Opinion
Docket No. 36040.
1954-10-22
W. T. S. MONTGOMERY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William T. Rogers, Esq., and John W. Donahoo, Esq., for the petitioner. A. E. Carpens, Esq., for the respondent.
William T. Rogers, Esq., and John W. Donahoo, Esq., for the petitioner. A. E. Carpens, Esq., for the respondent.
INCOME— HUSBAND'S OR WIFE'S— BUSINESS OPERATED FOR YEARS BY HUSBAND—ASSIGNED TO WIFE.— The income of a business, in which the husband was expert and to which he had devoted all of his time for many years, was taxable entirely to him and none was taxable to wife who had no knowledge of the business and devoted little or not time to its management and operation.
The Commissioner determined a deficiency of $5,529.66 in income tax for 1946 and one of $6,335.51 for 1947. The only issue for decision is whether the income of the Jacksonville Blow Pipe Company is taxable in its entirety to the petitioner.
FINDINGS OF FACT.
The petitioner filed his separate returns for the taxable years with the collector of internal revenue for the district of Florida.
The petitioner operated the Jacksonville Blow Pipe Company as sole proprietor for many years. Charles L. Ouldhouse, one of his employees, was involved in an automobile collision with another car on September 6, 1939, resulting in the death of Sylvester Mackel, the driver of the other car. The petitioner had no workmen's compensation insurance at that time and did not know what the effect of the collision might be upon Ouldhouse. The petitioner owed his father's estate more than his share of that estate and he executed a mortgage for $5,550.03 dated September 8, 1939, on his Jacksonville Blow Pipe Company property, naming himself, as executor of his father's estate, mortgagee. His purpose in giving the mortgage was to prevent his business property from being taken to satisfy any judgment based upon the automobile collision and to protect his father's estate.
The petitioner wrote a letter dated October 1, 1940, and sent copies to his sister, his brother, and his sister-in-law, each of whom ‘accepted’ the proposition made in the letter. Irene, mentioned in the letter, is the petitioner's wife. The letter was as follows:
When Mama died, I proposed a distribution of the Estate of my father, J. A. Montgomery, based upon Helen's taking over the Savanah bungalow and returning the Estate the surplus over her share of the estate which was to be distributed. As you will recall I told you that in order for me to make this distribution I would have to repay to the Estate $2020.80 of the money I had borrowed. At that time, Roderick agreed to wait for most of his and Helen also agreed to wait for whatever was needed of hers until such time as I could get this money together to repay the part of the loan I made that was in excess of my share of the Estate.
At the time I made the loans to myself out of the Estate's funds there was no question in my mind as to the Estate being amply secured by my assets, and I executed a mortgage in favor of the Estate covering all of my assets to be sure it was secured. Had nothing unforeseen occurred I know I would have been able to clear this up before long, but now all of my assets are threatened by a suit which is being brought against me, and should they secure a judgment and deprive me of my business, then I don't know how long it would be before I could clear this up. At the present time I owe about $40,000.00 or more on accounts which might have a claim against the inventory of my business if I deeded it over to the Estate under this mortgage. Irene has of course been worried about all of this, especially about my borrowing from the Estate in excess of my share of it, and she has been trying to make some arrangements that might solve the problem. She can borrow $4,000.00 and if it meets with the approval of all interested she will buy my share of the Estate. With this $4,000.00 I will pay up my debts so I can execute a bill of sale to the Estate of all of the assets of my business and this bill of sale could not then be attacked by my creditors.
Where the rub comes in is that all of the assets of my business would not bring enough money at public outcry to cover the amount that I owe the estate, as frankly, the business is not worth much without me to run it. It is only my expert knowledge of the blow pipe business that has enabled this business to survive when every other sheet metal shop in Jacksonville is in such bad financial condition that they have no credit standing with any of the supply houses. If sheet metal shops generally in Jacksonville were a paying proposition, then there might be a splendid chance of selling the assets at public outcry at a figure which would pay the Estate in full, but no one wants to buy a business which does not make money.
What I want to ask is your approval on the following: Irene will borrow the $4,000.00 and buy my interest in the Estate. I will pay my debts to clear any claim against the inventory or equipment with this $4,000.00. Irene will accept as my share of the Estate in the distribution the assets of my business as my full share of the Estate and will further guarantee that if I do not pay the balance owing the Estate, she will pay it.
What this will mean is that when the bungalow is sold you will not be able to get your full share of the money coming to you right away. Whenever I can make anything in excess of living expenses, I will apply it to this obligation, or if the business shows profits in excess of living expenses, Irene will pay it if I do not.
If this meets with your approval, please write me promptly and I will carry this out as stated. Then as soon as the bungalow is sold, I will distribute the available money equally, Irene will take none of the money but only the assets of my business as her full share, and as soon as I can get my head above water a little, I will pay each of you the deficiency in your shares and will pay interest on the full amount owing from the date of distribution until I pay everybody up in full.
If you approve this arrangement, it occurs to me that it might be better to make all conveyances direct from me to Irene in order to avoid making multiple instruments to the estate and then from the estate to Irene, and to avoid various recording charges and other expenses and complexities incident to the same. In other words, it would simplify the procedure and papers. If you approve such conveying direct to Irene to accomplish the proposal contained in this letter, let me have your approval of such method of conveying as well as of the general proposal and Irene will give a receipt to the estate (in which I will join) for my interest in the estate in accordance with this proposal.
Again I say I am sorry things have gone this way, but with better business prospects prevailing I hope to get it all cleared up very quickly.
The book value of the business at that time was more than twice $4,000.
The petitioner executed a deed and bill of sale dated October 14, 1940, conveying his blow pipe business to his wife and on the same day he, as executor of his father's estate, released that property from the mortgage dated September 8, 1939. The deed and bill of sale were recorded.
Irene borrowed $4,000 from Pindar Real Estate Company on her collateral note dated October 12, 1940, due in 6 months with interest at 6 per cent. The collateral described in the note consisted of ‘All my household goods and furniture and all of my personal jewelry.’ The petitioner had given the jewelry and some of the other items to Irene. She gave the petitioner her check for $4,000 dated October 14, 1940. The petitioner made out the check and wrote on it that it was in full payment for his share of his father's estate. The check endorsed by the petitioner was paid by the bank on October 14, 1940. The petitioner used most of the $4,000 to pay accounts payable of the business. The petitioner's sister and her husband owned Pindar Real Estate Company. Two thousand dollars was paid on the note during October 1940 from funds of the blow pipe business and the balance was paid on or before the due date.
The purpose of the transfers was to render the petitioner proof against judgments arising from the collision.
The petitioner and Irene filed joint returns for 1940 and 1941 and thereafter filed separate returns, all of which were prepared by the petitioner.
A suit for $50,000 damages was filed against the petitioner on August 15, 1940, by the employer of Mackel for its use and the use and benefit of Mackel's widow. A judgment for $35,000 was entered in the suit on December 4, 1944, with interests and costs. The court entered another judgment in that suit on November 2, 1945, holding that the plaintiffs had an equitable lien on the blow pipe business assets to secure payment of the judgment. The court vacated the deed and bill of sale from the petitioner to his wife insofar as the rights of the plaintiffs were concerned because the instruments were fraudulent as against the plaintiffs. The judgment was satisfied in November 1945 by the payment of $10,000.
The petitioner and Irene filed separate returns for 1945. The petitioner, on his 1945 return, reported as salary from Irene ‘trading as JBP Co.’ $15,475.95 and deducted $9,700 under losses with the explanation: ‘Judgment Loss in Circuit Court of Duval County, lost 14884-L, Judgment for $35,000.00 settled for $10,000.00 $9,700 of which I paid and $300.00 was paid by Charles L. Ouldhouse.’ Irene's return for 1945, prepared by the petitioner, reported $5,823.95 as the net profit from the business and $15,475.95 as salary paid to the petitioner. The petitioner wrote on the retained copy of Irene's 1945 return ‘This had to be done because I had to use the deductions on Page 3 to enter the law suit judgment deduction.’
The petitioner and Irene filed separate returns for 1946 and 1947 on which each reported the same amount of income from Jacksonville Blow Pipe Company, the petitioner reporting his as salary and Irene reporter hers as income from the business. The Commissioner, in determining the deficiencies, made several adjustments, which are not contested, and held that the entire income from the business was taxable to the petitioner.
Irene has had no experience in managing any business and had nothing to do with the running of the blow pipe business either before or after October 14, 1940. The record does not show that she took any part in the operation of the business at any time material hereto. She was not a licensed freetrader during the taxable years. The city and county licenses for the business were in the name of the petitioner at all times material hereto and Irene never obtained such licenses. Irene, for the first time, published notices in May 1945 under the Fictitious Name Law that she was the sole owner of Jacksonville Blow Pipe Company and filed proof of the publication on June 13, 1945.
The petitioner before and after October 14, 1940, could sign checks on the bank account in the name of Jacksonville Blow Pipe Company. Others were also authorized to sign checks on that account, including, after October 14, 1940, Irene.
The earnings of the business after October 14, 1940, were credited to a joint drawing account on the books of the business on which both the petitioner and Irene could draw. The books do not show to which of the two any balance in the account belonged or which owed the other and how much. The petitioner was content to allow any undrawn amount of his in the account to remain there to build up the business. The record does not show the extent, if any, to which Irene used or benefited separately from the earnings of the business after October 14, 1940.
The petitioner continued, after October 14, 1940, and during the taxable years, to manage and operate the business ‘very substantially’ as he had previously conducted it. There was no other person connected with the business who was capable of operating it or who attempted to supplant the petitioner after October 14, 1940.
The success and earnings of the business before and after October 14, 1940, and during the taxable years were due primarily to the knowledge, ability, and efforts of the petitioner. Capital and assets were not material income producing factors.
All facts stipulated and all exhibits attached to the stipulation are incorporated herein by this reference.
OPINION.
MURDOCK, Judge:
The question for decision is whether all of the income of the blow pipe business for 1946 and 1947 should be taxed to the petitioner or whether only one-half, as his salary, should be taxed to him. He went through the form of transferring the assets of the business to his wife in 1940 and other formalities were carried out, some belatedly, in their efforts to give the impression that Irene was really the owner and operator of the business. Yet they were inconsistent in that petitioner at times was indicated as the owner by certain formalities. The admitted motivating purpose of the transfers was to render the petitioner proof against a judgment in the suit for damages while saving the business so he could continue to earn his living from it. The transfers were held fraudulent and void as to the plaintiffs in that suit. The Commissioner contends that the petitioner never intended to convey more than legal title while retaining equitable ownership of the business for himself and, in any event, he actually earned the income and should be taxed with it.
The so-called arrangements pertaining to his father's estate do not help the petitioner's case. He testified that the mortgage for $5,550.03 equaled the entire amount he owed the estate at that time but thereafter he used additional funds of the estate for his own use, increasing his debt to $7,000 or more. He also indicated that his share of the estate would amount to between $3,000 and $4,000. Giving up his right to such a share would not compensate the estate for the larger amount owed or replace the mortgage for $5,550.03. However, those arrangements have little or no bearing upon the issue here for decision, except, perhaps, to show that the petitioner was taking good care of his own interests. The $4,000 borrowed by Irene never went to the estate but, on the contrary, most of it went into the blow pipe business to pay debts of that business. That $4,000 did not benefit the petitioner if the business was no longer his. However, if he continued to be the equitable beneficial owner, the $4,000 was not purchase price but a temporary loan to the business which was promptly repaid from the business so that neither was Irene out of pocket as a result of it nor was the petitioner enriched by it.
Irene testified, ‘I do not operate the business at all. I'm not an engineer and I don't have anything to do with the actual running of it.’ She had no office, rarely went to the place of business, and had no experience in managing any business. She mentioned ‘decisions about policy’ but gave no instance in which she had made any such decision and was extremely vague on the subject. Some effort was made to show that Irene's elderly father took over some executive authority and duties on her behalf after October 14, 1940. The record as a whole shows, however, that he did not. He had been employed in the business only a few years at that time and described his duties as ‘largely keeping the books.’ He received $50 per week and continued to keep the books and receive that same wage after October 14, 1940. He had no experience or ability to qualify him as an executive in the business, restricting the scope of the petitioner's freedom of control, and he never restricted that control in any important way, so far as the record shows.
It is not clear from the record that Irene ever withdrew earnings of the business for her personal use or benefit. The peculiarities disclosed by the 1945 returns relating to the judgment payment and deduction indicate the dominance and control of the petitioner over the income from the business. The $4,000 had little relation to the value of the assets in the going business, it actually went into the business instead of to the petitioner, and it was repaid promptly from the business. The petitioner testified that the assets of the business were worth very little without the benefit of his expert advice, knowledge, and skill on blow pipe installations. He said he would not have given his services to anybody else for as little as 50 per cent of the profits. He admitted that there was no great change in management after October 14, 1940, he was absolutely essential to the continued success of the business, and he was primarily responsible for its earnings at all times, including the taxable years. He also admitted that one of his purposes in transferring the business to his wife was to preserve his means of livelihood while divesting himself of anything that could be attached in the event of any judgment.
The evidence as a whole fails to show that the Commissioner erred in taxing the income of the Jacksonville Blow Pipe Company for 1946 and 1947 to the petitioner. Cf. Robert E. Werner, 7 T.C. 39; David J. Pleason, 22 T.C. 361.
Reviewed by the Court.
Decision will be entered for the respondent. LE MIRE, J., dissenting: The majority view sustains the respondent's determination that the income of the Jacksonville Blow Pipe Company is taxable in its entirety to the petitioner, apparently upon the principle that income is taxable to the person who earns it. Cf. Robert E. Werner, 7 T.C. 39. I am unable to agree that the rule invoked is properly applicable to the facts in this case.
The record establishes that on October 14, 1940, the petitioner sold the business he conducted under the name of the Jacksonville Blow Pipe Company to his wife for the sum of $4,000. The consideration paid was from the personal funds of the wife. On the same day the petitioner executed a deed and bill of sale of all his right, title, and interest in and to the real and personal property, excluding the accounts receivable and covenanting that all debts had been paid. With the reserved accounts receivable and the consideration received for the transfer the petitioner paid the then outstanding debts of the business.
There were no strings attached to the transfer. So far as this record reveals both parties intended that the legal title and beneficial interest in the property were to pass to the wife as absolute owner. The inference drawn in the majority opinion, that the $4,000 purchase price was a mere loan by the wife to the petitioner herein, appears to me to be unwarranted and without evidentiary support. The fact that the transfer was motivated by the existence of a contingent liability as the result of a negligence suit does not render the transaction invalid as between the parties or as to others except existing lienors. The Government was not a creditor at the time of the transfer nor was the transfer a device for defrauding the Treasury. After the execution and recording of the instruments of transfer on October 14, 1940, the petitioner's wife was the absolute owner of the property and could dispose of it as she saw fit, subject only to the rights of the existing lienor in the event of procuring a judgment. The fact that the book value of the assets transferred was greater than the consideration paid is of little significance, since the transfer would have been valid in law if it had been made by way of gift.
While it is true that the success of the business to a considerable extent was attributable to the technical knowledge and skill of the petitioner and that capital was a secondary attribute, the business was a manufacturing establishment employing a personnel of approximately 20 in the taxable years in question and was not purely a personal service enterprise.
In my opinion the majority view fails to recognize the distinction between actual control over income producing property with the consent of the true owner and the absolute right of control over the property and income which adheres in a valid legal title.
I am inclined to the view that the case of Robert E. Werner, supra, is distinguishable and that the facts in the instant case bring it within the ambit of Henson v. Commissioner, 174 F.2d 846, wherein the court said:
The controlling question in such cases is, therefore, not whether actual control over the property is exercised, but whether the right of control in fact exists; not who earns the income from such property, but who has the right to receive it. * * *
Cf. Willis H. Vance, 14 T.C. 1168; Hilda M. Royce, 18 T.C. 761.
I, therefore, dissent from the conclusion of the majority.