October 5, 1942.
Herbert Stern, of New York City (Aaron W. Berg, of New York City, on the brief), for plaintiffs.
Elizabeth B. Davis, of Washington, D.C., and Samuel O. Clark, Jr., Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington, D.C., on the brief), for defendant.
Before WHALEY, Chief Justice, and LITTLETON, WHITAKER, JONES, and MADDEN, Judges.
Action by City Bank Farmers Trust Company and others, as trustees under the last will and testament of Clarence J. Housman, deceased, Trust for Virginia H. Berg, against the United States, to recover back alleged overpayment of income tax and interest.
Judgment for defendant.
In this case plaintiffs seek to recover $7,326.11 alleged overpayment of income tax and interest, on the ground that their "interest" in a partnership acquired upon the death in 1932 of a member of the partnership and sold by them December 31, 1936, was a capital asset under and within the meaning of the capital gains section 117, Revenue Act of 1936, 26 U.S.C.A. Int. Rev. Acts, page 873, and that since they had held such "interest" for more than two years and not for more than five years, they were taxable only on 60 percent of the gain realized from the sale.
The defendant contends that plaintiffs, who continued, after the death of C.J. Housman, to share in the profits and losses of the partnership of E.A. Pierce Company, should be considered, for Federal income tax purposes and the purposes of section 117, as having acquired and held a pro-rata interest in the specific assets constituting the property of the partnership from the acquisition by the partnership of such assets to the date of sale by plaintiffs of their interest.
Special Findings of Fact.
1. Plaintiffs are the duly appointed, qualified and acting trustees of the trust for Virginia H. Berg, under the will of Clarence J. Housman, deceased, who died a resident of Monmouth County, New Jersey, November 13, 1932, and whose will was admitted to probate before the Surrogate's Court, Monmouth County, November 29, 1932. At the time of his death Clarence J. Housman was a limited partner of the firm of E.A. Pierce Co., by virtue of a partnership agreement made and executed in the City of New York and dated January 18, 1930, and thereafter amended from time to time by supplemental agreements made and executed in the City of New York. The partnership agreement and the amendment thereto provided that the assignee of a limited partner shall have the right to become a substitute limited partner with all the rights and obligations of his predecessor and further that the term assignee shall include the executor, administrator, committee or other legal representative of a limited partner. The decedent herein was entitled to share in the profits of the partnership in the proportion of 3 1/3 % and to bear the losses in like proportion, it being provided "that in no event shall any of the limited partners be liable for said losses, or any part thereof, in excess of their respective capital contributions", such excess losses to be borne by the general partners.
By agreement December 16, 1933, it was further agreed that the capital contribution of Clarence J. Housman, deceased, was being continued by his estate and that the estate as assignee should continue to share in the partnership profits and losses to the same extent as he had prior to his death.
At no time herein mentioned did the plaintiffs' testator, or his successors in interest, ever take an active part in the management of the said partnership, nor were they entitled to do so under the terms of the aforesaid agreements. January 18, 1930, the date of the first agreement mentioned above, the firm of E.A. Pierce Co. consisted of twenty-three general partners and five limited partners, the above named decedent being one of the latter, and at all times thereafter said firm was composed of at least twenty general partners, and at least three limited partners, the above named decedent, and following his death, the executors and trustees of his estate, always being one of the latter. The firm of E.A. Pierce Co. was at all times herein mentioned a limited partnership duly organized and existing under and by virtue of the Partnership Law of the State of New York, Laws of 1919, Chapter 408, as amended, Consol. Laws N.Y.C. 39, and was engaged in transacting a general brokerage business in stocks, bonds and other securities and commodities, having its principal place of business and office in New York City, New York.
2. Upon the death of Clarence J. Housman his above mentioned interest as a limited partner in the firm of E.A. Pierce Co. duly passed to the executors of his estate, pursuant to the terms of the agreement of January 18, 1930, and the amendments thereto, and was so held by said executors until August 1, 1936, on which date, and pursuant to the terms of the will, one-half of his interest in said partnership was transferred to the plaintiffs herein, as trustees of the trust for Virginia H. Berg. Plaintiffs, as such trustees, held, pursuant to the terms of said agreement of January 18, 1930, and the amendments thereto, said partnership interest until December 31, 1936, on which date they sold it for $189,550.25.
On the date of the aforesaid sale, the cost base of the above mentioned partnership interest held by the plaintiffs herein was evaluated at $119,364.45, said figure representing the fair evaluation of said interest as of the date of testator's death, as approved by the estate tax authorities of the Treasury Department and as reflected in the federal estate tax return filed by the estate and upon which a federal estate tax was paid, plus all gains and minus all losses which were included in the income tax returns regularly and properly filed by said testator's estate, upon which income taxes had been fully and properly paid from the date of his death to December 31, 1936.
3. March 15, 1937, plaintiffs, as trustees, herein, filed with the Collector of Internal Revenue an income tax return setting forth a $44,819.59 taxable income as having been received by their trust during 1936. In the fiduciary return, Form 1041, upon which this return was based plaintiffs reported as taxable income to their trust only 60% of the gain realized upon the aforementioned sale of their partnership interest on the ground that the provisions of section 117(a) and (b) of the Revenue Act of 1936 were applicable thereto, since the gain realized from said sale had been the result of the sale of a capital asset, which had been held by the taxpayers for more than two and for not more than five years, i.e., from November 13, 1932 (the date of testator's death) to December 31, 1936 (the date of sale by plaintiffs). With the filing of said return plaintiffs paid $7,939.07, the income tax due, as computed in said return.
4. Thereafter the plaintiffs received a report from the Internal Revenue Agent May 10, 1937, accompanied by a thirty-day letter, dated August 28, 1937, recommending an additional tax of $1,015.08 due from the above mentioned estate of Clarence J. Housman, deceased, based upon the income of said estate for 1935. This additional sum was paid by said estate to the Collector September 14, 1937. As a result of this payment the above mentioned cost base of plaintiffs' interest in the firm of E.A. Pierce Co. was increased to $124,230.25. Had this increased cost base been reflected in the return filed by plaintiffs herein for 1936, the net taxable income which would have been reported would have been $41,900.11, instead of the above mentioned sum of $44,819.59. Consequently, if the plaintiffs are correct in their computation of the tax on the return as originally filed, the income tax payable by the plaintiffs for 1936 would have been reduced from $7,939.07 (the sum actually paid) to $6,972.03 (the sum which should have been paid), a difference of $967.04.
5. September 23, 1937, within the time allowed by law, plaintiffs filed a claim for the refund of approximately $1,000.
This claim set forth that the plaintiffs had sold or exchanged their partnership interest in the firm of E.A. Pierce Co., December 31, 1936, this partnership interest being one of the assets of the estate of Clarence J. Housman, deceased, who died November 13, 1932; that the executors of the estate had continued this interest in the partnership and on August 1, 1936, had transferred one-half thereof to the plaintiff-trustees, pursuant to the terms of the will of Clarence J. Housman, deceased, and that the plaintiff-trustees had continued in the partnership until the termination of their interest by sale or exchange December 31, 1936; that the cost base of the plaintiffs' interest in the firm of E.A. Pierce Co. was evaluated at $119,364.45, and the price received therefor was $189,550.25; that the report of the Internal Revenue Agent in Charge had recommended an additional income tax assessment against the estate of Clarence J. Housman, deceased, for 1935, of $1,015.08, which had been paid September 14, 1937; that this report and the resultant additional assessment were based upon changes in the taxable income of the firm of E.A. Pierce Co. for 1935, which changes resulted in a substantial increase in the cost base of the plaintiffs' interest in E.A. Pierce Co., with the attendant decrease in the amount of taxable profits thereon for 1936, resulting in the decrease in the amount of income tax payable for 1936 from $7,939.07, the amount paid, to $6,972.03, the sum due and payable, namely, the sum of $967.04, the payment of which sum, together with legal interest from March 15, 1937, is now sought in this action.
6. Thereafter the Commissioner of Internal Revenue notified plaintiffs September 12, 1939, by registered mail that the claim for refund had been rejected in full. By letter November 2, 1939, the Commissioner explained that the claim was disallowed "for the reason that additional taxes were found due, which you state you have paid." The two aforesaid letters by this reference thereto are incorporated herein by reference.
7. July 22, 1938, the Revenue Agent in Charge advised the trust for Virginia H. Berg that a field investigation disclosed a deficiency in tax of $8,363.01 for 1936. In arriving at this deficiency, the profit from the sale of the partnership interest was held 100 percent taxable. A formal protest was filed August 12, 1938, and conferences were subsequently held in the revenue agent's office September 9, 1938, October 27, 1938, and January 4, 1939. In connection therewith on November 29, 1938, John Humm, the auditor for the partnership, filed an affidavit, showing the dates of acquisition of the various individual partnership assets, thus reflecting the length of time the various individual assets of the partnership had been held. As a result of these conferences, the proposed deficiency in tax was reduced from $8,363.01 to $5,691.46. In arriving at this deficiency, a cost basis for the sale of the partnership asset of $124,230.24 was used and the total profit of $58,985.57 attributable to this taxpayer subject to tax was computed as follows:
Assets held 1 to 2 years (3 1/3 %) ............... $ 1,469.83 80% of profit to be taken into account. Assets held 2 to 5 years (3 1/3 %) ............... 91,173.60 60% of profit to be taken into account. Assets held less than 1 year (3 1/3 %) ........... 286,457.06 100% of profit to be taken into account. __________ Aggregate proceeds received by both Trusts from sale ............................. 379,100.49 Cost Base ........................................ 248,460.48 __________ Gain on Sale .................................. 130,640.01 ========== One-half of gain to Trust for Ruth H. Cowen ........................................ 65,320.01 One-half of gain to Trust for Virginia H. Berg ....................................... 65,320.00 __________ 130,640.01
Percentage for application of limitation section 117(a) of the 1936 Act.----------------------------------------------------------------------------------------------- | | Total net | Profit | | | Percentage | profit on | applicable | Percentage | Profit | to be | sale each | to each | subject | subject Period held | applied to | trust | period of | to tax | to tax | net profit | separate | ownership | | -------------------------|-------------------------------------------|------------|------------ 1 to 2 years ........... | $1,469.83 | | | ---------- × $65,320.00= $253.26 | 80% | $202.61 | 379,100.49 | | | 91,173.60 | | 2 to 5 years ........... | ---------- × 65,320.00= 15,709.45 | 60% | 9,425.67 | 379,100.49 | | | 286,457.06 | | Less than 1 year ....... | ---------- × 65,320.00= 49,357.29 | 100% | 49,357.29 | 379,100.49 _________ | | _________ | 65,320.00 | .......... | 58,985.57 Profit previously included in income ............................... | .......... | 65,320.00 | | _________ Adjustment ...................................................... | .......... | 6,334.43 ----------------------------------------------------------------------------------------------- These figures and calculations were reflected in the revised schedules of the Treasury Department, Office of the Internal Revenue Agent in Charge, Newark Division, March 23, 1939.
A waiver assenting to the assessment and collection of the tax of $5,691.46 was filed by the trust for Virginia H. Berg February 2, 1939.
8. Plaintiffs on April 5, 1939, pursuant to the above mentioned revised schedules and waiver paid to the Collector $5,691.46, on account of additional taxes demanded, plus $667.61, as interest for the period March 15, 1937, to March 1, 1939, totaling $6,359.07.
9. Thereafter, July 8, 1940, within the time allowed by law, plaintiffs filed a claim for the refund of the $6,359.07 paid by plaintiffs, as set forth in the next preceding paragraph, together with legal interest thereon from March 30, 1939. More than six months at the time the petition was filed had elapsed since the plaintiffs filed their claim for refund and the Commissioner had not advised plaintiffs of any action thereon. June 14, 1941, plaintiffs were advised by registered mail that the claim had been disallowed and no part of the amount herein sought to be recovered has been refunded to the plaintiffs.
10. Plaintiffs' claim for refund set forth that the taxpayers had sold or exchanged their partnership interest in the firm of E.A. Pierce Co. December 31, 1936, said partnership interest being one of the assets of the estate of Clarence J. Housman, deceased, who died on November 13, 1932; that the executors of said estate had continued this interest in the partnership until August 1, 1936, when they transferred one-half thereof to plaintiffs, pursuant to the terms of the testator's will, and that the plaintiffs had continued to hold said partnership interest until the sale thereof on December 31, 1936; that the taxpaying trustees had reported only 60% of the gain realized upon the sale of said partnership interest in its return for 1936, pursuant to section 117(a) and (b) of the Revenue Act of 1936, inasmuch as said interest had been held as a capital asset for more than two, but for not more than five years; the Collector of Internal Revenue maintained that the tax due under section 117(a) and (b) of the Revenue Act of 1936 from the plaintiff-taxpayers was determined by and measured from the date of acquisition by and the date of disposal by the partnership of E.A. Pierce Co. of the specific assets belonging to the partnership of E.A. Pierce Co., in which plaintiffs herein, it was claimed, owned a pro rata interest.
Plaintiffs, as trustees for Virginia H. Berg, contend that the sale by them of their interest in the partnership of E.A. Pierce Company on December 31, 1936, was the sale of a capital asset held by them since the death of their testator, Clarence J. Housman, on November 13, 1932, and for more than two years and not for more than five years under and within the meaning of section 117(a) and (b) of the Revenue Act of 1936 and that, therefore, only 60 percent of the gain realized upon such sale of their interest in the partnership in December 1936 should have been included in computing the net income of the trustees for 1936.
Clarence J. Housman was at the time of his death, November 13, 1932, a limited partner of the firm of E.A. Pierce Company under a partnership agreement dated January 18, 1930. The partnership agreement, as amended from time to time prior to his death, provided that the assignee of the limited partnership should have the right to become a substitute limited partner and, further, that the term "assignee" should include the executor, administrator, committee or other legal representative of a limited partner. The decedent was entitled to share in the profits of the partnership in the proportion of 3 1/3 percent, but was not liable for any losses in excess of his respective capital contributions.
By agreement of December 16, 1933, after Housman's death, it was further agreed that the capital contribution of Clarence J. Housman should be continued by his estate and that the estate, as assignee, should continue to share in the partnership profits and losses to the same extent as he had prior to his death.
Upon the death of Clarence J. Housman, his interest in the partnership of E.A. Pierce Company passed to the executors of his estate and was held by them until August 1, 1936, upon which date one-half of his interest in the partnership was transferred to the plaintiffs herein as trustees of the trust for Virginia H. Berg, and the other half was transferred to the plaintiffs, as trustees, of the trust for Ruth H. Cowen. Plaintiffs, as trustees, held the partnership interest of the decedent until December 31, 1936, at which time they sold it for $189,550.25. (This represents one-half of the sales price of the full partnership interest.)
On the date of the sale, the cost basis of the partnership interest was evaluated at $119,364.45, this figure representing the fair valuation of the interest as of the date of Housman's death, as reflected in the estate-tax return, and upon which a Federal estate tax was paid, plus all gains and minus all losses which were included in the income-tax return regularly and properly filed by the estate. In due course plaintiffs, as trustees, filed an income-tax return for 1936 showing a taxable income of $44,819.59. In the Federal fiduciary return form, upon which this return was based, plaintiffs reported as taxable income only 60 percent of the gain realized on the sale of the partnership interest on the ground that the gain realized from the sale had been the result of the sale of a capital asset which had been held by the taxpayers for more than two and not more than five years.
The Commissioner determined a deficiency in respect of the tax due by the Virginia H. Berg trust of $5,691.46 in excess of the tax of $7,939.07 paid upon the return. In arriving at this deficiency a cost basis for the sale of the partnership asset of $124,230.24 was used, resulting in a total profit of $130,640.01, of which one-half, or $65,320, was attributable to the trust for Virginia H. Berg. A total taxable profit of $58,985.57 for this trust was determined. In computing the percentage of gain to be taken into account, it was determined that, of the aggregate proceeds of $379,100.49, the amount of $91,173.60 represented assets held two to five years, of which 60 percent of the profit was taken into account; the amount of $1,469.83 represented assets held one to two years, of which 80 percent was taken into account; and the amount of $286,457.06 represented assets held less than one year, of which 100 percent of the profit was taken into account.
The question presented is whether, when a partner sells his interest in a partnership business, the holding period for the purpose of applying the percentage rate specified in section 117 of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev. Acts, page 873, is to be measured from the date of the partner's acquisition of the partnership interest, or whether the holding period is to be measured from the date or dates of acquisition by the partnership of the specific partnership assets which the partnership owned at the date of sale of the "partner's interest." Section 117 provides as follows:
"(a) General rule. In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
"100 per centum if the capital asset has been held for not more than 1 year;
"80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
"60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years;
"40 percentum if the capital asset has been held for more than 5 years but not for more than 10 years;
"30 per centum if the capital asset has been held for more than 10 years.
"(b) Definition of capital assets. For the purposes of this title, `capital assets' means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business."
Plaintiffs' contention in substance is that the capital asset which they sold on December 31, 1936, was their "interest" in the partnership of E.A. Pierce Company, that is, their right to share in the profits and losses, which they acquired November 13, 1932, upon the death of Clarence J. Housman, a member of the partnership, and that they were therefore liable to tax upon only 60 percent under section 117 of the gain realized. In other words, plaintiffs contend for the separate entity theory of a partnership and argue that the partnership interest is by its very nature separate and distinct from the specific assets owned by the partnership itself; that it consists of certain rights against the other partners, but does not include any title or assignable interest in and to a pro rata share of the specific partnership assets. They, therefore, insist that the date when the "interest" in the partnership, as such, was acquired by them should mark the date of the beginning of the holding period. We cannot agree.
For Federal tax purposes in the absence of a specific statutory provision to the contrary, a partnership is treated, and therefore must be considered, as an association of individuals who are vested with an interest in the specific property of the partnership. This has become increasingly clear under recent decisions.
In Craik v. United States, 31 F. Supp. 132, 134, 90 Ct.Cl. 345, 350, 351, this court said: "The treatment of partnership income on the same basis as though it had been received by the partner directly is consistent with the common-law idea of a partnership. At common law, the personal property of the partnership was held not by the partnership, but by the partners in common. Real estate was held by an individual for the benefit of the partnership, because a partnership was not an entity and, therefore, could not hold the title. Each partner was liable for the debts of the partnership on the theory that they were the partners' debts and not the debts of the partnership. Each partner was the agent for the other partners in the carrying out of their common purpose. The income earned by the partnership was regarded as having been earned by each of the individual partners, either by himself individually or through his agents, the other partners." We accordingly held in the Craik case that income of a domestic partnership from sources without the United States retained its character as such when received by one of the partners, a nonresident alien, and should have been excluded from his taxable income as income received from sources without the United States.
In Neuberger v. Commissioner, 311 U.S. 83, 61 S.Ct. 97, 85 L.Ed. 58, the court held that an individual having net losses from sales of noncapital assets not connected with a partnership of which he was a member, was authorized to deduct such losses in computing his individual taxable income from his distributable share of gains of the partnership from sales by the partnership of noncapital assets. In discussing the question, the court, at page 88 of 311 U.S., at page 101 of 61 S.Ct., said: "Sections 181-189 of the Revenue Act of 1932, 47 Stat. 169, 222-223 [26 U.S.C.A. Int.Rev. Acts page 544 et seq.], provide generally for computation and reporting of partnership income. In requiring a partnership informational return although only individual partners pay any tax, Congress recognized the partnership both as a business unit and as an association of individuals. This weakens rather than strengthens respondent's argument that the privileges are distinct or that the unit characteristics of the partnership must be emphasized. Compare Jennings v. Commissioner, 5 Cir., 110 F.2d 945; Craik v. United States, 31 F. Supp. 132 [90 Ct.Cl. 345]; United States v. Coulby, D.C., 251 F. 982, affirmed, 6 Cir., 258 F. 27. Nor is the deduction claimed here precluded because Congress, in Sections 184-188, has particularized instances where partnership income retains its identity in the individual partner's return. The maxim `expressio unius est exlusio alterius' is an aid to construction not a rule of law. It can never override clear and contrary evidences of Congressional intent. United States v. Barnes, 222 U.S. 513, 32 S.Ct. 117, 56 L.Ed. 291." Upon these decisions we hold that a partnership is to be considered, for the purpose of measuring the holding period of the assets under section 117, as an association of individuals who, for taxing purposes, are vested with an interest in the specific partnership property, and that the defendant properly computed the gain includable in income upon the sale by plaintiffs of their interest in the partnership on December 31, 1936. Most of the assets which the partnership held at that time were acquired in years subsequent to the date of death of Clarence J. Housman on November 13, 1932, and it cannot, therefore, be said that plaintiffs held such assets or a pro-rata interest therein at the date of Housman's death.
Plaintiffs rely strongly on certain provisions of the New York statute — that statute having adopted the uniform partnership act. But we are of opinion that the statute is not controlling here. In Helvering v. Smith, 2 Cir., 90 F.2d 590, the court had occasion to consider the nature of an interest in a partnership under the law of New York and pointed out that the Uniform Partnership Act did not make a firm an independent juristic entity. The court, at pages 591, 592 of 90 F.2d, said:
"With this history before us, it would be a palpable perversion to understand the act as creating a new juristic person, which owned the firm property and was obligor of the firm debts, against which the partners had only a chose in action, and to which they were liable as guarantors.
"Moreover the Revenue Act gives no color to such a theory, but was framed on precisely the opposite plan. From the outset the tax had been imposed on the partners, and their taxable income has included their distributive shares, whether distributed or not."
In Stilgenbaur v. United States, 9 Cir., 115 F.2d 283, the court held that in California, where the Uniform Partnership Act had been adopted, a sale by a retiring partner of his interest to the other partners was a sale of capital assets under section 117(b) of the Revenue Act of 1934. While that case did not involve the holding period, it is applicable in principle to the question here presented. The court, at page 285 of 115 F.2d, said: "Under the California law a partner has three distinct interests arising from his partnership. One is his co-ownership in the specific property of the partnership property, another is his interest in the partnership as such, and the third is his right to participate in the management."
In Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74, 77 L.Ed. 199, and Lyeth v. Hoey, 305 U.S. 188, 191-194, 59 S.Ct. 155, 158, 83 L.Ed. 119, 119 A.L.R. 410, the court held that "State law may control only when the federal taxing act by express language or necessary implication makes its operation dependent upon state law."
Plaintiffs are not entitled to recover and the petition is dismissed. It is so ordered.