Opinion
Docket Nos. 425 426.
1945-02-28
ROSE MARY HASH, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.G. LESTER HASH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Charles W. Moxley, Esq., and Helmut Holz, C.P.A., for the petitioners. P. A. Bayer, Esq., for the respondent.
1. Petitioners, husband and wife, owned jointly in equal shares and operated as one partnership two businesses, one a clothing and furniture business known as the ‘Hash Furniture Company‘ and the other a finance business known as the ‘National Finance Company.‘ They have two children, who are schoolgirls without business experience. The husband, by two purportedly irrevocable assignments in trust for indefinite periods, conveyed one-half of his one-half interest in each of the aforementioned businesses naming as beneficiary of the conveyance covering his interest in the Hash Furniture Co. his daughter, Rosemary II, and naming in the assignment covering one-half of his interest in the National Finance Co. his daughter, Doris June. In each assignment his wife was named as trustee, together with one Mann, their personal attorney. Concurrently, the petitioner, Rose Mary Hash, executed two similar assignments conveying identical interests in the two businesses. The beneficiary named in the assignment of her interest in the Hash Furniture Co. was their daughter, Doris June, and the beneficiary of the interest in the National Finance Company was Rosemary II. In each of these assignments, Rose Mary Hash named her husband as trustee, together with the aforementioned Mann. Concurrently with the execution of these trusts, and as provided therein, the petitioners, individually and as trustees, together with the attorney named as cotrustee, executed two agreements of partnership, one to carry on the furniture business and to be known as the ‘Hash Furniture Company‘ and the other, the finance business and to be known as the ‘National Finance Company.‘ Since these transactions, the two businesses have operated with the same respective assets and under the same control of the petitioners as in the past, and there has been no distribution of income to either of the two beneficiaries of the trust. Held, that each grantor-petitioner retained such dominion and control over the corpus and income of the trusts they created, by the trusts and partnership agreements, as to render them respectively taxable on the income therefrom under section 22(a), I.R.C., as construed in Helvering v. Clifford, 309 U.S. 331.
2. Both of the petitioners account for income tax purposes on the calendar year basis, as did the Hash Furniture Co., which reported the income from the finance business prior to the above described transactions. Each contract of partnership and assignment of trust fixed a fiscal year basis for accounting purposes, which was followed in their accounts and their income so reported. In determining the deficiencies, respondent has disregarded these partnership and trust agreements and has computed the income of the furniture business and the finance business upon a calendar year basis. He did this on the theory that the partnership agreements did not, in fact, create two new partnerships and that the tax years of the old partnerships were still effective, since permission of the respondent to change those tax years from a calendar year to a fiscal year basis had not been granted. Held, two new separate and distinct partnerships were created, which had a right to and did adopt a fiscal year basis for accounting, and the income from each of such partnerships is to be computed upon the basis of such fiscal year.
3. Certain property, title to which was taken in the name of the petitioner, G. Lester Hash, was the property of Hash Furniture Co. and the income therefrom taxable as such. Charles W. Moxley, Esq., and Helmut Holz, C.P.A., for the petitioners. P. A. Bayer, Esq., for the respondent.
These two proceedings, consolidated for hearing and decision, involve deficiencies in income taxes as follows:
+---+ ¦¦¦¦¦ +---+
Docket Petitioner No. Year Deficiency ( 1940 $2,380.68 Rose Mary Hash 425 ( 1941 35,574.62 ( 1940 1,946.40 G. Lester Hash 426 ( 1941 45,248.95
The issues are (1) whether one-half of the income of businesses operated by the petitioners in partnership is taxable in equal proportions to each of their two daughters by reason of certain assignments by each of the petitioners of one-half of their respective interests to alleged trusts for their daughters and the execution of new partnership agreements by the petitioners individually and also in their capacity as trustees of those trusts; (2) whether the income of certain partnerships is to be determined on the basis of a calendar or fiscal year for inclusion in the income of petitioners; and (3) whether the income from certain ventures entered into by the petitioner, G. Lester Hash, represented personal and individual investments by him or by the business carried on by that petitioner and his wife in partnership. Certain of the facts are stipulated and others found upon evidence adduced at the hearing.
FINDINGS OF FACT.
The petitioners, husband and wife, during the taxable years resided in Beckley, West Virginia. They filed separate returns for those years with the collector of internal revenue for the district of West Virginia.
Shortly after they were married the petitioners jointly started in business by taking over a music store which had been owned by the father of the petitioner, G. Lester Hash. A short time later they changed their activities to the operation of a small furniture business. Their capital resources were small and both devoted all of their time to the operation of the business, which, through their combined efforts, became very successful as the Hash Furniture Co. During the taxable years their activities embraced about ten retail furniture and clothing stores, a small loan company doing business as the National Finance Co., and various other investments, the net value of all of which at that time was approximately a half million dollars. At the time of the transactions hereinafter detailed, the business activities of petitioners were being carried on in partnership, each owning a one-half interest. That partnership agreement was as follows:
ARTICLES OF PARTNERSHIP AGREEMENT.
This partnership agreement made this the 15th day of June, 1938 by and between G. Lester Hash and Rose Mary Hash, his wife, both of Beckley, Raleigh County, West Virginia.
WITNESSETH
THAT WHEREAS, the parties hereto are the joint owners of a retail merchandising business known by the several trade names as Hash Furniture Company of Beckley, West Virginia; Hash Furniture Company of Mullens, West Virginia; Hash Furniture Company of Welch, West Virginia; Hash Furniture Company of Oak Hill, West Virginia; King Clothing Company of Winston-Salem, North Carolina; King Clothing Company of Greensboro, North Carolina; Vera-Rose Beauty Shop of Beckley, West Virginia; Charlotte's Beauty Shop of Bluefield, West Virginia; Modern Beauty Shop of Welch, West Virginia, and
WHEREAS, the parties have been operating said business as Partners under and by virtue of a partnership agreement made between them in 1927 and and desire to execute this partnership agreement in renewal and continuance of said agreement of 1927.
NOW, THEREFORE, each of the parties hereto is hereby declared to be the owner of a one-half interest in all of said business, including all merchandise, stock, fixtures, cash, accounts receivable and good will as of December 31, 1935 and the statement of this partnership business prepared by N.G. Somerville Audit Company of Huntington, West Virginia for said date and this interest as so shown by said statement is hereby accepted by each of the parties as full settlement of all partnership accounts up to and including this date.
Each of the parties shall share equally all profits and losses of the business.
Each partner shall be entitled to withdraw a reasonable amount from the profits of the business at any time but the total amount so drawn by any partner shall not exceed the total amount withdrawn by the other in any one year without the express consent of the other partner.
This partnership agreement shall be perpetual and shall continue in force during the joint lives of the partners and in case of the death of either of the partners the survivor shall continue the partnership on equal terms with the legal heirs of the deceased partner.
It is agreed that G. Lester Hash shall be the active Manager of the entire partnership business, but both parties shall contribute full time personal services to the partnership business during the joint lives of the parties.
Petitioners have two daughters, Rosemary, born in 1924, and Doris June, born in 1926. Prior to September 1, 1940, the petitioners had discussed with an attorney the matter of creating trusts in favor of their daughters. This matter, including its possible tax consequences, had also been discussed with their accounting adviser and tax consultant, who conferred on various occasions with the attorney retained by petitioners to prepare the trust instruments. As a result of these various conferences there was prepared and executed, on September 1, 1940, by each of the petitioners, an ‘Assignment and Declaration of Trust.‘ These instruments were identical except that the one in which the petitioner, G. Lester Hash, is grantor named Rose Mary Hash and F. W. Mann as trustees and the daughter, Rosemary Hash II, as beneficiary, and Rose Mary Hash contingent beneficiary, while the one in which the petitioner, Rose Mary Hash, is grantor named the petitioner, G. Lester Hash, and F. W. Mann as trustees and the daughter, Doris June Hash, as primary beneficiary, with G. Lester Hash as contingent beneficiary. These assignments were acknowledged and recorded in the county clerk's office of Raleigh County, West Virginia, and are as follows:
THIS ASSIGNMENT AND DECLARATION OF TRUST made this September 1, 1940 by and between G. L. HASH, grantor, party of the first part and Rose Mary Hash and F. W. Mann, Trustees, parties of the second part.
WITNESSETH:
That G. L. Hash hereby declares that he is the sole owner of 1/2 interest in all the business, property, accounts, estate and goodwill of the partnership composed of himself and Rose Mary Hash now operated as a money lending business in Beckley, West Virginia under the trade name of National Finance Company; that the net worth of his 1/2 interest of said business as of this date as shown by the books of said company is $50,000.
That he desires to transfer a 1/4 interest in said business (1/2 of his interest) to the Trustees above named for the purpose and use and upon the conditions hereinafter set out.
NOW THEREFORE THIS ASSIGNMENT AND DECLARATION OF TRUST WITNESSETH:
That for and in consideration of the mutual agreements and undertakings and for the purposes hereinafter set forth, the said G. L. Hash does hereby assign, transfer and set over unto ROSE MARY HASH and F. W. MANN, Trustees, the following property, rights and interests:
1/4 interest in and to all the business, property, assets, franchises, accounts, rights in action and goodwill, together with all increases thereof and income therefrom of the money lending business now being operated at Beckley, West Virginia by G. L. Hash and Rose Mary Hash under the firm name of National Finance Company, the net worth of which 1/4 interest is declared to be $25,000 as shown by the books of National Finance Company, a statement of assets of which is attached herewith.
IN TRUST HOWEVER for the following beneficiary, purposes and uses and upon the following conditions:
1. BENEFICIARY. The beneficiary of this Trust as to corpus and income shall be ROSEMARY HASH II, daughter of the grantor for the term of her life, thereafter her children, if any, or in case she dies without children, her sister, Doris June Hash, for the term of her life, and thereafter her children, if any; thereafter their mother Rose Mary Hash, if living. The Trustees are hereby given authority to remove any beneficiary or beneficiaries who in the judgment of the Trustees prove themselves grossly unworthy of this trust and to appoint another beneficiary or beneficiaries to be selected from the contingent beneficiaries hereinabove named.
2. PURPOSES. The purposes of this trust are to create an estate for the beneficiary and to accumulate sufficient funds for the maintenance, education and support of the beneficiary in case the grantor should, by death or otherwise, be unable to furnish sufficient funds for that purpose.
3. CORPUS. The corpus of this trust shall be the original contribution by the grantor as above set out, any subsequent contributions by either the grantor or other persons and any increase from income which has not been distributed or set aside to be distributed to the beneficiary by the Trustees within 2 1/2 months after the close of the calendar year in accordance with the provisions hereinafter contained.
4. TERMINATION. This trust shall be terminated at the date upon which the youngest child of Rosemary Hash II attains its majority, or in case Rosemary Hash II dies without children, then this trust shall terminate at the date upon which the youngest child of Doris June Hash attains its majority, or in case both Rosemary Hash II and Doris June Hash die without children, then this trust shall terminate as of the date of the death of the one who lives longer.
PROVIDED, HOWEVER, that the Trustees may terminate this trust at any time prior to the date of final termination as above provided and turn over the corpus and accumulated income to the beneficiary, if, in the judgment of the Trustees, the purposes of the Trust will be accomplished by the beneficiary's own capable management of the corpus and income.
Upon termination of the trust the corpus and accumulated income are to be distributed to the beneficiary in such proportions and at such times as, in the judgment of the Trustees, will best serve the interest of the beneficiary.
5. ADMINISTRATION OF THE TRUST. This trust shall be administered by the Trustees herein named or by their successors who shall be appointed in the manner hereinafter provided. The corpus of this trust as determined by the provisions of paragraph 3 above shall be invested by the Trustees in such manner as to insure the largest possible yield without encountering any unreasonable hazard. (Sic.) The Trustees are authorized to invest said corpus in any venture or business in which the grantor is a partner, either by loaning to such business with or without security or by entering it as a partner, provided such procedure seems justifiable to the Trustees and is in their judgment a good business venture. The Trustees are also authorized to invest said corpus in the bonds and stocks of any corporation in which the grantor is a majority stockholder and officer. The Trustees are also authorized to invest said corpus in government, state or municipal bonds, annuities, life insurance contracts, notes or bonds secured by trust deeds or real estate where the margin of security is ample, or finance or loan companies which, in the judgment of the Trustees, are in good financial condition, and to lend or invest said fund under circumstances and with such security as will, in the judgment of the Trustees, adequately protect said fund. The Trustees are also authorized to deposit the corpus of this Trust and income therefrom in any reliable State of National Bank. Investments made in accordance with these provisions may be retained by the Trustees after the death of the grantor. The Trustees shall have no power to revest in the grantor title to the corpus of the trust or any profit or income therefrom.
6. DISPOSITION OF INCOME. The income from this trust so far as not needed for the payment of general expenses and taxes is to be accumulated as long as its distribution is not necessary to carry out the purposes of this trust. In case the distribution of income is necessary to carry out the purposes of the trust during the life of the grantor or after the death of the grantor the net income of the next preceding calendar year may be distributed in the next subsequent year in twelve equal monthly installments to the beneficiary, if in the judgment of the Trustees this is necessary, or the distribution of said income may be made in such proportions as in the judgment of the Trustees will best serve the needs of the beneficiary. If the income of the preceding year computed without deducting payments made to the beneficiary is insufficient, or in case of loss, the trustees are authorized to distribute from accumulated profits of prior years which have become a part of the corpus such amounts as to them appear necessary. If ready cash for such distribution is not available the Trustees may either borrow the necessary funds temporarily or sell or use enough of the corpus to meet the current years requirements, whichever in the judgment of the Trustees appears to be more favorable.
In no case is the corpus or income to be used for the personal benefit of the grantor and in no case shall corpus or income be used to relieve the grantor of his obligation to maintain and support the beneficiary.
7. ADDITIONAL TRUSTEES. In case of death, disability, or refusal to act by one or more of the Trustees the grantor, if living, may appoint an additional trustee or trustees; if the grantor be not living or be incapable of acting then the remaining Trustee shall appoint another to fill the vacancy created by death, disability, or refusal to act. In case of death, disability or refusal to act by both Trustees and the grantor be not living or incapable of acting then additional Trustees shall be appointed by the Judge of the Circuit Court having jurisdiction over the corpus of the Trust. In no case shall the grantor be named as a Trustee.
8. DISAGREEMENT OF TRUSTEES. Unanimity of decision on the part of the trustees shall be required for action. In case the Trustees disagree on any material matter they shall refer the matter in dispute to the Judge of the Circuit Court having jurisdiction over the corpus of the trust who shall decide the matter for them.
9. REVOCATION. The grantor shall have no power to revoke this trust.
10. LIABILITY OF TRUSTEES. The Trustees shall exercise reasonable care and diligence in the administration of this trust, but they shall not be personally liable except for fraud or embezzlement of trust funds.
11. PAYMENT BY TRUSTEES. The Trustees are authorized to pay taxes and general expenses of administration from trust funds.
12. The Trustees sign this agreement only for the purpose of indicating their present willingness to act as Trustees.
IN WITNESS WHEREOF we have hereunto set our hands and seals on this first day of September, 1940.
(Sgd) G. L. HASH Grantor. (Sgd) ROSE MARY HASH Trustee. (Sgd) F. W. MANN Trustee.
STATE OF WEST VIRGINIA
COUNTY OF RALEIGH,
I, T. Allan Gatherum, a Notary Public in and for the County and State aforesaid, do hereby certify that G. L. Hash, grantor; Rose Mary Hash and F. W. Mann, Trustees, whose names are signed to the foregoing Assignment and Declaration of Trust, bearing date the first day of September, 1940, have this day acknowledged the same before me in my said County.
Given under my hand this the 2 day of September 1940.
My commission expires:
July 15, 1947
(N.P. SEAL)
(Sgd) T. ALLAN GATHERUM Notary Public, Raleigh County, West Virginia
+-----------------------+ ¦NATIONAL FINANCE ¦ ¦COMPANY ¦ +-----------------------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------+
Beckley, W. Va.
FINANCIAL STATEMENT, SEPTEMBER 1, 1940.
ASSETS Cash in Raleigh County Bank 2870.01 Small loans receivable 98614.78 Returned checks 17.20 Prepaid Taxes and Licenses 91.67 Due from Hash Furniture Company 3516.34 $105000.00
LIABILITIES Notes payable--banks 5000.00 Net worth: G. L. Hash, investments $25000.00 R. M. Hash, “ 25000.00 Trust Rose Mary Hash 25000.00 Trust, Doris June Hash 25000.00 100000.00 Total liabilities and capital $105000.00
On the same date, September 1, 1940, the petitioners as individual partners and as trustees and F. W. Mann as trustee signed an ‘Agreement of Partnership‘ as follows:
THIS AGREEMENT OF PARTNERSHIP made this September 1, 1940 by and between G. L. HASH, party of the first part, ROSE MARY HASH, party of the second part, ROSE MARY HASH and F. W. MANN as Trustees, parties of the third part and G. L. HASH and F. W. MANN as Trustees, parties of the fourth part,
WITNESSETH:
THAT WHEREAS the said G. L. Hash and Rose Mary Hash are now engaged as equal partners in the ownership and operation of a business of lending money and trading under the style and firm name of NATIONAL FINANCE COMPANY, and
WHEREAS the said G. L. Hash by instrument dated September 1, 1940 has set up and established a trust with his daughter Rosemary Hash II as beneficiary therein and has set apart and transferred irrevocably to the said parties of the third part hereto, a one-fourth interest in the said National Finance Company and
WHEREAS the said Rose Mary Hash by instrument dated September 1, 1940 has set up and established a trust with her daughter, Doris June Hash as beneficiary therein and has set apart and transferred irrevocably to the said parties of the fourth part a one-fourth interest in the said National Finance Company, and
WHEREAS all the parties hereto desire to form this partnership for the operation of the National Finance Company and the Trustees in both of the aforesaid trusts having been authorized by the respective Trust Agreements to enter into this partnership,
NOW THEREFORE THIS AGREEMENT WITNESSETH:
That the said G. L. Hash, Rose Mary Hash, Rose Mary Hash and F. W. Mann, as Trustees and G. L. Hash and F. W. Mann as Trustees, are hereby declared to be and do hereby agree to become and remain partners under the terms of this partnership agreement in the ownership, management, operation and control in the business of lending money at interest under the provisions of Chapter 47, Article 7A of the official code of West Virginia, known as the Small Loan Act, and as heretofore conducted by G. L. Hash and Rose Mary Hash as partners under the trade name of National Finance Company at Beckley, West Virginia.
It is mutually understood and agreed that this partnership is limited exclusively to the ownership, operation, management and control of said National Finance Company as it is now and as it may hereafter be developed, and to the ownership, operation and control of other like or similar money lending businesses located at other points in this State or in other States. It shall not extend to any other business, industry, or activity as to either of the parties hereto.
It is further mutually understood and agreed that no other person or concern owns any part of or interest in said National Finance Company and that all of the property and assets of said National Finance Company now owned or hereafter acquired by it belong to the parties hereto jointly in the following proportion, that is to say, the net worth of said National Finance Company after deducting all liabilities, debts and accounts payable is ONE HUNDRED THOUSAND DOLLARS ($100,000.00) and this net worth of $100,000 is owned jointly by the partners in the proportion of $25,000 to G. L. Hash, $25,000 to Rose Mary Hash, $25,000 to Rose Mary Hash and F. W. Mann as Trustees, and $25,000 to G. L. Hash and F. W. Mann, Trustees, but this proportionate ownership however, is subject to such changes as may hereafter be made due to additional contributions of capital, undistributed profits and withdrawals by either party.
MANAGEMENT: The management partner shall be G. L. Hash and he shall have complete and exclusive control of the operation and management of this partnership so long as he faithfully discharges his duties and promotes the interests of all partners or until the partnership shall be dissolved. It is expressly provided that among the duties of the managing partner shall be to keep a complete and accurate set of books for the partnership and to make such books available at any time for inspection and audit by any partner or a reputable accountant designated by such partner and any failure to do so shall be wilful neglect of duty.
COMPUTATION OF PROFITS: Profits of the partnership shall be computed annually at the end of each fiscal year ending June 30th. The computation shall be completed as soon as practicable after June 30th of each year and not later than 60 days after the close of each fiscal year. The computation of profits shall be on the basis of cash receipts and disbursements according to the provisions of the Federal Revenue Act in force for the particular year.
DISTRIBUTION AND WITHDRAWALS. The said G. L. Hash shall be entitled to withdraw from the profits of the partnership $1,200.00 per year which shall be in full for his salary as Managing partner and any profits remaining after paying overhead, costs of operations, taxes, etc. shall belong to the partners jointly in equal portions. Losses shall likewise be borne equally. Each partner shall have the right to withdraw his share of the net profits of the partnership for the last fiscal year within 90 days after the close of such fiscal year or within 30 days after the computation of profits for such year whichever period is longer. Any profits not withdrawn or demanded within the periods thus provided shall become partnership capital to the credit of the partner who failed to make his withdrawal and shall not be subject thereafter to withdrawal except in case of mutual agreement.
DURATION OF PARTNERSHIP. The duration of this partnership shall be during the joint lives of the partners herein named or their successors and assigns according to the provisions hereinafter made, that is to say, so long as both G. L. Hash and Rose Mary Hash shall live and both of said Trusts shall continue in existence and effect. However, the duration of this partnership shall always be subject to the provisions for its dissolution as hereinafter set out.
DISSOLUTION OF PARTNERSHIP. The dissolution of this partnership may be accomplished by either of the following methods:
1 - At any time by mutual agreement of the partners.
2 - By either party for good cause. Good cause for dissolution shall be:
(a) Dishonesty on the part of any partner.
(b) Wilful neglect of duty on the part of the managing partner or any act of his grossly detrimental to the interest of any of the other partners.
(c) Failure of the partnership to earn a reasonable profit.
3 - By any partner giving to the other partners six months notice in writing of his intention to withdraw from the partnership which notice shall state the date of his intended withdrawal.
4 - By the death of either G. L. Hash or Rose Mary Hash, or the dissolution of either of said trust agreements. Provided, however, that in any such case the surviving partners may agree to continue the partnership on the same terms and conditions as herein set out with the heirs, personal representatives, successors or assigns of the deceased partner or partners, or the beneficiaries of the dissolved trust or trusts.
In case of a dissolution of the partnership as provided in (1) above, each partner, or any two or more of the partners, jointly, shall have the right and option to purchase the interest of any other partner or partners before it is offered for sale to any outside person.
In case of dissolution by (a) or (b) of No. 2 above, the partner or partners having good cause for dissolution shall have the right and option of purchasing the interest or interests of the defaulting partner or partners before it is otherwise disposed of.
In case of dissolution by No. 3 above the partners receiving the notice shall have the right and option of purchasing the interest of the partner or partners giving the notice of withdrawal or dissolution prior to its disposition to any other person.
In case of dissolution by No. 4 above the surviving partner or partners shall have the first right and option of purchasing the interest of any deceased or dissolved partner if the same shall not have been inherited by or bequeathed to the surviving partner or partners or the beneficiaries of either or both of said trusts. In case the cause for dissolution as set out in No. 4 above shall occur and the interest of the deceased or dissolved partner shall have been inherited by or bequeathed to the surviving partners or shall have passed to the beneficiary of either or both of said trusts, then they, the surviving partners, hereby agree to continue the business of the partnership upon the same terms and conditions as herein provided.
In case of the death, disability or refusal to act of the managing partner, nothing herein contained shall prevent the trustees of either or both trusts from withdrawing from the partnership its full share of capital and profits.
In case of a sale and purchase by one or more of the partners of the interest of one or more of the other partners whenever an option to buy is given hereunder, the value of the interest purchased shall be determined as follows:
All real estate, fixtures, equipment and appliances shall be appraised at their depreciated values as shown by the books of the partnership. Personal property, accounts receivable and other assets shall be appraised at the fair market value as agreed to by the parties at the time of the purchase. In case the parties cannot agree on such value then the matter of the values as to which no agreement can be reached shall be submitted to a Board of Arbitrators as herein provided.
LIQUIDATION. In case of a liquidation of the partnership the outstanding debts of the partnership business shall be first paid. Thereafter there shall be returned to each partner his share of the capital as shown by the books of the partnership at the time of the dissolution. There shall next be distributed to each partner his distributive share of the partnership profits in liquidation. In case there is a loss in liquidation each partner's distributive share of such loss shall be deducted from the capital account of such partner. All distributions in case of liquidation, shall be made in cash, and as accounts receivable become due and are collected unless all parties concerned agree otherwise.
ARBITRATION. In case of a dispute arising between the partners concerning the operation, management or dissolution of the partnership or the provisions of this agreement, the parties hereby agree to submit the same to arbitration as follows:
Each partner shall appoint one arbitrator and the two arbitrators thus selected shall select a third who shall be a competent reputable attorney at law. In case the two arbitrators cannot agree then the third arbitrator shall be appointed by the Judge of the Circuit Court of Raleigh County. In case an arbitrator is selected by one of the partners and the other partner delays more than five days after receiving notice in writing to appoint his arbitrator, then upon application by the partner who has already made his selection, the Judge of the Circuit Court of Raleigh County may appoint the other two arbitrators, one of whom shall be a competent and reputable attorney at law. The three arbitrators when duly appointed as above, shall, if they desire, have access to all books and records of the partnership and shall have the right to examine all of its account, notes, securities, books, inventories, assets and equipment and to hear evidence of the partners and other witnesses and to make any accounting necessary and to do all things fully and completely to enable them to make a fair and full settlement of all matters in arbitration. When the said Board of Arbitration has passed upon matters in dispute between the partners properly coming before it as herein provided, it shall notify each partner in writing of its decision and its decision shall be final and binding upon the parties which it affects unless one or more of the parties aggrieved by its decision shall file their bill in equity in any Circuit Court having jurisdiction within 60 days from the time he receives notice of the final decision by said Board of Arbitration praying for an accounting and settlement of all matters pertaining to the partnership business. In any such suit the written report and decision of the Board of Arbitration shall be considered competent evidence for or against any party to said suit.
It is expressly provided that neither of the Trustees mentioned herein assumes any personal liability nor shall said Trustees be personally liable either jointly or severally for any transaction in connection with this partnership, except, however, that the persons herein named who sign both as individual partners and as Trustees shall be liable to the extent that they have signed the partnership agreement as individual partners in addition to their signatures as Trustees.
This Agreement is executed in duplicate on this the first day of September, 1940.
WITNESS the following signatures and seals.
(Sgd) G. L. HASH (SEAL) G. L. Hash, partner (Sgd) ROSE MARY HASH (SEAL) Rose Mary Hash, partner (Sgd) ROSE MARY HASH (SEAL) As Trustee of Trust Agreement of which Rosemary Hash II is beneficiary. (Sgd) F. W. MANN (SEAL) As Trustee of Trust Agreement of which Rosemary Hash II is beneficiary. (Sgd) G. L. HASH (SEAL) As Trustee of Trust Agreement of which Doris June Hash is beneficiary. (Sgd) F. W. MANN (SEAL) As Trustee of Trust Agreement of which Doris June Hash is beneficiary.
STATE OF WEST VIRGINIA
COUNTY OF RALEIGH
I, T. Allan Gatherum, a Notary Public in and for the County and State aforesaid do hereby certify that G. L. Hash and Rose Mary Hash, G. L. Hash as Trustee, Rose Mary Hash as Trustee and F. W. Mann as Trustee, whose names are signed to the foregoing writing bearing date the 1st day of September, 1940, have this day acknowledged the same before me in ny said county.
Given under my hand this the 4 day of September, 1940.
My Commission expires:
July 15, 1947
(Sgd) T. ALLAN GATHERUM Notary Public, Raleigh County, West Virginia (N.P. SEAL)
On May 1, 1941, each of the petitioners executed another ‘Assignment and Declaration of Trust.‘ These instruments were identical except that the one in which the petitioner, G. Lester Hash, is grantor named the petitioner, Rose Mary Hash, and F. W. Mann as trustees and the daughter, Rosemary Hash, II, as first beneficiary, while the one in which the petitioner, Rose Mary Hash, is grantor named the petitioner, G. Lester Hash, and F. W. Mann as trustees and the daughter, Doris June Hash, as first beneficiary. The assignments are similar to those executed by petitioners on September 1, 1940, except that they cover interests of petitioners in the Hash Furniture Co., and whereas the assignment, of September 1, 1940, empowered the trustees to remove a beneficiary who, in his discretion, was deemed unworthy, the assignments executed on May 1, 1941, provided for this action to be taken by the Circuit Court having jurisdiction of the trust estate in a proceeding brought for that purpose by the trustees.
On the same date of execution of the two last mentioned assignments, May 1, 1941, each of the petitioners, as individual partners and trustees, and F. W. Mann, as trustee, signed an ‘Agreement of Partnership.‘ The provisions of this agreement, except as to the business which it covered, are practically identical with the provisions of the agreement of partnership dated September 1, 1940, and hereinbefore set out. The individual, F. W. Mann, named as trustee in the various assignments above mentioned, is the attorney retained by the petitioners to advise them and prepare the various instruments. At the time of the execution of these instruments, the businesses covered by the several assignments had been operated since their organization by the two petitioners. After the execution of these assignments and partnership agreements the businesses continued to be operated identically as before by the two petitioners. Their daughters were schoolgirls, with no business experience, and performed no services with respect to these businesses. F. W. Mann, named as trustee in each of the assignments, is a lawyer without experience in the furniture business or the small loan business and has taken no part whatsoever in the operation of those businesses, his activities as trustee having been limited wholly to endorsing and mailing to the petitioner, G. Lester Hash, certain checks made payable to him as trustee and signing certain income tax returns for the trusts prepared and brought to him for signature by the petitioners' tax consultant.
The income from the business of the National Finance Co. was reported in the income tax return of the old Hash Furniture Co. In the return of that company for 1940 the income from the National Finance Co. business to September 1 only was included.
The new partnership agreement of the National Finance Co. provided for a fiscal year ending June 30. Proper books of account were opened September 1, 1940. They were closed as of June 30, 1941, and again as of June 30, 1942. Partnership returns were filed covering the period September 1, 1940, to June 30, 1941, and for the period July 1, 1941, to June 30, 1942.
The books of the old Hash Furniture Co. partnership were closed as of April 30, 1941, and a final income tax return covering its operations in 1941 to that date was filed.
The new partnership agreement for the Hash Furniture Co. provided for a fiscal year ending April 30. Proper books of account were set up as of May 1, 1941, and closed as of April 30, 1942. A partnership return was filed covering the period May 1, 1941, to April 30, 1942.
The petitioners have reported in their incomes for the calendar year 1940 their distributive shares of the net income of the old Hash Furniture Co. They reported in their incomes for the calendar year 1941 their distributive shares of the income shown by the final return of the old Hash Furniture Co.; their share of the real estate partnership; and their share of the income of the National Finance Co. for the fiscal year ended June 30, 1941.
In determining the net income of the partnership, respondent allocated their reported net income from the fiscal year basis to a calendar year basis. He then determined that equal shares of this partnership net income were distributable to petitioners, respectively.
As so allocated and determined, respondent added to income reported by petitioners for the year 1940 a part of their share in the net income of the National Finance Co. for the fiscal year ended June 30, 1941.
The respondent has added to their income reported for the calendar year 1941 the remainder of their distributive shares in the net income of the National Finance Co. for the fiscal year ended June 30, 1941; he also added a part of their distributive share in the net income of the National Finance Co. for the period ended June 30, 1942; and has also added a part of their share in the net income of the new Hash Furniture Co. for the period ended April 30, 1942.
The trusts have established the same fiscal years as the partnership and have filed income tax returns on that basis.
None of the income of the partnerships allocated to the trusts has been distributed to the beneficiaries, but all has been retained and used in the businesses. Following the making of each one of the assignments above described each petitioner has returned the value of the interest so assigned for gift tax and has paid the tax thereon.
The petitioner, G. Lester Hash, prior to the taxable years, engaged with one Rubin in a venture of purchasing certain interests in oil wells. His proportion of the payments made from time to time has been made in some instances with his personal check or that of the petitioner, Rose Mary Hash, and at other times with the check of the Hash Furniture Co. These disbursements have been later adjusted upon the books of the Hash Furniture Co. by charging them to its ‘investment account.‘ Income from these investments has been received by the petitioner, G. Lester Hash, by checks made payable to him individually and some of these have been used by him in the purchase of additional oil interests. Title to all of the investments in these oil properties has been taken in his name individually. The income received has been included by the petitioners as partnership income of the Hash Furniture Co., but in determining the deficiencies has been charged by respondent to the petitioner, G. Lester Hash, individually. Investments made in the several oil properties, as set out in the stipulation, were partnership investments and the income therefrom was partnership income.
Prior to August 9, 1941, one W. H. Canterbury was the owner of a business known as the Crab Orchard Wrecking Co. The petitioner, G. Lester Hash, on that date negotiated with him the purchase of a one-half interest in this company for $1,000 and made an advance of a similar amount to the business. Payment both for the one-half interest and the advance was made by checks of the Hash Furniture Co. These checks were charged on the books of that company against ‘Account of G. Lester Hash,‘ but this entry was later corrected by a charge of these amounts on those books to ‘investments,‘ a credit being made to this petitioner's account to offset the former charge. Following the purchase of a one-half interest in this company as described, the business was continued as the Beckley Auto Exchange and on October 7, 1941, was incorporated under this name, the stock being issued in equal amounts in the names of W. H. Canterbury and G. Lester Hash, with the exception of one share each in the names of Rose Mary Hash and Dorothy Canterbury. The income received in the taxable years from the Beckley Auto Exchange was included by petitioners as partnership income of the Hash Furniture Co., but in the determination of the deficiencies here all of such income was assigned to the petitioner, G. Lester Hash. Investment made in the Beckley Auto Exchange was one of the partnership business and the income therefrom represented partnership income.
OPINION.
LEECH, Judge:
The primary issue is whether by these trusts and partnership agreements to which the trusts were parties the petitioners each retained such a ‘bundle of rights‘ in the property transferred to the trusts as to render them respectively taxable on the income therefrom under section 22(a) of the Internal Revenue Code, as construed by Helvering v. Clifford, 309 U.S. 331.
The petitioners owned two flourishing partnership businesses. One was a furniture business and the other, small loans. Petitioners testified, in effect, that after discussing the matter, including its tax consequences, with their attorney and tax consultant they decided to create separate trusts for each of their two minor daughters— for the purpose of assuring economic security to their children, who were minors attending a private school in Virginia and, of course, never had furnished any services to either business. The means selected, as petitioners testified, were the trusts and partnership agreements described in the findings of fact. Each trust and partnership agreement to which it became a party was executed simultaneously. They were intended as a single transaction. All parties, including the children, understood this intention. Both the trusts and the partnership agreements in which they joined evidence conclusively the respective inseparability of such trusts and partnership agreements. Thus construed, what do we find?
It is not denied— in fact the circumstances seem to confirm— that petitioner, Rose Mary Hash, made her husband, G. Lester Hash, a trustee and possible sole beneficiary of the trusts she created in consideration of his similar action in those he created. The corpora of the former were identical with the latter. They were therefore cross-trusts and the effect for tax purposes was that the settlor of each trust became a trustee thereof. Lehman v. Commissioner, 109 Fed.(2d) 99. F. W. Mann, the second trustee in each trust, was the intimate friend and personal attorney of both petitioners. They were advised by him as well as their accountant in connection with the plan. The testimony of Mann was that he knew little or nothing about either the furniture or small loan business and that his connection with both of them was merely formal and consisted only of endorsing checks presented to him for that purpose and executing income tax returns prepared by the accountant. Thus, the second trustee was not independent and the settlor is therefore to be considered, for present purposes, as the sole trustee. Commissioner v. Barbour, 122 Fed.(2d) 165; Commissioner v. Lamont, 127 Fed.(2d) 875; Bush v. Commissioner, 133 Fed.(2d) 1005.
Unless dissolved, as provided in the agreements, the partnerships were to continue as long as petitioners lived and the trusts existed. But dissolution would have been difficult, if not impossible, without the consent of the settlor-trustee. In fact, in some of the dissolution as well as the arbitration provisions of the partnership agreements, the settlor-trustees are alone recognized as members of the partnership. During the lives of the partnerships, though their profits were to be determined at the close of the tax year and were then payable in equal proportions to the partners on demand within two and one-half months thereafter, the share of any partner failing to make such demand was credited to his capital account and could not thereafter be withdrawn except with the consent of all other partners. As settlor-trustee, each petitioner could and did thus fail to withdraw that income. In their individual capacities, as partners, petitioners could thereafter prevent its withdrawal during the life of the partnership. None of it was withdrawn and it remained in the business of the partnerships as it had been theretofore. This capitalized income, under the trusts, became capital thereof and was distributable by the trustees only after the termination of the trust and then ‘in such proportions and at such times as, in the judgment of the Trustees, will best serve the interest of the beneficiary.‘ The trustees were not only authorized under the trusts to become members of or loan to these partnerships, with or without security, but were likewise authorized to invest it ‘in the bonds and stocks of any corporation in which the grantor is a majority stockholder and officer‘— and all this without liability except for fraud or embezzlement. Neither trust was to terminate until the youngest child of the daughter, the primary beneficiary, attained the age 21, or, on the failure of such issue, until the youngest child of the other daughter became 21, and if both children, primary beneficiaries of the trusts, died without issue, then the trust terminated at the date of the death of the daughter who lived longer— except that the trustees could terminate each trust ‘if, in the judgment of the Trustees, the purposes of this Trust will be accomplished by the beneficiary's own capable management of the corpus and income.‘
It is true that the interests, the legal title to which petitioners assigned to the trusts, were valuable. Admittedly, specific beneficiaries were named as the recipients of the trust benefits. But, we think, the transfers to the trusts were practically limited to legal title. Petitioners retained substantially the same control over the income as well as the corpora of the trusts as they had theretofore. They were, for present purposes, the real beneficiaries of the trusts. They intended this to be so. They say they desired to create separate estates for their children, but in the same breath they emphasize their fear that either or both of their daughters might marry ‘fortune hunters‘ or ‘liquor heads.‘ So they proposed to retain, at least during their lives, control over these ‘separate estates‘ until the petitioners, settlors, were certain the conditions they desired had come to pass. Thus, whatever may be the legal effect as to the beneficiaries of the trusts, under provisions in the first trusts ‘the Trustees are hereby given authority to remove any beneficiary or beneficiaries who in the judgment of the Trustees prove themselves grossly unworthy of this trust and to appoint another beneficiary or beneficiaries to be selected from the contingent beneficiaries hereinabove named.‘ These were later ‘clarified‘ by decree of the local West Virginia courts to accord with the provisions of the latter two trusts under which ‘the trustees‘ were authorized to bring an action in those courts for such a change in beneficiaries which could result in their respective recovery, as named contingent beneficiaries, of any legal title that might have passed to the trusts. Moreover, and very significantly, unless terminated by the settlor, both the corpora and accumulated income were to revert to the respective settlors unless both or either of their daughters had issue who lived to be 21 years of age.
The facts here are strikingly similar to those in the case of A. R. Losh, 1 T.C. 1019; affd., 145 Fed.(2d) 456, where we applied the Clifford rule. We do so here.
Our conclusion from this record is that by these trusts and partnership agreements each petitioner retained such a ‘bundle of rights‘ in the corpora of the trusts which each petitioner created as to constitute them the substantial owners thereof, respectively, and taxable on the income therefrom under section 22(a) of the code, as construed in Helvering v. Clifford, supra.
Petitioners rely heavily on Robert P. Scherer, 3 T.C. 776. But the situation there is readily distinguishable. In that case more than mere legal title was transferred to the trusts. The settlor was not even a trustee. The children, beneficiaries, could and did receive funds from the trust. Moreover, the respondent did not attack the validity of the transfers to the trusts as gifts to the children. In fact he had determined and was attempting in that proceeding to sustain a deficiency in gift tax resulting from his increased appraisal of the value of the gifts. Respondent's ‘ * * * own expert witness testified as to valuation of the gifts upon the basis that completed gifts had been made and that Mrs. Scherer and the three minor children were the owners of respective interests in the business and entitled to shares of its annual net income * * * .‘ On that record, we held in effect that respondent had conceded that the gifts to the beneficiaries of the trust were complete and that the income of the trust was therefore not taxable to the grantor under section 22(a). Upon that premise, we were left, as was stated, with the single question as to whether the trust was, for income tax purposes, to be recognized as a member of the partnership. It is against this background that the remainder of our opinion in the Scherer case must be read. It was then decided that the trust was to be so recognized and therefore under section 181 of the Internal Revenue Code the income of the partnership was taxable to the several partners, including the trust.
Here, respondent in no way conceded that the transfers to the trusts were valid and completed gifts to the named beneficiaries. True, gift tax returns were filed and purported gift taxes paid. But those facts can not be contorted into a concession that the transfers allegedly basing such action were completed gifts to those beneficiaries. Helvering v. Clifford, supra; Armstrong v. Commissioner, 146 Fed.(2d) 457 (C.C.A., 7th Cir.). In fact, respondent directly attacks here the validity of the transfers to the trusts as such gifts. That is essentially the premise of his determination. He does not question the fact that the trusts received legal title to property, nor that the trusts are empowered to exercise the rights conferred by those instruments. He does not challenge the validity of either the trusts or the partnerships under the law of West Virginia, where they were created and functioned. In fact he has recognized the trusts as such in his determinations of the deficiencies. See Helvering v. Clifford, supra; M. M. Argo, 3 T.C. 1120. He rests his position here solely upon the contention that the beneficial interests in the property, the legal title to which passed to the trusts, because of the powers and control retained by the grantors, remained in the grantors instead of going to the named beneficiaries, as a result of which the grantors are taxable on the income of the trusts and, as we have seen, such contention finds much more support in the record here than in the Scherer case. The settlor in this case was, for present purposes, sole trustee of each trust. Little, if anything, except legal title was transferred to the trusts for the children. The transactions worked no substantial change in the economic status of the settlors.
Petitioners argue that even if we find, as we have, that the trusts and new partnership agreements to which the trusts were parties did not relieve the petitioners, grantors of those trusts, from income tax on the income of the trusts, we must recognize both these trusts and partnerships for the purpose of determining the tax years of the petitioners in which this income shall be included. They contend that, except for their respective liabilities for income taxes as settlors of the trusts, both the trusts and partnerships were valid and must be so recognized here.
Their position is that (1) the income of each partnership must be computed on the basis of its fiscal year (secs. 183 and 41, Revenue Act of 1938; Regulations 101, art. 187-1); (2) the computation of that income must give effect to the deduction of the salaries of petitioners as provided in those partnership agreements and which were actually paid before the equal division of the resulting net income and that such salaries are then to be added to, as a part of, the share of partnership income distributable to each petitioner (S. U. Tilton, 8 B.T.A. 914); and (3) that these distributive shares of petitioners and those of the trusts are to be included in the income of petitioners for the calendar years in which the fiscal years of the partnerships ended (the trusts had the same fiscal years as the partnership). Secs. 188 and 164, Revenue Act of 1938. Mary E. Wenger, 42 B.T.A. 225; Jerome P. Burr, 11 B.T.A. 1005; F. E. Malm, 11 B.T.A. 859; W. J. Woodruff, 11 B.T.A. 477; J. E. Asbury, 4 B.T.A. 1244; J. H. Goadby Mills, 3 B.T.A. 1245.
Respondent apparently concedes that if these new partnership agreements were such in fact, then the petitioners' position on this point would be sound. He has completely disregarded these new agreements simply because, he argues, they were actually no more than an attempt on the part of the petitioners to change the tax year of the old partnership from a calendar to a fiscal basis without respondent's consent. This, of course, presents only a question of fact. We think it must be decided for the petitioners. A mere reading of the old and new contracts is convincing on the point. Moreover, it must be noted that before the execution of the new National Finance Co. partnership contract, the income from the business of that company was included in that of the old Hash Furniture Co. and so reported. Thus the business of the Hash Furniture Co. under the new partnership agreement was not what it was before. It was limited to the furniture business. And that of the National Finance Co., under its new partnership agreement, was to be and was conducted as a separate business and not as a department or division of the Hash Furniture Co.
We sustain the alternative position of petitioners on this issue.
The remaining issue concerning the ownership of the business known as the Beckley Auto Exchange, and certain oil interests, has been determined by our finding that the properties involved were those of the partnership known as the Hash Furniture Co., and the earnings therefrom should be included in the partnership income. We think this finding is amply supported by the evidence, since it appears that these properties were acquired with partnership funds and the disbursements were entered on the partnership funds and the disbursements were entered on the partnership books as its investments. The mere fact that title to the properties was held in the name of one of the partners does not contradict this conclusion.
The parties have stipulated the facts necessary for recomputation of the deficiencies in accordance with the foregoing opinion.
Decisions will be entered under Rule 50.