Summary
In LeVine v. Commissioner, 24 T.C. 147, 155-156 (1955), the court listed as a factor included in good will the fact that the selling firm had "assembled and trained a group of highly skilled employees accustomed to working together."
Summary of this case from District of Columbia v. ACF Industries, Inc.Opinion
Docket Nos. 46961 46962.
1955-04-29
SIDNEY V. LEVINE AND SADYE LEVINE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ARTHUR I. LEVINE AND BETSY V. LEVINE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Albert Rosenblum, Esq., and Harry F. Weyher, Esq., for the petitioners. Richard G. Maloney, Esq., for the respondent.
Albert Rosenblum, Esq., and Harry F. Weyher, Esq., for the petitioners. Richard G. Maloney, Esq., for the respondent.
1. The petitioners were equal partners in an offset printing business which they sold to a corporation wholly owned by them at a stated price exceeding the value of the tangible partnership assets by $100,000. During the 28 months of its existence the partnership had acquired and trained a highly skilled group of employees, developed new and efficient techniques, and showed rapidly growing and substantial profits. Held, on the facts the partnership transferred to the corporation goodwill and other intangibles of a value of $45,000.
2. The petitioners on January 15, 1951, revised upward their estimated taxes for 1940 but failed to pay the full amount due. Held, further, lack of funds is not reasonable cause for failure to pay estimated taxes so as to preclude imposition of the penalties prescribed by section 294(d)(1)(B) of the Internal Revenue Code of 1939.
3. Petitioners' final returns filed March 15, 1951, disclosed the liability but, again, they failed to pay the full amount shown to be due. Held, further, the filing of the final returns terminated the accretion of the 1 per cent increments to the penalties under section 294(d)(1)(B). Stephan v. Commissioner, 197 F.2d 712, followed.
Respondent determined deficiencies in the income taxes of petitioners and penalties under section 294(d)(1)(B) of the Internal Revenue Code of 1939, as follows:
+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Sec. 294 (d) (1) ¦ +-------------------------+------------+------+------------+------------------¦ ¦Petitioners ¦Docket No. ¦Year ¦Deficiency ¦(B) penalty ¦ +-------------------------+------------+------+------------+------------------¦ ¦Sidney V. and Sadye ¦46961 ¦1950 ¦$24,362.92 ¦$2,385 ¦ ¦LeVine ¦ ¦ ¦ ¦ ¦ +-------------------------+------------+------+------------+------------------¦ ¦Arthur I. and Betsy V. ¦46962 ¦1950 ¦$19,902.71 ¦$2,070 ¦ ¦LeVine ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Arthur I. LeVine and Sidney V. LeVine, hereinafter referred to as petitioners,
were the sole stockholders in Ad Press, Ltd., and were also equal partners in Legal Offset Printers Company. During the year in question, 1950, the assets of the partnership were purchased by the corporation for an amount exceeding the value of the tangible assets by $100,000. The principal question for decision is whether the partnership possessed and transferred to the corporation goodwill or other intangibles worth $100,000 or whether Arthur and Sidney received disguised dividends in that amount from the corporation through the transaction.
It is not explained why February 17, 1948, was used in the stipulation rather than March 1, 1948, the date of the partnership agreement.
The wives are involved here only because of the filing of joint returns. 2. These are net figures after allowance for accrued salaries of $50,000 in the case of Arthur and $42,500 in the case of Sidney. 3. Judge Rives of the Court of Appeal stated:‘Section 294(d)(1)(B), like other penal statutes, is to be interpreted liberally in favor of the taxpayer and strictly against the Government. See 50 Am.Jur.Statutes, Section 407, et. seq. We can see no reason why the word ‘unpaid’ as used in subparagraph (B) should be given any different construction than the words ‘due but unpaid’ used throughout the preceding subparagraph A and also in the final sentence of subparagraph (B). To say that an installment of the estimated tax remains unpaid presupposes a continuing duty to pay such installment. The declaration of estimated tax had served its function when the final return was filed. There was then no longer any uncertainty, and the tax should thereafter be paid on the basis of the final return rather than as estimated. It follows that installments of the estimated tax were then no longer due.'
As to the penalties for failure to pay estimated tax, respondent's original determination was that where the estimate was revised upward on January 15, 1951, but the estimated tax was not then paid, the penalty should be computed as if the entire amount shown to be due by the amended estimate had been reported, but not paid, in four equal amounts on March 15, 1950, June 15, 1950, September 15, 1950, and January 15, 1951. Respondent concedes on brief that this method of computation is erroneous. The question remaining for decision, however, is whether the increments of 1 per cent provided by section 294(d)(1) (B) continue to accrue after the filing of the final Federal income tax return covering the year involved in the estimates.
Additional adjustments set forth in the deficiency notice are not contested and will be given effect under Rule 50. The stipulated facts are found as facts and incorporated herein by reference.
FINDINGS OF FACT.
The petitioners in each proceeding are husband and wife. The principal place of business of the husbands is in New York City. Joint income tax returns for 1950 were timely filed by the petitioners with the collector of internal revenue for the second district of New York.
Ad Press, Ltd., hereinafter sometimes called Ad Press, was incorporated under the laws of the State of New York on July 16, 1923. Arthur I. LeVine, hereinafter sometimes called Arthur, has been president of Ad Press since its incorporation. Sidney V. LeVine, hereinafter sometimes called Sidney, had been associated with Ad Press for over 28 years and was its vice president at the time of the hearing.
The principal business of Ad Press is the printing of legal and financial documents such as briefs, records, financial statements, proxies, and reorganization plans.
Prior to March 1948, Ad Press confined its operations to letterpress printing and generally declined to accept work which could not be handled completely by its standard letterpress equipment and methods. The standard letterpress method of printing employs linotype machines which cast solid lines of type. The printing is then done directly from the raised lead surfaces.
In the photo-offset method of printing, a picture is taken of any material that is reproducible and the film is exposed to a plate. The matter to be printed is then etched out with chemicals. The inked plate is offset to a rubber blanket which in turn is offset to the paper.
Prior to March 1, 1948, Ad Press did not do any photo-offset printing itself but did accept work requiring offset printing in two instances. In both cases, Ad Press subcontracted the work, with unsatisfactory results.
After studying the photo-offset printing business and its possibilities for several years, Sidney became convinced that photo-offset printing could be successfully employed in the legal and financial printing business. When Sidney first talked with Arthur, his father, about going into the photo-offset business, his father was dubious and saw little advantage in the idea. Moreover, Arthur feared that if the photo-offset business did not succeed, the successful reputation which Ad Press had established in the letterpress printing business over a period of 40 years might be jeopardized.
After considerable discussion, Sidney was able to convince his father that a photo-offset printing business should be established but Arthur, who was then the sole common stockholder in Ad Press, convinced Sidney that the photo-offset operation should be undertaken not by Ad Press but by a separate business entity.
On March 1, 1948, Arthur and Sidney as equal co-partners formed a partnership under the name Legal Offset Printers Company for the purpose of engaging in the business of photo-offset printing.
The partnership agreement, dated March 1, 1948, provided, among other things, as follows:
TWENTY-SECOND: The Partners agree that the goodwill of the partnership has no fixed value, and that, in the opinion of the partnership, it is without value and shall not be computed in any . . . . . provided for herein. The parties agree that the determination of . . . . . . to be paid to either Partner shall be determined by the auditor or certified public accountant then employed by the partnership, and such computation shall be final and conclusive upon them; and that sufficient cash reserves for the prompt payment of any and all taxes, or any contingent liabilities of any nature whatsoever that may become due or mature after the dissolution of the partnership, shall be estimated by such auditor or certified public accountant, and set aside and kept and maintained in a separate bank account to be drawn upon by the signature of both Partners and countersigned by the auditor or certified public accountant, and final distribution to each of the Partners shall not be made until all such taxes and contingent liabilities shall have been paid.
A certificate of conducting business as a partnership and a certificate of conducting business under the assumed name ‘Legal Offset Printers Company’ were filed in the office of the clerk of the county of New York on February 19, 1948.
Commencing March 1, 1948, the partnership leased space from Ad Press on the fifth floor of the Ad Press Building at 102 Grand Street, New York, New York, for a term of 3 years. The partnership was given an option to renew for an additional 3 years on 60 days' written notice before the end of the term.
On or about March 17, 1948, new photo-offset printing equipment was purchased for the partnership and paid for largely from the proceeds of a $25,000 loan made to the partnership by a New York bank. The loan was secured by the endorsements of the partners and by chattel mortgages on the photo-offset printing equipment. Thereafter, during the partnership's first fiscal year ended January 31, 1949, additional capital was provided by aggregate contributions of $18,829.15 made to the partnership by Arthur and Sidney. In addition, the partnership earnings of $35,473.08 for the first fiscal year were allowed to accumulate in the partnership. It took about 9 months to install the machinery and get it running satisfactorily.
None of the partnership's employees were former employees of Ad Press. Advertisements for employees were inserted in the newspapers and trade journals. It took about 9 months to train the necessary skilled employees to the point where they were operating efficiently.
During the period Legal Offset was in existence, important technological improvements were made by Sidney in the photo-offset printing process, adding substantially to the adaptability of that method to legal work.
In studying the advantages of photo-offset printing, Sidney concluded that it would also be advantageous in performing financial work such as proxies and annual reports which involved a great many numbers. Under the letterpress system, discrepancies would sometimes creep into the work. By employing the photo-offset method, reports could be prepared in 20 minutes without the necessity of proofreading for accuracy. The offset method of printing is generally quicker and cheaper than the letterpress method but not as attractive in appearance.
Ad Press owned 2 buildings located at 100-102 Grand Street, New York City, each containing 6 floors. The machinery of Ad Press was located in both buildings whereas all of the machinery of Legal Offset was on the fifth floor of the building located at 102 Grand Street. Ad Press and Legal Offset had a common business office located on the fourth floor at 100 Grand Street.
During the period of its existence from March 1, 1948, to June 28, 1950, Legal Offset performed services for 40 customers, including Ad Press. Legal Offset solicited customers through the efforts of the partners who contacted customers of Ad Press and others and in addition sent out circulars.
The partnership billed its customers for photo-offset work either directly or through Ad Press. Where there was strictly offset work done, Legal Offset billed the customer directly. Where there was both letterpress work done by Ad Press and photo-offset work done by Legal Offset, the customer was billed through Ad Press for all work performed regardless of the question of which business had been first contacted by that customer. In turn, Legal Offset billed Ad Press in the amount which Ad Press had charged the customer for the photo-offset work done by the partnership.
During the period March 1, 1948, through June 28, 1950, Legal Offset billed its customers in the total gross sales amount of $253,791.02. Of that amount, $194,054.90 was billed through Ad Press as described above. The balance of $59,736.12 was billed by Legal Offset directly to 39 customers, 18 of whom had not done business with Ad Press prior to the organization of Legal Offset. Of the $59,736.12 billed directly by the partnership, $3,671.65 was to the 18 new customers.
As of March 1, 1948, all of the stock of Ad Press was held as follows:
+-------------------------------------+ ¦ ¦Shares ¦ +----------------+--------------------¦ ¦ ¦Preferred ¦Common ¦ +----------------+-----------+--------¦ ¦Arthur I. LeVine¦490 ¦100 ¦ +----------------+-----------+--------¦ ¦Sidney V. LeVine¦440 ¦ ¦ +-------------------------------------+
Sidney acquired 50 shares of the common stock of Ad Press in July 1948 and on June 28, 1950, all of the stock of Ad Press was held as follows:
+--------------------------------------+ ¦ ¦Shares ¦ +-----------------+--------------------¦ ¦ ¦Preferred ¦Common ¦ +-----------------+-----------+--------¦ ¦Arthur I. LeVine ¦490 ¦50 ¦ +-----------------+-----------+--------¦ ¦Sidney V. LeVine ¦440 ¦50 ¦ +-----------------+-----------+--------¦ ¦Total outstanding¦930 ¦100 ¦ +--------------------------------------+
The net profits earned by Legal Offset during the period of its existence, as computed before audit by respondent and without deduction for partners' salaries, were as follows:
+------------------------------------------------+ ¦Feb. 17, 1948 1 to Jan. 31, 1949¦$34,504.54 ¦ +----------------------------------+-------------¦ ¦Feb. 1, 1949 to Jan. 31, 1950 ¦48,687.30 ¦ +----------------------------------+-------------¦ ¦Feb. 1, 1950 to June 28, 1950 ¦2 19,145.52¦ +----------------------------------+-------------¦ ¦ ¦ ¦ +------------------------------------------------+
The net worth of Legal Offset as of February 17, 1948 (see footnote 1 to table above), February 1, 1949, and February 1, 1950, was equal to $18,229.15, $53,333.69, and $70,256.76, respectively, as computed before audit by respondent.
At a combined meeting of the Ad Press stockholders and directors held on December 21, 1949, the possibility of Ad Press entering the offset business was discussed.
In May 1950, Arthur and Sidney called in their accountant, Maxwell Schmerler, to discuss the possibility of selling the business of the partnership to Ad Press and the price to be paid for their interests therein. Schmerler was asked to give his opinion as to the method to be used in evaluating the intangibles owned by the partnership. He first computed the average annual income of the partnership as $43,089. He next computed the partnership's average capital at $42,137. In his third step, Schmerler deducted 10 per cent of average capital, or $4,214, from average annual income of $43,089 as a normal return on physical assets. The balance, $38,875, was attributed by Schmerler to excess earnings resulting from goodwill or other intangible assets.
In his final step, Schmerler capitalized the excess earnings of $38,875 at 20 per cent, or 5 to 1, thereby reaching a goodwill valuation of $194,375. In advising Arthur and Sidney, Schmerler recommended reduction of the $194,375 figure to $100,000 to allow for compensation to the partners and to err on the side of ultra-conservatism because of the relationship between the partners and the corporation.
At a special meeting of the Ad Press board of directors held on May 16, 1950, Arthur and Sidney offered to sell to Ad Press their partnership interests for a sum equivalent to the actual cost of the machinery and equipment of the partnership without reserve for depreciation, plus actual book value of all other tangible assets of the partnership, less liabilities, plus $100,000 for the goodwill of the partnership, the name Legal Offset Printers Company, and other intangible assets.
Ad Press accepted this offer and authorized its officers to execute the necessary documents to effectuate the purchase of Legal Offset on the terms offered.
On June 6, 1950, Arthur and Sidney, as co-partners doing business under the name of Legal Offset Printers Company, entered into an agreement of sale with Ad Press setting forth in detail the terms agreed to generally at the directors' meeting of May 17, 1950.
On June 28, 1950, Arthur and Sidney sold and transferred to Ad Press all their right, title and interest in and to the business known as Legal Offset Printers Company in accordance with the terms of the agreement of sale for $184,841.07. Of that amount, $100,000 was attributed to goodwill and other intangibles of the partnership.
Both Arthur and Sidney maintained drawing accounts on the books of Ad Press. Drawings were made from time to time to meet current bills and expenses. Neither Arthur nor Sidney drew a weekly or monthly salary but each was paid an annual salary of $50,000 which was credited at the end of each year to their drawing accounts.
Prior to the sale of the partnership interests, Arthur was indebted to Ad Press because of his drawings in the amount of $155,624.50 and Sidney was indebted to Ad Press because of his drawings in the amount of $42,624.67.
This figure does not include a loss of $12,820.27 on the sale of machinery.
Arthur and Sidney did not receive payment from Ad Press in cash. Ad Press credited Arthur's portion of the agreed purchase price, $92,420.54, against Arthur's indebtedness to Ad Press, which indebtedness exceeded the amount of the credit by $63,203.96. Sidney's portion of the agreed amount, $92,420.53, was credited to his account on the books of Ad press and was applied to the extent of $42,624.67 against Sidney's indebtedness to Ad Press. The balance of the credit, constituting an indebtedness from Ad Press to Sidney in the amount of $49,795.86, was assumed by Arthur who gave Sidney his personal note dated June 30, 1950, in that amount and Ad Press credited that amount against the balance of the indebtedness due from Arthur to Ad Press. The books of Ad Press then showed that it was owed $13,408.10 by Arthur and nothing by Sidney.
A certificate of discontinuance of business as partners and a certificate of discontinuance of the use of the assumed name Legal Offset Printers Company were filed by Arthur and Sidney on July 19, 1950, with the clerk of the county of New York.
After June 28, 1950, Ad Press was engaged in photo-offset printing as well as letterpress printing. Of the total amount of printing done by Ad Press at the time of this hearing, about 90 per cent thereof was done by the photo-offset method and 10 per cent by the standard letterpress method. In the photo-offset operations conducted by Ad Press subsequent to June 1950, Ad Press employed all of the machinery acquired from Legal Offset as well as all of its employees. Ad Press acquired three photo-offset printing units from the partnership and has itself purchased another unit since June 1950.
After notifying its customers that it had acquired the offset business, Ad Press never used the name Legal Offset Printers Company subsequent to the purchase of the partnership assets.
At the time of the sale of its assets to Ad Press, Legal Offset owned and transferred goodwill and other intangible assets of a value of $45,000.
The petitioners in Docket No. 46961, Sidney V. and Sadye LeVine, filed a declaration of estimated tax on March 15, 1950, showing an estimated tax of $2,000 for the calendar year 1950, after deducting estimated tax to be withheld of $4,744.80. Three installments of $500 each were paid by Sidney V. and Sadye LeVine in 1950 on March 15, June 15, and September 15, respectively, on account of the estimated tax of $2,000 for the year 1950.
Sidney V. and Sadye LeVine filed an amended declaration of estimated tax on January 15, 1951, showing an estimated tax of $24,500 after deducting estimated tax withheld of $6,446.10 and showing an unpaid balance of estimated tax of $23,000 after deducting the payments made in respect of the original declaration of estimated tax. A payment of $1,500 was made by Sidney and Sadye at the time of filing the amended declaration of estimated tax. The reason Sidney did not remit the balance of $21,500 of estimated tax shown on his amended declaration was that he did not have the money.
The joint income tax return of Sidney and Sadye for the calendar year 1950 showed a tax of $30,460.06, less tax withheld of $6,446.10 and less the payments of $3,000 made on account of the declaration and amended declaration of estimated tax, and an unpaid balance of $21,013.96. They remitted a payment of $1,000 with their joint income tax return filed for the calendar year 1950 on March 15, 1951.
The petitioners in Docket No. 46962, Arthur I. and Betsy V. LeVine, filed a declaration of estimated tax on March 15, 1950, showing an estimated tax of $4,000 for the calendar year 1950, after deducting estimated tax to be withheld of $7,194. Three installments of $1,000 each were paid by Arthur I. and Betsy V. LeVine in 1950 on March 15, June 15, and September 15, respectively, on account of the estimated tax of $4,000 for the year 1950.
They filed an amended declaration of estimated tax on January 15, 1951, showing an estimated tax of $22,000 after deducting estimated tax withheld of $7,555.50 and showing an unpaid balance of estimated tax of.$19,000 after deducting the payments made in respect of the original declaration of estimated tax. A payment of $1,500 was made by Arthur and Betsy at the time of filing the amended declaration of estimated tax.
The joint income tax return filed by Arthur and Betsy for the calendar year 1950 showed a tax of $28,658.71, less tax withheld of $7,555.50 and less the payments of $4,500 made on account of the declaration and amended declaration of estimated tax, and an unpaid balance of $16,603.21. They remitted a payment of $1,000 with their joint income tax return filed on March 15, 1951.
The major portion of the increase in the amount of estimated tax declared in the amended declarations filed by the petitioners herein, over the amount of estimated tax declared in the original declarations filed by petitioners herein, is attributable to the sale of their interests in Legal Offset and to partnership income in the amounts of $3,162.62 and $3,162.63 in the cases of Sidney and Arthur, respectively, with respect to the partnership period beginning February 1, 1950, and ending with the sale of the assets on June 28, 1950, which income was in addition to the partnership income for the fiscal year ending January 31, 1950. As a result of the sale, 2 fiscal years of the partnership ended within 1 taxable year of the partners.
OPINION.
ARUNDELL, Judge:
The principal question in this case concerns the tax treatment of the proceeds from the sale of the assets of a partnership. The petitioners were equal partners in the vendor partnership and were also the only stockholders in the purchasing corporation.
Respondent does not question the separate entities of the parties to the sale nor does he contest the fact that a sale has taken place. He agrees that the valuation placed upon the tangible assets of the partnership was reasonable and that gains on the sale of the tangibles are properly treated as capital gains.
The deficiency is founded essentially in respondent's contention that the partnership had absolutely no goodwill or other intangible assets and that the provision in the contract of sale for the payment of $100,000 by the corporation to the partners for goodwill and other intangible assets was nothing more than a disguised dividend to shareholders, a subterfuge designed to permit the taxation of ordinary income at capital gains rates.
We think it clear that the partnership did own and transfer goodwill of substantial value. The partnership had assembled and trained a group of highly skilled employees accustomed to working together. Specially designed equipment had been developed for the particular work done by the partnership. A distinct pattern of growth had been established despite the mere 28 months of operation, and the partnership from its very inception showed substantial and constantly increasing profits far beyond what might be expected as a normal return on the investment in tangibles. The $100,000 valuation placed on goodwill by petitioners is based essentially on capitalization of those ‘excess earnings.’
In the case at bar, the earnings of the partnership were derived in large measure from customers who had previously been and were customers of Ad Press. The record shows that when Arthur and Sidney contacted the regular customers of Ad Press they also solicited business for the partnership. Moreover, Sidney viewed the photo-offset process from the start as a more advantageous method of performing certain types of work previously done only by the letterpress method employed by Ad Press. It would seem that at least a part of the work done by the partnership would normally have been done by the corporation if it had not been diverted to the partnership by Sidney and Arthur. This is borne out by the fact that offset printing subsequently accounted for about 90 per cent of the business of Ad Press.
We are convinced that the corporation would not have been willing to pay an unrelated third person for the expectation of that part of the business that would presumably have come to it in any event and, for that reason, we think a goodwill valuation based on capitalization of partnership earnings largely arising from such business is distorted.
We cannot determine, of course, exactly how large a part of the partnership business was diverted from the corporation. We do know that the larger part of the business came directly or indirectly from or through Ad Press. Of the total billings of $254,791.02 to customers during the life of the partnership, the stipulation shows that $194,054.90 was billed through Ad Press for business involving both offset and letterpress work. The balance of $59,736.12 was billed by Legal Offset directly to 39 customers, 18 of whom had not done business with Ad Press prior to the organization of Legal Offset. Of the $59,736.12 billed directly by the partnership, $31,671.65 was to the 18 new customers. Taking into consideration all of these facts and circumstances, we cannot agree that the goodwill of the partnership at the time of the sale of the offset business to Ad Press had a value as high as $100,000.
As we have heretofore stated in this opinion, we think the partnership had a substantial goodwill. We have carefully studied the record and have taken into consideration the various factors bearing on goodwill and, after making a reasonable allowance for salaries and giving due weight to the source of the partnership clientele, we have concluded that Legal Offset owned and transferred to Ad Press intangibles of the value of $45,000.
It follows that the profit on the sale of partnership assets and the sums found to be distributed to Arthur and Sidney should be recomputed accordingly.
George J. Staab, 20 T.C. 834, is clearly distinguishable. There the vendor partnership was engaged in the manufacture of molds and dies of the type used by the purchasing corporation in its plastic business. There was no element of duplication of customer lists.
As to the penalties for failure to pay estimated tax, petitioners assert initially that since they had no funds available at the time payment became due, the failure to pay was due to reasonable cause and not to willful neglect. We find no merit in this contention. Cf. Rene R. Bouche, 18 T.C. 144.
An additional question is presented as to the amount of the penalty. Section 294(d)(1)(B) of the Internal Revenue Code of 1939 provides as follows:
SEC. 294. ADDITIONS TO THE TAX IN CASE OF NONPAYMENT.
(d) ESTIMATED TAX.
(1) FAILURE TO FILE DECLARATION OR PAY INSTALLMENT OF ESTIMATED TAX.
(B) Failure to Pay Installments of Estimated Tax Declared.— Where a declaration of estimated tax has been made and filed within the time prescribed, or where a declaration of estimated tax has been made and filed after the time prescribed and the Commissioner has found that failure to make and file such declaration within the time prescribed was due to reasonable cause and not to willful neglect, in the case of a failure to pay an installment of the estimated tax within the time prescribed, unless such failure is shown to the satisfaction of the Commissioner to be due to reasonable cause and not to willful neglect, there shall be added to the tax 5 per centum of the unpaid amount of such installment, and in addition 1 per centum of such unpaid amount for each month (except the first) or fraction thereof during which such amount remains unpaid. In no event shall the aggregate addition to the tax under this subparagraph with respect to any installment due but unpaid, exceed 10 per centum of the unpaid portion of such installment.
Respondent concedes, on brief, that the penalty begins to run only from the date of the amended estimate, January 15, 1951. It is his contention, however, that the maximum penalty of 10 per cent is payable.
Petitioners take the position that even though some penalty may be due, the accretion of the 1 per cent increments was terminated by the filing of their final income tax returns on March 15, 1951, notwithstanding the fact that the bulk of the taxes remained unpaid thereafter. They argue that the penalty, if any, is limited to 6 per cent of the unpaid amount consisting of 5 per cent for the period from January 15 to February 15, 1951, and an additional 1 per cent from that date to March 15, 1951.
The identical question was before us in Carl M. Stephan, 16 T.C. 1157, in which we held that the filing of the final return did not prevent the accretion of the additional 1 per cent increments to the penalty for failure to pay estimated tax. The Court of Appeals for the Fifth Circuit reversed our decision, sub nom. Stephan v. Commissioner, 197 F.2d 712. After carefully reviewing the opinions and further study of the question, we think that the correct rule was stated by the Court of Appeals.
We agree with the Court of Appeals that the word ‘unpaid,‘ as it appears in section 294(d)(1)(B) should be construed as ‘due but unpaid’ and that with the making of the final return, what is due and unpaid is the entire unpaid tax as is shown by the return and not an installment of an estimated tax.
This construction is in harmony with the general pattern of the statute. Section 294(a)(1) specifically provides that where the amount determined by the taxpayer as the tax imposed is not paid on or before the date prescribed for its payment, there shall be collected as part of the tax interest upon such unpaid amount at the rate of 6 per cent per annum from the date prescribed for its payment until it is paid. If the estimates were accurately made, any tax unpaid at the time the final return is filed would always include some part or all of an unpaid installment. If Congress had intended the two additions to tax to run concurrently, we think it would have made it plain. It is interesting to note that in the 1954 Code it is provided that the penalty of 1 per cent per month imposed by section 294(d)(1)(B) runs not later than the date for making the final return.
It follows that in the case at bar, the penalty under section 294(d)(1)(B) must be limited to 6 per centum of the unpaid balance. Our opinion in Carl M. Stephan, supra, will no longer be followed.
Reviewed by the Court.
Decisions will be entered under Rule 50.