Comm'r of Internal Revenue

Tax Court of the United States.Sep 18, 1945
5 T.C. 732 (U.S.T.C. 1945)
5 T.C. 732T.C.

Docket Nos. 4732 4743.



W. T. Durant, Esq., and S. D. Miller, Esq., for the petitioners. Walter W. Kerr, Esq., for the respondent.

Where petitioners' wives contributed neither capital nor services to two partnerships and the petitioners retained economic ownership and control of the partnership properties and income, it is held that the wives were not members of the partnership during 1941, for Federal income tax purposes, and the income thereof is properly taxable one-half to each of the petitioners. W. T. Durant, Esq., and S. D. Miller, Esq., for the petitioners. Walter W. Kerr, Esq., for the respondent.

The respondent determined deficiencies in income tax for the year 1941 against Leonard W. Greenberg and William Arenson in the respective amounts of $19,533.53 and $19,608.71.

The only issue in controversy is whether the income of two businesses carried on in partnership is taxable one-half to each of the petitioners, or one-fourth each to the petitioners and their respective wives.


The petitioners are individuals, residing in Toledo, Ohio. The returns for the year in controversy were filed with the collector of internal revenue for the tenth district of Ohio.

Toledo Machinery Exchange Co., hereinafter called Exchange, was organized as a corporation in 1922 for the purpose of engaging in the business of buying and selling new and used machinery. Petitioner Arenson was one of the original stockholders. In 1924 he was employed as manager of the corporation. In 1937 the corporation was dissolved and a certificate of dissolution was issued.

Immediately prior to its dissolution the stockholders of the corporation were Ruth V. Arenson, wife of petitioner Arenson, owning about 195 shares; Sylvia Greenberg, wife of petitioner Greenberg, owning about 5 shares; and Arenson, owning 1 share. Mrs. Arenson was president of the corporation and a director; Mrs. Greenberg was secretary; and Arenson was vice president and a director.

Upon the dissolution of the corporation all its assets were distributed to Arenson, who operated Exchange as a sole proprietorship from that time until January 1, 1941, receiving all the net profits arising from its operation.

Petitioner Greenberg is a younger brother of Mrs. Arenson. In 1926 he went to Toledo and became an employee of Exchange. After spending a year familiarizing himself with the business, he became a traveling salesman for the company, buying and selling machinery. He worked as an employee until January 1, 1941. During that time he was paid a salary and commission. He did not share in the profits of Exchange.

Some time after Greenberg entered the employ of Exchange he and Arenson discussed the advisability of manufacturing machine tool equipment and marketing it at a price that would be attractive to dealers. Eventually, one of the customers of Exchange, who was unable to meet his obligations for machines purchased, agreed to start manufacturing machine tools for the petitioners in order to pay for his equipment out of profits. Thereafter the petitioners organized L.W. Chuck Co., hereinafter called Chuck, for the purpose of manufacturing these items. Chuck was organized under an oral partnership agreement, providing for an equal distribution of profits between the petitioners.

The operations of Exchange and Chuck were closely interrelated. They occupied the same office space and used the same telephone service. The same personnel was used for both companies. No separate accountings have been kept of funds furnished by each company in the management and operation of the common office. Arenson attended to the financial affairs of both companies.

It was considered essential to maintain separate identities of the two companies, since dealers or competitors in the used machinery business would not purchase the products of Chuck if they knew there was a connection between the two companies.

In 1940 Greenberg was doing practically all the buying and selling of machinery for Exchange. He produced almost all of the machinery business for that company and was also devoting some time to Chuck. Arenson at that time was devoting most of his attention to the latter company. Greenberg felt that the salary and commission he received from Exchange were insufficient compared with his efforts on behalf of that company and he told Arenson that he wanted an interest in Exchange.

Arenson agreed that Greenberg was entitled to an interest in the company. However, he stated that he desired his wife also to acquire an interest in the business and proposed the formation of a partnership consisting of himself, his wife, and Greenberg, each owning a one-third interest in Exchange. Greenberg expressed his dissatisfaction with this proposed arrangement, since he felt that he should have more than a one-third interest in the business. Accordingly, a compromise arrangement was arrived at, whereby it was agreed that the petitioners and the respective wives should all become partners, each owning a one-fourth interest in Exchange.

Because of the interrelation in the operations of the two companies, it was decided at the same time that Mrs. Arenson and Mrs. Greenberg should also be allowed to acquire a one-fourth interest each in Chuck.

In accordance with this agreement, on January 27, 1941, the petitioners and their respective wives executed with respect to Exchange, a writing styled ‘Articles of Partnership,‘ providing in pertinent part as follows:

This AGREEMENT OF PARTNERSHIP made this twenty-seventh day of January, 1941, as of January first, 1941, at Toledo, Ohio, between WILLIAM ARENSON, first party; RUTH ARENSON, second party; L. W. GREENBERG, third party; and SYLVIA GREENBERG, fourth party, witnesseth:

THAT WHEREAS first party has heretofore been the sole proprietor of a certain business known as Toledo Machinery Exchange Co., the net worth of which business, as of the date hereof, it is stipulated and agreed by and between the parties hereto, is the sum of $26,126.13; and

WHEREAS, the parties above named intend by this agreement to form a partnership to carry on said business jointly for the purposes hereinafter stated;

NOW, THEREFORE, in consideration of the premises, the promises and agreements hereinafter stated, and of one dollar to each in hand paid by each other, receipt of which is hereby acknowledged, it is hereby mutually agreed by and among the parties hereto as follows:

ARTICLE I. The second party, third party, and fourth party shall severally, and contemporaneously with the execution hereof, execute and deliver to first party their respective promissory notes, each in the sum of $6,531.53, payable at the time and in the manner therein specified, in payment for their respective partnership interests as set forth in this agreement.

ARTICLE II. The partnership shall be for the carrying on of the business of buying, selling, and dealing in new and used machinery, equipment, and similar products.

ARTICLE III. This partnership shall begin as of the first day of January, 1941, and shall continue until terminated in accordance with the provisions hereinafter set forth.

ARTICLE VI. The capital of said partnership shall consist of all of the personal property and assets, heretofore owned individually by first party, which are and were, as of January 1, 1941, used in the conduct of the business known as TOLEDO MACHINERY EXCHANGE CO., and which said assets had as of said date a net value of $26,126.13. Said property and assets, together with all the income and profits arising from the employment thereof, shall become and constitute a permanent fund for partnership purposes, subject however, to all liabilities and claims of creditors which existed as of, and arose prior to, January 1, 1941.

ARTICLE VII. Each partner shall share equally in all the profits and losses that may arise out of, or occur in, the prosecution of said partnership operations, and said profits shall be withdrawn and distributed at such times and in such manner as first party and third party may from time to time mutually determine and agree.

ARTICLE VIII. The funds of said partnership shall be withdrawn, whether in cash or by check, only by first party or third party, or by such person or persons as may be mutually designated in writing by said first party and third party.

ARTICLE IX. The first party and third party shall diligently employ themselves in the business of said partnership, and be faithful to the others in all transactions relating to the firm, and give, whenever required by the other parties hereto, a true account of all business transactions arising out of, or connected with, the conducting of the partnership. Said first party and third party shall devote such time and effort to the conduct of the partnership business as may be reasonably necessary for the efficient and beneficial prosecution thereof. Second party and fourth party shall perform such services for the partnership as may be requested from time to time by first party and third party, but neither second party nor fourth party shall be entitled to exercise control of the management, or to determine questions of policy in the conduct, of the partnership business, such control and determination being, by this agreement, expressly delegated by second party and fourth party to first party and third party so long as said first party and third party shall remain alive during the existence of this agreement. None of the parties hereto shall, without the written consent of the other partners, employ either the capital or the credit of the partnership in any other than the partnership business.

The agreement further provided that books of account should be kept in which each partner should cause to be entered an account of all his dealings, receipts, and expenditures for or on account of the firm. All questions of differences as to management were to be decided by a majority of the partners and in case they were unable to agree, the matter was to be referred to three disinterested arbiters.

The agreement could be terminated by any of the partners upon breach by any other or upon one month's notice in writing given to all the other partners. Death of a partner would not in itself work a termination of the agreement. In the event of the death of either of the petitioners, his surviving widow could elect to terminate the agreement, in which case the surviving petitioner or his wife could purchase the interests of the deceased petitioner and his widow at a price determined to be the book value of such shares or their mean appraised value, whichever was higher. In the event of the death of one of the petitioners and the surviving widow did not elect to terminate, the surviving petitioner could purchase the decedent's share under like conditions. No right of termination arose on the death of either wife, but her surviving husband was given the right to purchase her share for an amount equaling its book value on the date of her death or the sum of $6,531.53, whichever was lower. The agreement could also be terminated by vote of a majority of the parties.

The ‘Articles of Partnership‘ pertaining to Chuck were in most part identical to those relating to Exchange. It was stated therein that the petitioners had been conducting Chuck as a copartnership; that they had agreed to admit their respective wives in the partnership with them; and that, in consideration of the sum of $6,922.95 (one-fourth of the stated value of the business) paid by each wife to her respective husband, the parties agreed to become copartners in the conduct of the business.

Article VIII of the agreement provided as follows:

The first party and the third party shall each be entitled to receive, and shall be paid out of partnership funds, an annual salary of $5,200.00, payable in weekly installments of $100.00, as additional compensation for their services and experience. Said salaries shall be in addition to the participation in the profits of the partnership provided for in the next preceding paragraph.

The second party and the fourth party shall receive no salary for services performed for the partnership. Said second and fourth parties shall each be permitted to draw the sum of $2,600.00 per annum, payable in varying optional instalments. Such sums so drawn shall be charged respectively to said second and fourth parties, and at the annual accounting, the amounts so drawn shall be charged against their respective shares of the profits. If their share of the profits in any year shall not be equal to the sum so drawn, such withdrawals shall be charged against their said shares of profits in the next succeeding year or years, and shall constitute a debt of said parties until paid or otherwise satisfied.

In all other respects, except for the numbering of the various articles, the documents were identical.

In consideration for their purported interest in Exchange, Greenberg, Mrs. Greenberg, and Mrs. Arenson each gave Arenson his or her promissory note in the amount of $6,531.53. Each of these notes was paid by cash in the sum of $3,000 on September 30, 1941, and by check in the sum of $3,531.52 on December 27, 1941.

For their purported interests in Chuck, Mrs. Arenson and Mrs. Greenberg each gave to her husband her note dated January 27, 1941, in the amount of $6,922.95.

Mrs. Arenson's note was paid by a gift from her husband in the amount of $4,000, which was credited against said note on February 16, 1941, and by check in the amount of $2,922.95 on December 4, 1941. Mrs. Greenberg's note was paid by a gift from her husband in the amount of $4,000, which was credited against the note on June 23, 1941, and by check in the sum of $2,922.95 on December 4, 1941.

Following the creation of the purported partnerships, the companies' bank, Toledo Trust Co., was informed of the change, as was Dun & Bradstreet. Insurance companies insuring the place of business were also advised.

From 1926, shortly after her marriage, to 1929 Mrs. Arenson frequently accompanied her husband on trips about the country when he was engaged in buying second-hand machinery, going with him into different shops that had machinery for sale. Through this experience she gradually learned something about the business. Both before and after the execution of the partnership agreements Mrs. Arenson occasionally looked after the office, answering the telephone, waiting on customers, and sometimes making sales. In the years prior to 1941 she received no compensation for these services.

Mrs. Greenberg is a housewife. She knew little about the business. Occasionally she would tend the office when both of the petitioners were out of town.

At the time the agreements were entered into, Mrs. Arenson and Mrs. Greenberg owned the homes in which they lived, and they were beneficiaries of policies of insurance upon the lives of their respective husbands.

Arenson had great confidence in his wife's judgment. One of the reasons he wanted her in the business was that Greenberg had involved Exchange in some deals which that company was unable to handle and Arenson thought his wife could exercise a restraining influence over Greenberg, since she was his older sister.

Neither Mrs. Arenson nor Mrs. Greenberg had any income aside from the amounts allegedly distributed to them as their shares of the earnings of the two partnerships. The funds with which they paid the notes above referred to were a part of the profits of the two businesses. Each of the two wives had her own checking account, in which the amounts so distributed were deposited. Their respective husbands were authorized to draw checks on these accounts, but up to the time of the hearing neither had done so.



The only question for our determination is whether partnerships, effective for income tax purposes, were in existence during 1941 among the petitioners and their respective wives with respect to Toledo Machinery Exchange Co. and L.W. Chuck Co.

The respondent has determined, and here contends, that the petitioners are taxable one-half each on the income of the two companies. He asserts that no bona fide partnerships existed among the petitioners and their wives, but that there was merely an attempt to redistribute the tax burden of the petitioners without any substantial change of control or present ownership of the property producing the income.

The petitioners contend that valid partnership agreements were entered into which must be recognized for Federal income tax purposes and that each of the parties thereto is taxable only upon one-fourth of the income.

Numerous cases involving so-called ‘family partnerships‘ have been decided by this and other courts in recent months (see, e.g., cases collected in Lewis Hall Singletary, infra). Such cases are not easy of disposition, for, although arrangements of this character are not to be stricken down merely because entered into among members of a close family group, they must be analyzed with particular care lest that close relationship be used as a device for circumventing the mandates of the revenue laws. As was said in Harry C. Fisher, 29 B.T.A. 1041; affd., 74 Fed.(2d) 1014:

Arrangements within families for the diversion of income, while not necessarily subject to condemnation because of the close relationship of the parties, are always subject to careful scrutiny, and clear and convincing evidence is required to establish their bona fides.

The facts in the instant cases are not seriously in dispute. From them we must determine the answer to the fundamental question involved in all cases of this character, namely, whether or not the petitioners and their respective wives were actually carrying on the businesses in partnership during 1941. See Lewis Hall Singletary, 5 T.C. 365.

First, with respect to Exchange, it is clear that no real business purpose was served by the formation of the alleged partnership with the wives. They brought no new capital into the business. It is admitted that they had no income of their own other than the amounts allegedly distributed to them as their shares of the profits. It was contemplated that the consideration for their alleged interests in the company should be paid out of the profits of the business. Furthermore, they performed no services. While it is true that occasionally Mrs. Arenson, and infrequently Mrs. Greenberg, attended to the office, this was not a result of their having been made members of the partnership. Both women had performed the same services prior to 1941 and had received no compensation therefor.

The petitioners contend that there was a definite business purpose in bringing Mrs. Arenson into the company. Arenson testified that Greenberg had involved the company in some deals it was unable properly to take care of and that generally he was becoming ‘too hot to handle.‘ Arenson hoped that his wife would exercise a restraining influence on Greenberg, who was her younger brother.

Such a purpose, however, stems directly from the family relationship rather than from any ordinary business motives. The record indicates quite clearly that Mrs. Arenson had made her influence felt before the creation of the alleged partnership. The petitioners testified that prior to 1941 Mrs. Arenson frequently took part in discussions relating to the business.

The petitioners do not contend that it was necessary or helpful to the operation of the business to make Mrs. Greenberg a member of the partnership. Greenberg testified that he insisted upon his wife being made a partner largely because of the fact that Mrs. Arenson was going to acquire an interest in the business.

The evidence further shows that it was not intended that the wives should have control over their alleged interests in the company or their shares in the profits. The agreement provided that the profits of the business could be withdrawn and distributed only at such times and in such manner as the petitioners should determine and agree. Funds could be withdrawn only by the petitioners or persons designated by them. Article IX of the agreement provided that neither Mrs. Greenberg nor Mrs. Arenson should ‘be entitled to exercise control of the management, or to determine questions of policy in the conduct, of the partnership, such control and determination being by this agreement expressly delegated‘ to the petitioners.

The petitioners ‘carefully guarded against any interest in the business passing into the hands of third parties.‘ Grant v. Commissioner, 150 Fed. (2d) 915. The agreement provided that in the event of the death of either Mrs. Arenson or Mrs. Greenberg the surviving husband had the right to purchase the interest of his deceased wife at a price not in excess of that which she had ‘paid‘ for her interest.

We may say also that we are by no means convinced that the income of Exchange was not a result primarily of the petitioners' personal services. Cf. Doll v. Commissioner, 149 Fed.(2d) 239. Arenson testified that at the end of 1940 the machinery business was ‘pretty brisk‘ and that ‘Mr. Greenberg produced about 98 per cent of it.‘ Yet the partnership agreement made no provisions for compensation for these personal services, a factor we deem significant.

In support of their contention that the partnership was valid and subsisting, the petitioners point out that ledger accounts were set up for each of the partners; that customers and creditors were notified of the change in status of the business; and that distributions were made to the wives.

It is of no moment that all the formalities were gone through. It has frequently been held that the fact that all the formalities under state law were complied with is immaterial in determining whether or not a partnership shall be accorded recognition for Federal income tax purposes. Doll v. Commissioner, supra; Bradshaw v. Commissioner, 150 Fed.(2d) 918; Lusthaus v. Commissioner, 149 Fed.(2d) 232; Miller v. Commissioner, 150 Fed.(2d) 823. In the last cited case, the court said: ‘ * * * the completeness with which the forms were observed is of no significance, for it is precisely what we should expect, if they were to be only forms.‘

The testimony with regard to the distributions to the wives is not wholly satisfactory. Neither of the wives was present at the hearing to testify as to amounts received by them. Furthermore, from the evidence in the record it clearly appears that such amounts as were distributed were not placed at their unfettered disposal. These amounts were, in each case, placed in the wife's checking account. Each of the petitioners, however, was authorized to draw on his wife's account without limit. He was thus able completely to exhaust the account and to use the sums so distributed for his own purposes.

The petitioners strongly urge that Greenberg can not be charged with more than one-fourth of the income from Exchange, since he never owned a greater interest in that company. This contention is stated in their brief as follows:

Up until the formation of the partnership on January 1, 1941, Greenberg never had any interest in the Toledo Machinery Exchange Company. On that date he acquired a quarter interest in the company. He never acquired more than this one-quarter interest. That his wife acquired a one-quarter interest is immaterial since she acquired it from petitioner Arenson in a completely arm's-length transaction. Her interest was one for which she paid. It was never owned or paid for in any manner by her husband.

This contention might be entitled to considerable weight if an arm's-length transaction were shown by the record. However, the facts fall far short of indicating such a transaction. It is admitted that the motive for the formation of the partnership was that Greenberg might acquire a proprietary interest in Exchange. Greenberg was dissatisfied with Arenson's original proposal, since he wanted more than a one-third interest. Greenberg testified that ‘I persisted that I wanted more than a third interest and finally, we concluded a partnership where I did get a fourth interest and my wife bought a fourth interest in the Toledo Machinery Exchange.‘ Arenson testified on the same matter that ‘Mr. Greenberg was dissatisfied. He didn't want a third. He wanted a half interest or if I was going to have my wife in, he wanted his wife in, which made it a four-way.‘

Manifestly, Mrs. Greenberg was admitted into the partnership for the sole reason that she was Greenberg's wife. For all practical purposes,she was essentially the nominee of her husband for one-half of his interest in the company. Under such circumstances, we think her interest was but a derivative interest, within the rationale of Burnet v. Leininger, 285 U.S. 136, and related cases.

What we have said with respect to the ownership of Exchange applies with equal force to Chuck. The partnership with the wives was formed ‘for the obvious, if not the sole, purpose‘ of avoiding income taxes. Cf. A. L. Lusthaus, 3 T.C. 540. The petitioners offer no reason for making their wives partners in this company except that it was necessary in view of the close relationship between the two companies in order to maintain an equal and proportionate division of interest of all parties with respect to the combined property, rights and affairs of the two companies. However, this would not appear to be an insuperable obstacle, since the record shows that prior to 1941 the companies were operated on different bases, Chuck being a partnership and Exchange a sole proprietorship.

Here, again, the wives brought no new capital into the business. Their alleged interests in the company were paid for in part out of profits and in part by ‘gift‘ from their respective husbands. They performed no services except occasionally to attend to the common office, as has been noted above. As in the case of Exchange, the petitioners retained all substantial economic ownership and control of the business and, therefore, we are of the opinion that the respondent correctly determined that each of the petitioners is properly taxable upon one-half of the income.

It follows that the respondent's determination must be sustained.

Reviewed by the Court.

Decisions will be entered for the respondent.

KERN, J., dissents.

BLACK, J., dissenting: It seems to me that the written partnership agreement entered into on January 27, 1941, amount petitioner William Arenson and his wife and L. W. Greenberg and his wife to transact business as a partnership under the name of Toledo Machinery Exchange Co. must be recognized for income tax purposes and taxes as the law provides for individuals carrying on business as partners.

The partnership agreement provides that it shall be retroactive to January 1, 1941. While that provision may be valid as between the parties, the tax effect of the partnership agreement would date from the date of the execution of the agreement and putting it into effect. But as I have already indicated, I think the business of Toledo Machinery Exchange Co. was operated as a partnership from the date of the signing of the partnership agreement and should have been so treated by the Commissioner in his determination of the deficiencies.

It is true that neither Mrs. Arenson nor Mrs. Greenberg contributed any services to the partnership, but they did contribute the share of capital assets which they each acquired by purchase in the giving of their promissory notes. These notes were subsequently paid in full, and the fact that they were paid in part out of profits received from the business and in part by gifts from their husbands, it seems to me, does not make any difference. The payments were legally made. One does not have to contribute services to be a member of a partnership. Many perfectly valid partnerships exist where one or more partners contribute no services at all, their contribution consisting of capital only. See vol. 6, sec. 35.03, Mertens Law of Federal Income Taxation. Cf. Montgomery v. Thomas, 146 Fed.(2d) 76.

As I have already stated, I think the facts show that a valid, legal partnership existed during most of the taxable year 1941 among the four persons named in the partnership agreement. Sections 181, 182, and 183 of the Internal Revenue Code prescribe how partnership income shall be taxed, and these provisions of the law afford no justification for the Commissioner to tax petitioners with the part of the partnership income which belonged to their wives.

It is true that the partnership agreement grants to the two active partners, Arenson and Greenberg, rather large powers of management and control of the partnership business, including the power to determine when partnership profits shall be withdrawn and distributed to the respective partners. See article VII of the partnership agreement. However, I do not think these provisions are so unusual in a partnership agreement as to invalidate it. On this point see Robert P. Scherer, 3 T.C. 776, at page 795, where we said:

* * * While it is true that under the terms of the partnership agreement Scherer, as managing partner, did exercise a large measure of control over the partnership business and had the sole discretion to determine whether the profits of the partnership of any particular year should be distributed to the respective partners or whether such profits should be retained in the partnership business, this discretion did not make him the owner of the shares of income which belonged to the other partners. Any income not distributed had to be credited to the capital accounts of the respective partners and accounted for as such in a final distribution of the partnership assets. * * *

We thereupon held that Scherer was not taxable on the profits which belonged to the other partners but was only taxable on the part which belonged to him. I think we should so hold in the instant case.

What I have said above with reference to the partnership operated as Toledo Machinery Exchange Co. applies with equal force, I think, to the partnership operated under the name of L.W. Chuck Co. There appears to be no essential differences in the two partnership agreements and the majority opinion does not make the point that there are any differences.

For the reasons I have given above, I respectfully record my dissent to the conclusion reached in the majority opinion.

LEECH and TYSON, JJ., agree with this dissent.