Opinion
Docket Nos. 38111 38112 38113.
1954-05-28
CHARLES J. DINARDO AND KATHLEEN B. DINARDO, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.CLARENCE B. P. SLAUGHTER AND GERTRUDE SLAUGHTER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.SAMUEL J. RESTIFO AND VALERIE R. RESTIFO, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Norman B. Miller, Esq. , for the petitioners. Michael J. Clare, Esq. , for the respondent.
In 1947, petitioners formed a partnership for the practice of medicine. They organized a nonprofit corporation which operated a private hospital, Collinwood Hospital. Admissions to the hospital were limited to patients of the petitioners. The petitioners' medical partnership had an accident and industrial injury practice; patients were referred to petitioners because they could provide hospital care at Collinwood Hospital. The medical partnership received fees from patients referred to the hospital for medical services rendered by petitioners as members of the partnership. There was a direct benefit to the partnership's earnings from the existence of the hospital. The partnership's offices were located in the hospital building. Although it was expected that the current expenses of the hospital would be paid out of its current receipts, expenses exceeded receipts. Therefore, in order to keep the hospital in operation and to avoid loss of medical fees, the partnership agreed to pay its operating deficits. The partnership paid the hospital's operating deficits in 1948 and 1949. Held, that the amounts of the payments constituted ordinary and necessary business expenses of the medical partnership under section 23(a)(1)(A) of the Internal Revenue Code. Interstate Transit Lines v. Commissioner, 319 U. S. 590, distinguished. Robert Gaylord, Inc., 41 B. T. A. 1119, and Scruggs-Vandervoort-Barney, Inc., 7 T. C. 779, followed. Norman B. Miller, Esq., for the petitioners. Michael J. Clare, Esq., for the respondent.
The Commissioner determined deficiencies in income tax for each of the years 1948 and 1949, as follows:
+-------------------------------------------------------------------+ ¦Docket No.¦Petitioners ¦1948 ¦1949 ¦ +----------+-------------------------------------+---------+--------¦ ¦38111 ¦Charles J. and Kathleen B. Dinardo ¦$1,677.46¦2,101.62¦ +----------+-------------------------------------+---------+--------¦ ¦38112 ¦Clarence B. P. and Gertrude Slaughter¦2,071.44 ¦2,121.98¦ +----------+-------------------------------------+---------+--------¦ ¦38113 ¦Samuel J. and Valerie R. Restifo ¦1,679.02 ¦1,916.04¦ +-------------------------------------------------------------------+
The petitioners, Charles J. Dinardo, Clarence B. P. Slaughter, and Samuel J. Restifo, are partners. The Commissioner increased the distributive share of the partnership income of each partner for each taxable year as the result of disallowing deductions claimed by the partnership. The partners concede that certain adjustments made by the Commissioner are correct.
The only question to be decided is whether the respondent correctly disallowed, in 1948 and 1949, a deduction claimed by the partnership representing amounts paid to reimburse a nonprofit hospital corporation for operating losses incurred by the corporation during the years in question.
FINDINGS OF FACT.
The facts which have been stipulated are found as facts; the stipulation and the attached exhibits are incorporated herein by this reference.
The petitioners are residents of either Shaker Heights, or South Euclid, Ohio. Joint returns were filed with the collector for the eighteenth district of Ohio. Since the question to be decided relates only to Charles J. Dinardo, Clarence B. P. Slaughter, and Samuel J. Restifo, they are referred to hereinafter as the petitioners. The wives of the petitioners are involved only because joint returns were filed.
Each of the petitioners is a physician duty licensed in the State of Ohio. Restifo and Dinardo are members of the Cleveland Academy of Medicine. Restifo is on the visiting staff of Huron Road Hospital and enjoys courtesy privileges at Doctors Hospital, both in Cleveland, Ohio. Slaughter became a member of the Cleveland Academy of Medicine and of the staff of Doctors Hospital in about June 1950.
On July 28, 1947, petitioners formed a partnership for the general practice of medicine at 928 East 152d Street, Cleveland, Ohio.
The partnership agreement was made effective as of June 1, 1947, and provided that each of the petitioners was to have an equal interest in the partnership.
This partnership was formed as a result of an agreement (hereinafter referred to as the sales agreement) entered into on May 19, 1947, between Emergency Clinic, Inc., first party, Olive S. Hanson, second party, Dr. and Mrs. J. B. Hanson, third party, Dr. J. B. Hanson, fourth party, and petitioners, as fifth parties. Emergency Clinic, Inc., was a nonprofit hospital corporation which Dr. Hanson had operated since 1927. In addition to forming the partnership referred to above, as the successor to a former partnership of Dr. Hanson and Dr. Slaughter, petitioners agreed to purchase the goodwill and certain assets of parties one through four, to lease the premises at 992–928 East 152d Street, Cleveland, Ohio, from the Hansons, to organize a new nonprofit hospital corporation as a successor to Dr. Hanson's Emergency Clinic, Inc., and to name Dr. Hanson as a trustee of the new hospital.
The Hansons and Emergency Clinic, Inc., also agreed to assign to petitioners an otherwise unidentified contract existing between them and the New York Central Railroad.
On May 28, 1947, petitioners organized a nonprofit Ohio corporation for the purpose of conducting a hospital, as they were required to do by the sales agreement. This corporation changed its name to Collinwood Hospital on May 19, 1949, and will be hereinafter sometimes referred to as Collinwood Hospital or Collinwood.
The trustees of Collinwood Hospital were Dr. J. B. Hanson, Norman Miller, Norman Cadkin, and Lester Rosenthal. Miller was appointed by Restifo; Cadkin was appointed by Dinardo; and Rosenthal was appointed by Slaughter. These trustees were to look after the respective interests of the petitioners who appointed them.
On June 1, 1947, the lease contemplated by the sales agreement was executed by the Hansons, as lessors, and petitioners, as losses, for the premises at 922–928 East 152d Street. The lease was for a term of 5 years, beginning on June 1, 1947, at a total rental of $71,100, payable in monthly installments of $1,185.
On the same day, June 1, 1947, petitioners purchased certain items of personal property from the Hansons, ‘numerous items of capital property’ from Emergency Clinic, Inc., and certain items of chattel property from Olive S. Hanson. On June 2, 1947, petitioners gave a chattel mortgage to the Hansons on the property purchased from Emergency Clinic, Inc., and from Olive Hanson, to secure the unpaid balance of the purchase price. On August 20, 1947, Emergency Clinic, Inc., sold to petitioners all the drugs and medical supplies in and about the premises at 922–928 East 152d Street, Cleveland, Ohio. The petitioners did not make any contributions of assets to the hospital and the hospital acquired no assets except drugs and thermometers.
As was contemplated by the sales agreement, Collinwood Hospital became the successor to Dr. Hanson's hospital and petitioners' partnership became the successor to the partnership of Dr. Hanson and Dr. Slaughter from about June 1, 1947, and both organizations occupied the premises leased from the Hansons.
During the years in question, there existed in Cleveland hospitals a shortage of hospital beds for emergency cases. In addition, a physician's right to treat a hospitalized patient was conditioned on whether the doctor enjoyed staff privileges at the particular hospital in which his patient was hospitalized.
The operation of Collinwood Hospital was controlled by petitioners, and they accordingly had unrestricted access to its facilities. Cases were admitted only as patients of one of the three petitioners, and were treated only by the petitioners or doctors hired by the partnership, except in instances when consultants were called in.
The partnership had a large accident and industrial injury practice. A number of companies arranged for the partnership to render medical care for injuries sustained by employees, on the assurance that adequate hospital facilities would be available for any employees requiring hospitalization. In addition, the police authorities brought accident victims to the partnership and to Collinwood. There was no other hospital in the vicinity, and both the partnership and Collinwood remained open 24 hours every day. All fees for medical care rendered to hospitalized patients were paid directly to the partnership. Charges for bed and board were paid to the hospital. Nursing fees were included in the hospital's bed charges. The hospital did not operate X-ray or anesthesia facilities, but it did have a pharmacy; however, no profits accrued from the operation of the pharmacy.
The existence of Collinwood Hospital and petitioners' unrestricted access to its facilities enhanced the partnership's income from medical fees. In the first place, the partnership received all fees for medical services rendered to hospitalized patients. In addition, patients were attracted to the partnership for medical treatment although they might not have required hospitalization at the time. Immediately after Collinwood closed in 1950, three or four of the larger employers ceased sending employees to the partnership and police authorities ordered that no cases requiring hospital care were to be brought to petitioners for treatment.
When Collinwood was organized, it was contemplated that its current expenses would be paid from operating revenue. However, the hospital's income never did approach expenses, primarily due to the failure of patients to pay their bills.
On December 9, 1947, Collinwood Hospital (then called Emergency Clinic, Inc., after the predecessor hospital) and the partnership entered into the following agreement:
AGREEMENT
This agreement made and concluded at Cleveland, Ohio, this 9th day of December, 1947 by and between Emergency Clinic, Inc. a corporation duly organized under the Laws of Ohio, Party of the First Part, and Dr. Charles J. Dinardo, Dr. Samuel J. Restifo and Dr. Clarence B.-P. Slaughter, partners, trading as Emergency Medical Clinic, Party of the Second Part.
WITNESSETH
WHEREAS, the Emergency Clinic, Inc., a hospital has been operating at a financial loss and,
WHEREAS, it is to the benefit and advantage of the Party of the second Part to have a hospital located in the same building as their medical partnership
NOW, THEREFORE, said Party of the First Part in consideration of the promises and agreements of said Party of the Second Part herein set forth, hereby promises and agrees to maintain and keep their hospital at 928 East 152nd Street, Cleveland, Ohio and to always keep and maintain not less than two beds available at all times for patients of said Party of the Second Part.
IN CONSIDERATION HEREOF, Said Party of the Second Part hereby promises and agrees to pay all operating deficiencies and obligations of said party of the First Part in order that the same can continue in operation
It is mutually agreed by and between the parties hereto upon the considerations aforesaid that this agreement shall be retroactive to June 1, 1947 and that all indebtedness of said Party of the First Part paid by said Party of the Second Part for said hospital whether represented by negotiable instruments or otherwise shall be null and void.
IN WITNESS WHEREOF, the authorized representatives of the parties have hereunto set their hands to duplicates hereof the day and year first above written.
EMERGENCY CLINIC, INC.
by NORMAL B. MILLER
Norman B. Miller, Secretary
EMERGENCY MEDICAL CLING
by C. J. DINARDO
Charles J. Dinardo, Partner.
This agreement was not executed in conformity with the terms of Article XII of the partnership agreement, which reads as follows:
ARTICLE XII.
(a) No partner shall accept or undertake any personal business after being requested in writing by the other two partners not to do so.
(b) No partner shall at any time sign the firm name or his own name or pledge the firm's credit or his own personal credit in any manner as surety or guarantor on any paper, bill, bond, note, draft or other obligation, whatever.
(c) No partner shall employ any person for the partnership on a permanent basis without the consent of the other partners.
(d) No partner shall release or cancel any debts or claims due the partnership except on full payment without the consent of the other partners.
(e) No partner shall become a candidate for public office without the consent of the partners.
The partners approved the payment of Collinwood's operating deficits in order to enable the hospital to continue operating and thereby to avoid a loss to the partnership of patients and income from medical fees.
In 1948 and 1949, the partnership reimbursed Collinwood for the latter's operating deficits in the amounts of $15,913.73 and $21,007.84, respectively. The partnership took deductions for these payments and reported ordinary net income of $67,488.78 for 1948 and $52,789.81 for 1949.
OPINION.
HARRON, Judge:
The principal question to be decided is whether payments made by petitioners' partnership in 1948 and 1949 to Collinwood Hospital to make up operating deficits sustained by Collinwood, were properly deductible by the partnership under section 23(a)(1)(A) of the Internal Revenue Code as ordinary and necessary business expenses.
The respondent disallowed the deductions taken in the partnership returns for these payments and increased the distributive share of partnership income on the individual returns of each petitioner for 1948 and 1949. Respondent's position is that the payments were not incurred in the partnership's business, that is, the practice of medicine, but rather were connected with the business of the hospital, a separate entity, and in any event, that the payments do not constitute ordinary and necessary expenses.
We have found that the payments in question were made to keep Collinwood Hospital in operation and thereby to protect the partnership's practice and income from a loss which the partners believed would result if the hospital closed. The petitioners controlled the operation of the hospital and reserved its facilities exclusively for patients admitted in their names. All fees for medical services rendered to hospitalized patients constituted partnership income, and the partnership also earned medical fees from patients who, although not requiring hospitalization, came or were sent to the partnership for medical care because the latter enjoyed unrestricted access to hospital facilities. That the existence of Collinwood did constitute a source of partnership income is illustrated by the refusal of several companies to send their industrial injury cases to the partnership after Collinwood closed in 1950, and a similar reaction on the part of the police with respect to severely injured accident victims.
Respondent's first contention is that the deductions are not allowable because the payments were incurred in carrying on Collinwood's business, and not that of the partnership, citing Interstate Transit Lines v. Commissioner, 319 U. S. 590, rehearing denied 320 U. S. 809, affirming 44 B. T. A. 957, affd. 130 F. 2d 136.
We think that the facts distinguish this case from Interstate Transit Lines v. Commissioner, supra. The partnership did not pay Collinwood Hospital's operating deficits to enable Collinwood to make profits from the operation of a hospital, thereby to augment the partnership income with hospital income. The payments were made to keep Collinwood in operation in order that the medical partnership itself could continue to earn medical fees from patients who would be hospitalized at Collinwood, or who would come, or would be sent to the medical partnership because of the latter's access to Collinwood's facilities.
This case also is distinguishable from Deputy v. DuPont, 308 U. S. 488, and Eskimo Pie Corporation, 4 T. C. 669, affirmed per curiam 153 F. 2d 301, which involve disallowance of a stockholder's deductions for expenditures made on behalf of his corporation, where the corporation's business operations are unrelated to any business the stockholder may carry on other than as a source of investment income.
Respondent next maintains that the partnership's payment of Collinwood's operating deficits was not an ordinary and necessary business expense. Respondent relies on Welch v. Helvering, 290 U. S. 111. See also Carl Reimers Co. v. Commissioner, 211 F. 2d 66, affirming 19 T. C. 1235.
We disagree with respondent's contentions. The facts in this case more closely resemble the situations involved in decisions which allow, as ordinary and necessary business expenses, payments made by a taxpayer to protect or preserve its business income from loss or diminution. See, for example, Robert Gaylord, Inc., 41 B. T. A. 1119; Hennepin Holding Co., 23 B. T. A. 119; First National Bank of Skowhegan, 35 B. T. A. 876; Edward J. Miller, 37 B. T. A. 830; Scruggs-Vandervoort-Barney, Inc., 7 T. C. 779; Dunn & McCarthy v. Commissioner, 139 F. 2d 242, reversing a Memorandum Opinion of this Court entered March 19, 1943; Catholic News Publishing Co., 10 T. C. 73; L. Heller & Son, Inc., 12 T. C. 1109. See also United States v. E. L. Bruce Co., 180 F. 2d 846; B. Manischewitz, 10 T. C. 1139.
In Scruggs-Vandervoort-Barney, Inc., supra, the taxpayer acquired the assets and liabilities of a retail department store named Scruggs-Vandervoort-Barney Dry Goods Company in a nontaxable statutory reorganization, and operated the business without changes in personnel or physical properties. The predecessor had owned 97.25 per cent of the stock of a bank, the Scruggs, Vandervoort & Barney Bank. The bank was located in the predecessor's store, and most, if not all, of the bank's depositors were its customers. The bank failed in 1933, and the depositors eventually were paid liquidating dividends aggregating 80.5 per cent of their deposits. The taxpayer undertook to reimburse the depositors in the amount of their 19.5 per cent loss in order to avoid unfavorable customer reaction which would result in a loss of patronage and diminution of business to the department store. To this end the taxpayer forwarded to each depositor, as a ‘voluntary action,’ a ‘voluntary gift offer’ of merchandise purchase certificates equal to the depositor's unsatisfied claims against the bank. This Court held that the cost of the goods purchased by the depositors with the certificates was an ordinary and necessary business expense.
In Dunn & McCarthy, supra, the taxpayer's president had borrowed a substantial amount of money from the firm's top ranking salesmen and had committed suicide, leaving a hopelessly insolvent estate. The corporation paid the loans in order to prevent impairing the salesmen's loyalty toward the company and to avoid the adverse opinion of customers who had learned of the situation. The deduction taken by the corporation for the payment of the former president's indebtedness was allowed as an ordinary and necessary business expense. Similarly, in Catholic News Publishing Co., supra, the taxpayer's business and reputation were threatened by a controversy between the taxpayer's president and a trade association, of which the taxpayer was a member. The dispute grew out of a claim asserted against taxpayer's president, personally, for an alleged mishandling of funds during his tenure as the association's treasurer. The taxpayer's board of directors decided that the claim against its president should be paid to avoid further injury to the taxpayer's business and reputation, and the amount so expended by the corporation to settle the controversy was held by this Court to be an ordinary and necessary business expense. In Hennepin Holding Co., supra, the taxpayers leased a large office building for 20 years and much of the surrounding area for 99 years, hoping to create a new retail district in the city of Minneapolis. When the building lease had only 6 years more to run, it became apparent that the business of the taxpayer's principal sublessee, a retail clothing house, was in jeopardy due to a continuing decrease in business. A new tenant could have been secured for the remaining few years only with difficulty and probably only after extensive repairs and remodeling, the cost of which could not be recovered before the termination of the principal lease. The sublessee also was indebted to the taxpayer. The taxpayer spent substantial sums in advertising the sublessee's business in an effort to rehabilitate the latter's sales. This expenditure was undertaken to avert the injury to the taxpayer's rental income which would have resulted from the sublessee's vacation of the premises and from the adverse affect of the sublessee's failure on the taxpayer's other tenants in the vicinity. The sums so spent by the taxpayer were held to be properly deductible as business expense.
These decisions, and the other cases previously cited, allow, as ordinary and necessary business expenses, expenditures made by a taxpayer seemingly on another's behalf, to prevent injury to its own business income. We think the expenditures made by petitioners' partnership to preserve the source of medical fees provided by Collinwood's existence should be accorded similar treatment.
The payments were not capital advances made to finance a new enterprise, such as were involved in Kenneth Carroad v. Commissioner, 172 F. 2d 381, affirming a Memorandum Opinion of this Court. Respondent also relies on A. Giurlani & Bro. v. Commissioner, 119 F. 2d 852, affirming 41 B. T. A. 403. The taxpayer's income was derived principally from the sale of Star Brand olive oil, which it purchased from an Italian corporation, the principal stockholders of which were two brothers of the taxpayer's two principal stockholders. The taxpayer compromised and paid certain claims against the Italian corporation, which had been placed in bankruptcy and whose assets were to be auctioned. It claimed that the payment was made to protect its source of supply of Star Brand olive oil, which allegedly had a distinctive and unusual blend. The payment was held not to constitute an ordinary and necessary business expense.
Concededly there is a similarity between the two cases. However, we observe several factors adverted to by the Court of Appeals in the Giurlani case which we consider of importance and which are not present in this case. Among the distinctions noted in the Giurlani case, supra, p. 854, was the taxpayer's failure to attempt to establish that it would have been
impossible to do business with the successor of the Italian corporation had the latter's creditors forced its stockholders out of control; or that it would have been impossible for it to specify to other producers of olive oil in the Lucca district of Italy, a blend which would approximate that which is known as ‘Star Brand.’
In the instant case, we have found that the medical practice of the partnership would have been adversely affected if Collinwood closed. Respondent claims that the partners could obtain privileges at other Cleveland hospitals, but the evidence establishes that even though petitioners did enjoy such privileges, the closing of Collinwood was attended by an immediate loss of part of the partnership's industrial accident practice, and also the loss of income it had derived from treating cases of severe injury brought in by the police. On this aspect, the present case is more similar to Robert Gaylord, Inc., supra, which this Court decided shortly after the Giurlani case. In the Gaylord case, the taxpayer, whose principal office was in St. Louis, manufactured and sold shipping containers. It executed a guaranty in favor of the First National Bank of St. Louis against any loss the latter might sustain in taking over the assets and liabilities of the Franklin-American Trust Company, also of St. Louis. The taxpayer was not a depositor or stockholder of the Franklin-American Trust Company. It executed the guaranty to prevent the failure of the latter bank and a potential financial crisis in St. Louis, which according to the evidence, would have jeopardized the taxpayer's accounts receivable, paralyzed its current business, particularly the Christmas trade then at its height, and cut down its prospective orders. The amount the taxpayer was required to pay under its guaranty was held to be deductible as a business expense.
Respondent also contends that the agreement of December 9, 1947, in which the partnership undertook to pay the hospital's deficits, should not be regarded as creating a legal obligation on the partnership's part in favor of the hospital, since the transaction was between closely related parties and the terms were such that the partnership would not have undertaken the agreement if dealing with a hospital at arm's length. Further, respondent maintains that the agreement was not binding on the partnership, inasmuch as it was signed by one of the three partners, contrary to an express prohibition contained in the partnership articles. We agree with respondent in part. The record does not support petitioner's explanation that the agreement merely formalized an obligation, implicit in the sales agreement of May 19, 1947, whereby the partnership was required to keep the hospital operating. We also agree that the hospital's promise to keep two beds available for the partnership at all times was without substance and should not be regarded as supporting an obligation to pay the deficits. The hospital's purported promise gave the partnership nothing it did not in fact enjoy previously, inasmuch as the partners exercised control of the hospital's operations and the facilities had always been maintained for their exclusive use.
Similarly, it is apparent that the agreement was not executed as required by the partnership articles, inasmuch as it was executed by only one partner. On the other hand, it is equally apparent from the evidence that all three partners did approve the payment of Collinwood's deficits both in 1948 and in 1949. We regard these payments as having been made voluntarily by the partnership without consideration from the hospital. The fact that the partnership was under no obligation to make up Collinwood's operating deficits is not decisive, in view of the benefits to the partnership medical practice which the hospital's continued existence afforded. L. Heller & Son, Inc., supra; Ray Crowder, 19 T. C. 329. See also Dunn & McCarthy v. Commissioner, supra; Scruggs-Vandevoot-Barney, Inc., supra.
It is held that the partnership is entitled to deduct the payments to Collinwood of $15,913.73 in 1948 and $21,007.84 in 1949 as ordinary and necessary business expenses, and that the respondent erred in disallowing these deductions and in increasing the petitioners' shares of distributive partnership income in 1948 and 1949. The petitioners have conceded the correctness of several other adjustments made by respondent. Accordingly,
Decisions will be entered under Rule 50.