Summary
explaining that a deduction for the taxpayer's loss of time or the value of that lost time is disallowed because the taxpayer has not included any amount attributable to the lost time in gross income and therefore has no tax cost basis in the lost time that he can deduct
Summary of this case from Haff v. Comm'rOpinion
Docket Nos. 27319 27320.
1951-07-12
PALMER HUTCHESON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ELEANOR T. HUTCHESON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Palmer Hutcheson, Esq., pro se. Joseph P. Crowe, Esq., for the respondent.
Petitioner Palmer Hutcheson, as a partner in the law firm of Baker, Botts, Andrews and Wharton, owned a 7.5 per cent interest in the firm for which he paid $22,500. During the period from 1921 through 1945, the law firm purchased furniture, equipment, etc. out of partnership earnings which it capitalized and upon which it took depreciation. On December 31, 1945, Hutcheson's unrecovered basis in these assets was $3,058.93. On December 31, 1945, Hutcheson withdrew from the firm to practice law as an individual and pursuant to the partnership agreement Hutcheson's investment was forfeited to the law firm for which he received no consideration. Held, petitioner sustained a loss of $25,558.93 not occasioned by the sale or exchange of a capital asset and the loss is deductible under section 23(e) of the Internal Revenue Code. Held, further, petitioners have not shown themselves entitled to deduct as an additional loss $18,750 which petitioner alleged represented his part of uncollected fees at the time that he retired from the firm and no part of which he had ever returned as income. Held, further, petitioners are not entitled to deduct as an additional loss $3,479.23 representing petitioner's share of nondeductible contributions which the law firm had paid through the years 1921-1945, inclusive. Palmer Hutcheson, Esq., pro se. Joseph P. Crowe, Esq., for the respondent.
These proceedings have been consolidated.
The Commissioner has determined deficiencies in income taxes for the calendar year 1945, as follows:
+----------------------------------------------+ ¦Petitioner ¦Docket No. ¦Deficiency ¦ +--------------------+------------+------------¦ ¦Palmer Hutcheson ¦27319 ¦$7,329.80 ¦ +--------------------+------------+------------¦ ¦Eleanor T. Hutcheson¦27320 ¦7,195.65 ¦ +----------------------------------------------+
These deficiencies result from two adjustments to petitioners' net income; however, the only adjustment in controversy relates to respondent's disallowance of a loss claimed by petitioners. This was explained in the deficiency notice sent to petitioner Palmer Hutcheson as follows:
(a) The community loss of $22,500.00, alleged to have been sustained during the taxable year 1945 at which time you withdrew from the law firm of Baker, Botts, Andrews & Wharton, Houston, Texas, is disallowed as it has not been established that a loss was sustained from the above transaction.
A similar explanation was given in the deficiency notice sent to petitioner Eleanor T. Hutcheson. By appropriate assignments of error petitioners contest these adjustments. In the petitions and in an amendment to the petitions petitioners allege that their loss resulting from the retirement of petitioner Palmer Hutcheson from the partnership exceeds the $22,500 originally claimed in their returns for the year 1945, and ask for a decision of overpayment with a consequent refund.
In an amended answer respondent alleges that in the alternative, in the event it should be determined that petitioners suffered a loss from the transaction that such loss is a capital loss and not an ordinary loss.
FINDINGS OF FACT.
Some of the facts have been stipulated and they are found accordingly. Other facts are found from the evidence. The parties have agreed that all the relevant facts in the Gaius G. Gannon case, 16 T.C. 1134, may be considered facts in this case.
Petitioners, husband and wife, were married on June 8, 1912, and have continuously since that date maintained their residence in Houston, Texas, and are citizens of the State of Texas. Petitioners filed their Federal income tax returns for the year 1945 with the collector for the first district of Texas. The case of petitioner Eleanor T. Hutcheson is here solely because of her community property status with her husband and, therefore, for the sake of convenience petitioner Palmer Hutcheson will hereinafter sometimes be referred to as petitioner.
Petitioner was licensed and admitted to the Bar of Texas in June 1911, and since then had continuously practiced law in Houston. In 1919 he became a member of the firm of Baker, Botts, Parker and Garwood in Houston, Texas. At the time of petitioner's retirement from the firm it bore the name Baker, Botts, Andrews and Wharton. The firm has used the names of Baker and Botts continuously since 1874 and is frequently referred to as the ‘Baker-Botts‘ firm.
Petitioner voluntarily withdrew from the firm of Baker-Botts on December 31, 1945, and on that day became associated with the firm of Hutcheson, Taliaferro, & Hutcheson in Houston.
Under the partnership agreement of the Baker-Botts firm each unit of interest had a fixed value of $3,000, regardless of actual value of the tangible assets so that all 100 units had a fixed total value of $300,000 at all times. At the time of petitioner's withdrawal as a partner from the Baker-Botts firm, he held a 7.5 unit (7.5 per cent) interest in the partnership for which he had paid the sum of $22,500 in cash out of community funds, some of which had been previously or ever thereafter returned to him. The provisions of the partnership agreement were substantially the same from January 1, 1921, when petitioner acquired a four unit interest in the firm until his retirement from the firm on December 31, 1945. At the time petitioner withdrew from the partnership the material provisions of the partnership agreement relating to the accounting as to interests in assets and interest in income on death or withdrawal of a partner were as follows:
ARTICLE VII
DEATH OR
WITHDRAWAL
OF MEMBERS
As and when a member withdraws from the firm or dies his interest in the firm shall thereupon automatically revert to the firm, and settlement for his interest in the assets and income shall be made by the firm with him or with his estate as the case may be, in accordance with the provisions of this Article VII, as follows:
A. Accounting as to Interest in Assets
(1) In the Event of Death
The estate of a deceased member shall be entitled to receive out of, but only out of, the net income of the firm in future years the agreed value of said interest in the assets (computed at the rate of $3,000 for each 1% interest owned in the assets at the time of his death, with interest thereon at the rate of 6% per annum from the date of his death, subject to the option to anticipate payments granted under paragraph D of this Article VII.
(2) In the Event of Withdrawal
In the event a member voluntarily withdraws from the firm at any time and remains in the active practice of law after such withdrawal, or in the event the withdrawal of a member is requested for any cause by a vote of the firm in accordance with the provisions of Article VIII, no compensation shall be paid to such member for his interest in the assets of the firm, but if a member voluntarily withdraws from the firm and from the active practice of law he shall receive the agreed value of his interest in the assets of the firm, to be computed and paid on exactly the same basis as is applicable in the case of the death of a member as provided in subparagraph (1) next above.
B. Accounting as to Interest in Income
(1) In the Event of Death
The estate of a deceased member shall be entitled to receive from the firm the distributions set forth as (a) and (b) next below in lieu of any interest which such deceased member otherwise might have in uncollected income of the firm earned prior to his death:
(a) His proportion of the net income of the firm computed on the basis specified in Article VI hereof to the end of the month during which such death occurred, less withdrawals theretofore made by him against his interest therein; and,
(b) An amount equal to $2,500 for each 1% interest owned in the assets of the firm at the time of such death, plus a proportionate part of $2,500 for any fractional interest so owned, to be distributed, without interest, out of, but only out of, the net income of the firm in future years, in three equal annual installments beginning one year from the date of such death. The surviving members shall have the right to collect all fees, earned or partially earned and uncollected at the date of such death, and each party hereto agrees for himself, his heirs, executors, administrators, and other legal representatives that the surviving members shall have the exclusive right to apportion all such fees when collected to the year or years when, in the judgment of such surviving members, the same were actually earned or collected within the intent and meaning of Article VI; to determine the interest of any deceased member in the income of the firm in accordance with the provisions hereof; and such apportionment and determination shall be conclusive and binding upon each party hereto, his heirs, executors, administrators, and other legal representatives.
(2) In the Event of Withdrawal
In the event a member voluntarily withdraws from the firm at any time and remains in the active practice of law after such withdrawal his interest in the income of the firm shall cease effective as of the end of the month during which he withdraws, but in the event of withdrawal under any other circumstances (irrespective of how such withdrawal shall occur) he shall be entitled to receive from the firm, in lieu of any interest which he otherwise might have in uncollected income of the firm, the same distributions as his estate would have been entitled to receive in the event he had died instead of withdrawn, to be computed and paid on exactly the same basis as provided in subparagraph (1) next above.
During the period from 1921 through 1945, Baker-Botts purchased furniture, equipment, etc. which it capitalized. During this period Baker-Botts' annual depreciation was taken on these assets. On December 31, 1945, petitioner's ‘share‘ in the assets purchased from 1921 through 1945, minus the depreciation deducted during these years, was $3,058.93. During the same period Baker-Botts made certain donations, some of which petitioners claim were ‘non-deductible donations‘ and on December 31, 1945, petitioner's ‘share‘ of these nondeductible donations for the entire period was $3,479.24.
Since 1930, it was the policy of the Baker-Botts firm that no son or immediate relative of a partner would be employed by the firm out of law school. Because petitioner desired to practice law with his three sons he withdrew from the firm and entered into the practice of law with two of his sons and his first cousin. Since that time petitioner's third son has joined him in the practice of law.
Petitioner received nothing for his share of fees which were earned and uncollected or for his interest in the assets of the firm. Petitioner's withdrawal on December 31, 1945, from the firm of Baker-Botts resulted in a loss of $25,558.93 incurred in his trade or business and which loss did not represent the sale or exchange of a capital asset.
Any part of the facts stipulated not included herein are incorporated by this reference.
OPINION.
BLACK, Judge:
The issue in these proceedings may be stated as follows: When petitioner Palmer Hutcheson withdrew from a law partnership and pursuant to the partnership agreement he received no compensation for his partnership interest, did petitioner sustain a loss (and if so to what extent) within the meaning of either subsections (e) or (g) of section 23 of the Internal Revenue Code.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.(e) LOSSES BY INDIVIDUALS.— In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—(1) if incurred in trade or business; or(2) if incurred in any transaction entered into for profit, thought not connected with the trade or business; or(g) CAPITAL LOSSES.—(1) LIMITATION.— Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.
The parties have agreed that all of the relevant facts in Gaius G. Gannon, supra, may be considered facts in this case. In Gaius G. Gannon, petitioners therein claimed as loss in 1944 $10,770.42 which Gannon had invested in Baker-Botts to acquire a 6.2 unit (6.2 per cent) interest in the firm. In that case, as in the instant proceedings where petitioner herein paid $22,500 for his 7.5 unit (7.5 per cent) interest in the firm, the entire amount of Gannon's investment reverted to Baker-Botts in accordance with the partnership agreement when Gannon withdrew from the firm and continued in the active practice of law. Neither petitioner herein nor Gannon received anything in return for his investment. In Gaius G. Gannon, supra, we held that the loss sustained was a loss incurred in his trade or business and the loss did not represent the sale or exchange of a capital asset. On the authority of Gaius G. Gannon we hold that respondent erred in disallowing the loss of $22,500 claimed by petitioners in their tax returns for the year 1945.
An additional problem is raised in these proceedings which was not raised in Gaius G. Gannon, supra. In their petitions the petitioners claim as a loss, in addition to the $22,500 which represented the sum that petitioner had paid for his 7.5 units in the Baker-Botts firm, a deductible community loss of $18,750 forfeited by petitioner Palmer Hutcheson at the time of his withdrawal as a liquidated amount to which he alleges he would have been otherwise entitled in lieu of earned and uncollected fees. By amended petitions petitioners also claim as a loss (a) petitioner's share of Baker-Botts' investment in furniture, equipment, etc., less depreciation from 1921 through 1945, or $3,058.93; and (b) petitioner's share of the ‘nondeductible donations‘ made by Baker-Botts from 1921 through 1945, or $3,479.24.
The $18,750 claimed by petitioners as a loss represents as amount which petitioner alleges he would have received in lieu of earned but uncollected fees if petitioner had retired from the practice of law or if petitioner's death occurred while he was a member of the firm. See Article VII B(2) of the partnership agreement incorporated in our findings of fact. This amount was never reported as income, and petitioners show no other way of having obtained a basis for this claimed loss. Section 111 and 113, Internal Revenue Code. To allow petitioners this amount as a loss would be akin to allowing a deduction for a bad debt arising from unpaid wages, salaries, rents, and other similar items of taxable income which were never reported as income by the taxpayer. Regulations 111, section 29.23(k)-2. Charles A. Collins, 1 B.T.A. 305; Bush Terminal Buildings Co., 7 T.C. 793. Petitioners are not entitled to deduct as a loss this $18,750.
Petitioners also contend that the loss of $22,500 claimed on their tax returns for the year 1945 should be increased by petitioner's share in the furniture, equipment, etc. which was purchased and capitalized by Baker-Botts during the years 1921 through 1945, less such amounts as were recovered by depreciation during this period. From 1921 through 1945, petitioners reported their distributive share of the partnership earnings and some of these earnings were invested in furniture, equipment, etc. Although the partnership took depreciation on these assets for each of the years 1921 through 1945, some of these assets had not been fully depreciated at the time petitioner retired form the firm and petitioners have not recovered by way of depreciation or otherwise $3,058.93 of the distributive share of partnership income which was invested in these assets. Section 29.113(a)(13)-2 of Regulations 111 provides in part as follows:
Sec. 29.113(a)(13)-2. READJUSTMENT OF PARTNERSHIP INTERESTS.— When a partner retires from a partnership, or the partnership is dissolved, the partner realizes a gain or loss measured by the difference between the price received for his interest and the sum of the adjusted cost or other basis to him of his interest in the partnership plus the amount of his share in any undistributed partnership net income earned since he became a partner on which the income tax has been paid. * * *
Since the evidence shows that petitioners reported as income his share of the earnings of the partnership unreduced by the investment in furniture, equipment, etc., their basis in the partnership assets is to be increased by $3,058.93 and they are, therefore, entitled to an additional loss of the amount which was forfeited by petitioners.
Petitioners also contend that from 1921 through 1945, the firm of Baker-Botts made certain ‘non-deductible donations‘ of which Palmer Hutcheson's share for the entire period was $3,479.24, and that they are also entitled to increase the loss claimed on their returns by this amount. There is not showing as to the nature of the contributions. These contributions by the partnership which were not allowed as deductions did not become capital investments of the partnership as did investments in furniture, equipment, etc., discussed in the paragraph just above. There was nothing of a capital nature about them. We know of no law which would entitle petitioners to deduct any part of these nondeductible contributions as a loss upon petitioner's retirement from the firm and we are not cited to any. This claimed deduction of $3,479.24 by petitioners is denied.
Decisions will be entered under Rule 50.