Docket No. 87744.
09-28-1939
H. LEWIS BROWN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
H. Lewis Brown, Esq., pro se. Frank M. Thompson, Esq., for the respondent.
H. Lewis Brown, Esq., pro se.
Frank M. Thompson, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax for the year 1933 in the amount of $9,338.43. The sole issue is whether or not $20,900, being one-half of a fee for legal services rendered by the law partnership of Burroughs & Brown, must be included in petitioner's income.
FINDINGS OF FACTS.
Petitioner was a member of the partnership of Burroughs & Brown, attorneys at law, with offices in New York City. Beginning about February 1927 and continuing to October 1929, the partnership rendered legal services for Charles T. Davis in a controversy between him and one Kelsey. Burroughs died June 19, 1929, while the action was pending and before any judgment had been rendered or any settlement had been reached. The firm voluntarily withdrew as Davis' attorney and subsequent proceedings were conducted by other attorneys.
Petitioner was unable to agree with Davis upon the fee and an action was instituted in the name of Burroughs & Brown in the Supreme Court of New York County for a determination of the amount of the fee and for a decree establishing a lien upon the proceeds of the litigation, a portion of which had been deposited with a trust company. The Supreme Court dismissed the action but the Appellate Division reversed, holding that Burroughs & Brown had not lost their lien by reason of the substitution of a new attorney in their stead; that there had been no waiver of their lien by reason of an assignment executed by Davis; and that "petitioner's the firm's lien, when established, will attach to * * * the trust fund if any part thereof is necessary to satisfy petitioner's lien." In re Burroughs & Brown, 263 N. Y. S. 772.
Pursuant to the order of the Appellate Division, the amount of the compensation for legal services rendered by the firm of Burroughs & Brown was fixed on November 2, 1933, at $50,000 with interest from November 10, 1929. The defendent in that action appealed but a settlement was reached on December 6, 1933, under which the sum of $41,800 was to be, and was, paid to the firm of Burroughs & Brown.
Petitioner caused the Eastern Chemical Co. to be organized as of August 23, 1933, with an authorized capital stock of $10,000, par value $10 a share, all of one class. Petitioner subscribed for 100 shares and the certificate therefor was issued to him on December 5, 1933.
On October 29, 1933, petitioner assigned to the Eastern Chemical Corporation his "entire undivided one-half interest in and to a certain claim of Burroughs & Brown against Charles T. Davis and/or Austin S. Davis as Trustee for legal services between the years 1927 and 1929, both inclusive, which claim is the subject matter of a certain proceeding now pending in the Supreme Court * * *." He also assigned to the corporation all of his "right and interest in and to any lien or remedy for the enforcement thereof so far as I have the legal right to assign the same, or may be able to do so without impairing the force or effect thereof." The assignment, which was written in longhand upon the stationery of the Waldorf Astoria, states that it was given at 7 p. m., October 29, 1933, and in the upper right-hand corner thereof appears the following statement, also in longhand: "Delivered to me for the within named Eastern Chemical Corporation, by the signer this October 30th, 1933, at 9:00 o'clock a. m. Clyde D. Sandgren."
The assignment recited a consideration of "one dollar ($1.00) and other valuable consideration." The other consideration consisted of 100 shares of the capital stock of the Eastern Chemical Corporation which were issued to petitioner on that date or very shortly thereafter.
The amount of $41,800 was paid to the firm of Burroughs & Brown on December 6, 1933, in two checks, each for $20,900. One check was made payable to the estate of A. H. Burroughs, the deceased partner, and the other was made payable to the petitioner. Petitioner endorsed the check to the Eastern Chemical Corporation and it included the amount thereof as part of its gross income for the year 1933. A claim for refund was subsequently filed by the corporation for the amount of tax paid. It was stipulated that "in the event the Board's determination sustains the Commissioner in his treatment of the thing which had been made the subject of testimony in this proceeding, that a refund would be made to the Eastern Chemical Corporation of the amount of tax attributable to the identical fee which was included in that corporation's return."
Following the death of Burroughs, petitioner continued the practice of law under the firm name of Burroughs & Brown. He caused a partnership return of income to be filed for the year 1933, showing the entire net earnings of the firm distributable to him as an individual. Attached to and forming a part of said return was a statement signed by petitioner reading as follows:
Beginning in the year 1927 and ending in the month of October, 1929, Burroughs & Brown, a partnership composed of the late A. H. Burroughs, who died on June 19, 1929, and the undersigned, H. Lewis Brown, performed certain services for one Charles T. Davis. After the service was terminated, litigation ensued with respect to the amount of compensation due Burroughs & Brown for the services performed.
Under the terms of the partnership agreement, the estate of the said Burroughs and the said Brown are entitled each to one-half of whatever might be recovered. While the litigation was pending, the said Brown assigned his one-half interest in the claim to Eastern Chemical Corporation, solely in exchange for an issue of stock, and immediately after such exchange the said Brown was in control of said corporation. After such assignment and transfer, the claim was compromised for $41,800, and one-half thereof, to-wit: $20,900, was paid to City Bank Farmers Trust Company, as executor of the estate of the said A. H. Burroughs, and the other half was paid to said Eastern Chemical Corporation, as assignee of the said Brown. No part of said amount is covered in the present return.
Petitioner reported on his personal return of income the amount shown by the partnership return as being distributed to him, but no part of the $41,800 was reported as income in the partnership return or in petitioner's personal return. Petitioner and the partnership kept their books and made their returns of income on the cash basis.
The 200 shares of stock of the Eastern Chemical Corporation (which were the only shares ever issued) were subsequently transferred by petitioner to his wife as a gift, and report thereof was made under the gift tax law both by petitioner and his wife. On September 16, 1936, the Eastern Chemical Corporation was dissolved and its assets distributed to petitioner's wife as a liquidating dividend.
OPINION.
MELLOTT:
Petitioner contends that respondent erred in including the $20,900 in his gross income. He argues that the assignment of his interest in the claim of the partnership for stock in the Eastern Chemical Corporation constituted a nontaxable exchange under section 112 (b) (5) of the Revenue Act of 1932. Hence, he says, no taxable gain is to be attributed to him from the exchange. The respondent contends, and we think correctly, that there is no reason to discuss the applicability of this section; for he did not determine the deficiency in tax upon the theory, nor does he now urge, that the exchange gave rise to taxable gain. He merely determined that the amount, "representing a fee for personal service, which was transferred to Eastern Chemical Corporation, is income to you who earned it." In making this determination he relied upon the rule enunciated and applied by the courts in such cases as Lucas v. Earl, 281 U. S. 111; Van Meter v. Commissioner, 61 Fed. (2d) 817; Harry A. Daugherty, 24 B. T. A. 531; affd., 63 Fed. (2d) 77, and others. If the rule of the cited cases is applicable, the deficiency should be upheld; otherwise it should be set aside. The issue, therefore, may be resolved by determining whether or not such rule is applicable.
Lucas v. Earl, supra , applies literally the section of the revenue act imposing a tax upon the net income of every individual, including "income derived from salaries, wages or compensation for personal service * * * of whatever kind and in whatever form paid." (Cf. sec. 22, Revenue Act of 1932.) It holds that the import of the act is to tax income to those who earn it and to prevent the escaping of the tax "by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earns it."
Van Meter v. Commissioner, supra , follows the Earl case and holds that the "earner" of income — "the one whose personal efforts have produced it" — is taxable upon such income. Two other situations in the same category are income from owned property (Corliss v. Bowers, 281 U. S. 376) and income derived from combined personal effort and property (Burnet v. Leininger, 285 U. S. 136).
Harry A. Daugherty, supra, applied the same general rule, holding that an assignment by a husband to his wife of an undivided one-half interest in a contract of employment "effected merely an equitable assignment of petitioner's possible future income" and that the amount received was taxable income to the assignor.
It would serve no useful purpose to list and discuss the various cases applying the principles of the above cases. Suffice it to state that they hold, as succinctly stated by the Court of Appeals for the Fifth Circuit, that "No device or arrangement, be it ever so shrewdly and cunningly contrived, can make future earnings taxable to any but the earner of them, can make future income from property taxable to any but the owner of the right or title from which the income springs." Saenger v. Commissioner, 59 Fed. (2d) 631. Cf. Wallace Groves, 36 B. T. A. 14; affd., 99 Fed. (2d) 179; Gerald A. Eubank, 39 B. T. A. 583.
But, says petitioner, the facts in the instant proceeding bring the income in question within the rule of such cases as Hall v. Burnet, 54 Fed. (2d) 443; Helvering v. Seatree, 72 Fed. (2d) 67; Shanley v. Bowers, 81 Fed. (2d) 13; and Matchette v. Helvering, 81 Fed. (2d) 73. Other cases to the same general effect are J. V. Leydig, 15 B. T. A. 124; affd., 43 Fed. (2d) 494; Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 286 U. S. 565; Commissioner v. Ross, 83 Fed. (2d) 18; Julius E. Lilienfeld, 35 B. T. A. 391; Louis Boehm, 35 B. T. A. 1106; Fontaine Fox, 37 B. T. A. 271; and Blair v. Helvering, 300 U. S. 5. These cases stand for the general principle that property, which in and of itself is a producer of income, together with any income theretofore produced by it but not yet reduced to possession by the owner, may be assigned without subjecting the assignor to the income tax upon the income ultimately collected by the assignee. Petitioner recognizes the scope of the above decisions and argues that the income in question is not taxable to him because, as he expresses it, "the thing assigned was not income but was a capital asset, itself a producer of income."
Petitioner cites New York cases — Gilbert v. Ackerman, 159 N. Y. 118; 53 N. E. 753; In re Delaney, 256 N. Y. 315; 176 N. E. 407 — and statements by textbook writers to the effect that a chose in action, a right to recover money or property under a contract, and similar rights, constitute property and are assignable. But we are of the opinion that the answer to our question is not to be found in generalities. We are not concerned with the question whether petitioner did or did not have an assignable right in the claim for compensation. The question, as correctly stated by the petitioner, is whether the thing which was assigned was itself a "producer of income" or whether what was assigned was the income itself. In determining this question the transaction should be examined in the light of the revenue acts rather than by merely determining whether or not the assignment is considered to be a property right under the laws of the state.
Section 182 (a) of the Revenue Act of 1932 provides that there shall be included, in computing the net income of each partner, "his distributive share, whether distributed or not, of the net income of the partnership for the taxable year * * *." The partnership of Burroughs & Brown, though dissolved by the death of Burroughs in June of 1929, had an income of $41,800 in 1933. If there had been no assignment by petitioner of his right to receive his aliquot portion of such income, he would probably not deny that it was taxable to him as "net income of the partnership", or as his share of partnership earnings. At first blush it may seem to be somewhat anomalous that a partnership may have income notwithstanding the fact that it has been dissolved by the death of a partner; but "the winding up of the business of the firm is the precise result which is contemplated by the partnership agreement." Williams v. Whedon, 109 N. Y. 333; 16 N. E. 365. As pointed out by the Court of Appeals for the Second Circuit in Rossmoore v. Commissioner, 76 Fed. (2d) 520, "on dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed." Thus, when petitioner instituted and carried on the suit in the Supreme and Appellate Courts of New York in his capacity of surviving partner, he was, as the partnership agreement contemplated, attempting to recover the income which the partnership had earned. The dissolution of the partnership by the death of Burroughs did not have the effect of vesting a one-half interest in all of the partnership property in his executors and a like interest in petitioner. Their rights were fixed by the partnership agreement; and even "the representatives of the deceased partner have no legal interest in the firm assets and no legal right to interfere in their administration, so long as the survivor is prosecuting the business of closing up the estate and applying its proceeds in the payment of firm debts." Williams v. Whedon, supra . In other words, it could not be ascertained whether the partnership would, or would not, have anything to distribute until its various claims were collected and its debts paid. This of necessity was dependent upon the outcome of the litigation which was being carried on by the surviving partner.
Petitioner's argument, that the services had been rendered prior to the taxable year and that therefore the income resulted from the "property" which had been transferred, is not convincing. The income resulted from the performance of legal services by the partnership. Petitioner did not attempt to assign anything but his "undivided one-half interest in and to a certain claim of Burroughs & Brown." The evidence does not show that Davis or the trust company ever had any notice of the assignment nor does it disclose that the assignee ever took any part either in carrying on the litigation or in making settlement of it. The litigation was carried on by the surviving partner for the benefit of the partnership and it received the fee. The fact that petitioner chose to recognize the assignment which he had made to his wholly owned corporation and to turn the check over to it is immaterial. The income was the income of the partnership in the year it was received. The only alternative to this conclusion, which seems to suggest itself, is, that the partnership realized income in an earlier year; but petitioner does not argue that any such conclusion should be reached, for in that event the income to the partnership would antedate the assignment and be taxable to him.
Burnet v. Leininger, supra , and Rossmoore v. Commissioner, supra , seem to justify including the amount in controversy in petitioner's income for 1933. Here, as in the Leininger case, "that which produced the income was not the assignor's * * * individual interest in the firm, but the firm enterprise itself. * * * There was no transfer of the corpus of the partnership property to a new firm with a consequent readjustment of rights in that property and management." The assignee may have become the beneficial owner of one-half of the income which the assignor received from the firm enterprise, but "it is still true that * * * the assignor and not * * * the assignee was the member of the firm and that * * * the assignee had only a derivative interest." As pointed out in the Rossmoore case, the theory that a partner's interest is "like that of a shareholder in a company * * * — a right against the `firm entity' and assignable as such" is incompatible with the whole idea of partnerships under the revenue acts; for they "have consistently retained the common-law view, treating all income of the firm as taxable to the partners, whether distributed or not, and ignoring the firm as a taxpayer except for purposes of information."
Petitioner's contention that "the thing assigned was a producer of income" is not sustained merely by a showing that the assignee received the amount from the assignor after he had collected it. The activities of the partnership produced the income and the thing assigned "produced" nothing.
Petitioner's contention, that the firm, prior to the assignment, had done everything necessary to make the fee payable and hence that the income had been completely "earned" before the assignment, is materially weakened, if not entirely negatived, by the showing that it was necessary to carry litigation to enforce its collection to a successful conclusion before the amount was payable. If the firm had abandoned all efforts to enforce collection, the present controversy would probably never have arisen; for in that event it is quite likely that the fee would not have been collected by anyone.
We are of the opinion and hold that the respondent did not err in including the amount in controversy in petitioner's gross income for the year 1933.
Reviewed by the Board.
Judgment will be entered for the respondent.