thereof to the trustees; that the trustees as they deemed proper should pay portions of the income to the use of the beneficiary but not on account of any legal obligation of his parents; that the trustee should distribute one-half of the trust fund and accumulations to the beneficiary upon his written request after attaining 25 years of age and distribute the remainder upon his attaining 35 years of age; that if the beneficiary predecease the grantor without issue or surviving brother or sister, then the remaining portion of the trust estate to revert to the grantor and his spouse as joint tenants with right of survivorship; and that the grantor reserved the right to purchase the subpartnership interest at any time at the value thereof as shown by the last preceding audit of the Boyt Partnership.
Under date of June 1, 1942, the partners of the Boyt Partnership and a trustee of the various trusts executed a notice of amendment to the articles of partnership setting forth the percentage share of the net income of Boyt Partnership distributable to each partner and to each of the 17 trusts, beginning June 1, 1942.
An audit was made of the books of account of the Boyt Partnership as of May 31, 1942, and based thereon accounts were set up showing the percentage interest and dollar share of the capital account of each trust. The drawing account for each trust showed the percentage of interest and the dollar share of the partnership's net income.
In determining the deficiencies involved in Docket Nos. 23940, 23941, 23942, and 23945, the respondent refused to recognize the trusts and taxed their allocated shares of the net income of Boyt Partnership, to the petitioners in those dockets, respectively.
OPINION.
In the determination of the deficiencies involved in these proceedings, the respondent has recognized the Limited Partnership as a separate venture or enterprise the net income of which was distributable in certain proportions to the limited partner Glen Herrick and to the general partner Boyt Partnership, respectively. No issue has been raised with respect thereto or Boyt Partnership's income from that source. However, the existence of the Limited Partnership and its prospective profits from war contracts and the dissolution of the Boyt Corporation and the substitution of the Boyt Partnership as the general partner of the Limited Partnership, are presented in these proceedings as part of the circumstances bearing upon the good faith of the parties in the formation of the Boyt Partnership as of August 30, 1941. We have given those circumstances due consideration in reaching our conclusions herein.
The respondent, in his determinations in these proceedings, has also recognized the Boyt Partnership as a separate venture or enterprise which, during the taxable years 1942 and 1943, realized net income distributable to certain persons recognized by him as partners. The two main issues presented are first, whether Helen, Marjorie, and Dorothy Boyt were bona fide partners taxable on their respective distributive shares of the net income of Boyt Partnership and second, whether the 17 trusts are recognized as taxable on their respective designated percentages of the Boyt Partnership's net income, as contended by petitioners. A minor issue involves the claimed salary deduction in determining the net income of Boyt Partnership for the year 1942.
With respect to the minor issue we sustain respondent's determination that $3,000 represented reasonable compensation for the services rendered by John Boyt during 1942. The meager facts of record on this issue are mere generalities and fail to establish, to our satisfaction, the extent or value of the services rendered by John Boyt.
With respect to the question of whether the three wives, Helen, Marjorie, and Dorothy Boyt, were duly constituted partners of the Boyt Partnership and recognizable as such for tax purposes, we conclude that they were and that respondent erred in determining otherwise. This conclusion rests upon our findings of facts clearly established by the record herein. Briefly, the wives were part owners of the Boyt Corporation stock originally issued in the names of their husbands in 1934. They contributed vital services toward the development of the new line of business of that corporation in textile products which, as shown by the uncontradicted testimony, was the reason the corporation first sought Government contracts in 1940 for canvas products and which led ultimately into the business of the Limited Partnership formed in November 1940. The issuance of shares of Boyt Corporation stock in the names of the wives on August 1, 1941, merely made their ownership thereof a matter of record. Upon dissolution of the Boyt Corporation on August 30, 1941, the wives became entitled to their proportionate distribution of the corporate assets, subject to liabilities, and they made a contribution thereof as part of the capital of the Boyt Partnership. We have found as a fact that the parties to the articles of partnership, including the wives, thereby intended in good faith to become partners for the purpose of carrying on a business and agreed to share the profits and losses thereof in certain proportions. In reaching our conclusion on this issue, we have applied the principles announced in Commissioner v. Culbertson, 337 U.S. 733; Commissioner v. Tower, 327 U.S. 280 and similar cases. In Rupple v. Kuhl, 177 F.2d 823 and Harry Klein, 18 T.C. 804, it was held that a husband's partnership interest was in turn divided (and so recognized for tax purposes) between himself and his wife on the basis of a subpartnership to which the wife contributed capital or vital services. The instant case is stronger than those cases for here the wives were not merely subpartners with their husbands, but were full bona fide partners with eight other persons entitled to proportionate shares of the Boyt Partnership income which happened to be derived from two sources, namely, its activity in producing certain civilian goods and its separate activity as the general partner and manager of the Limited Partnership engaged in a business in which borrowed capital was an important income producing factor.
The respondent erred in taxing to J. W. Boyt, A. J. Boyt, and Paul A. Boyt, their respective wives' distributive shares of the net income of the Boyt Partnership for the years 1942 and 1943.
The last question presented is whether the 17 trusts should be recognized as taxable on their respective designated percentages of the net income of the Boyt Partnership as contended by petitioners, or, whether such income is taxable to the grantors of those trusts as determined by respondent.
The petitioners involved in this issue concede that the trusts were not intended to be and never were actual partners in the Boyt Partnership. That fact clearly distinguishes this case from Edward D. Sultan, 18 T.C. 715, and Thomas H. Brodhead, 18 T.C. 726. Further, petitioners take the position that the trusts were not subpartners with the grantors and as such entitled to a division of the income share of the grantor-partner of Boyt Partnership. Thus, the Rupple and Klein cases are not applicable to this issue.
The petitioners contend that the trusts were validly established under the laws of Iowa by completed, irrevocable gifts of designated percentage interests in the Boyt Partnership, that is in the partnership assets, and hence subject to tax on the income therefrom. The respondent contends that, for tax purposes, the trusts amounted to nothing more than assignments of percentages of the grantors' future earnings in the Boyt Partnership, as tax-saving devices.
Under the scheme of Federal income taxation, persons carrying on business in partnership are liable for tax, in their individual capacity, on their distributive share of all of the partnership net income. Here the trusts are admittedly neither partners nor even subpartners or joint venturers with the actual partners of Boyt Partnership, who earned the income in question. The trusts contributed nothing to the enterprise and their creation merely provided a means whereby they became passive recipients of shares of income earned by the grantor-partners. Furthermore, the grantors in their individual capacities, aside from also being the trustees, retained complete dominion and control over the corpus of the trusts, that is the assigned percentage interest in the partnership assets. We think it is clear, under the facts herein, that the grantor-petitioners actually earned the income in question and under the doctrine of Lucas v. Earl, 281 U.S. 111, and Burnet v. Leininger, 285 U.S. 136, we hold that the trusts are not recognized for tax purposes and that those petitioners are taxable on all of their distributive shares of the net income of Boyt Partnership for each of the years 1942 and 1943. On this issue the respondent's determination is approved.
Decisions will be entered under Rule 50.