Comm'r of Internal Revenue

Tax Court of the United States.Jun 17, 1946
7 T.C. 142 (U.S.T.C. 1946)
7 T.C. 142T.C.

Docket No. 4370.



Louis E. Burke, Esq., for the petitioner. A. J. Friedman, Esq., for the respondent.

1. Petitioner and Johnson were partners in the Johnson & Greene construction company. Petitioner had petitioner's wife and Johnson enter into a partnership agreement forming the Alliance Co. The Alliance Co. purchased and immediately leased to Johnson & Greene the exact construction equipment which Johnson & Greene needed to perform its construction contracts. Petitioner's wife contributed to the Alliance Co. no capital originating with her, nor did she perform any services for the Alliance Co. Held, petitioner was taxable under section 22(a) on the income of the Alliance Co. distributable to the wife in 1941.

2. In 1941 petitioner and his wife received rental income from property which they held in the State of Michigan as tenants by the entireties. Held, petitioner was taxable on only one-half of the rental income. Louis E. Burke, Esq., for the petitioner. A. J. Friedman, Esq., for the respondent.

Respondent has determined a deficiency in the income tax liability of petitioner for the calendar year 1941 in the amount of $19,869.04. Certain adjustments have been conceded. Two issues, however, remain for decision. One relates to the inclusion in petitioner's gross income of all the rents derived from real property owned in the names of petitioner and his wife. The other issue is whether petitioner, and not his wife, was taxable on one-half of the income of a partnership in which petitioner's wife and Hollis L. Johnson were the alleged partners.

Petitioner filed his return with the collector for the district of Michigan.


Issue 1.— Petitioner and his wife, Margaret C. Greene, were married in 1931. They have since continued to be, and have lived together as, husband and wife in Whitmore Lake, Michigan.

Petitioner's wife has suffered from tuberculosis since 1926. Petitioner himself has an arrested condition of tuberculosis. His wife, however, constantly has been under the care of a doctor and frequently has been confined to several hospitals and sanitariums. During the last three months of the taxable year 1941 here involved she was confined to a sanitarium. At the time of the hearing in May 1945 petitioner's wife was excused from answering the subpoena to appear and testify because of ill health.

During the period here involved petitioner and his wife each maintained a separate bank account in the State Savings Bank. Petitioner's account was entitled ‘Paul Greene or Margaret.‘ His wife's account was in the name of ‘Margaret C. Greene or Paul.‘ The accounts were opened in the joint names of petitioner and his wife only to give the right of survivorship to the surviving spouse in case of the death of the other. Petitioner had no interest in his wife's account while she was alive. She likewise had no interest in his while he remained alive. The bank treated each account as the separate account of petitioner and his wife, respectively.

Petitioner paid from his own account his personal expenses and certain expenses connected with the home, such as taxes, telephone bills, and other utilities. He also deposited in his wife's account various amounts throughout the year. The wife paid from her account during 1941 all the other household expenses, including food and merchandise, and the salaries of a housekeeper and a gardener, as well as her expenses at the sanitarium. Petitioner has never drawn on his wife's account.

In 1927 petitioner and Hollis L. Johnson formed a partnership to engage in the business of building and constructing highways, bridges, airports, and similar structures. The firm name of the partnership was Johnson & Greene. Petitioner was the so-called inside man of the firm. He obtained the new work, estimated on contracts, submitted bids, arranged finances, and attended to the other paper work and correspondence. Johnson, on the other hand, was the practical contractor, who supervised the actual construction work.

In 1940 Johnson & Greene derived gross income from its construction business in the amount of $346,852.05. The net ;income distributable to the partners was $80,908.43. In 1941 the gross income from the business was $402,084.21. The net amount distributable to the partners after adjustments by the Commissioner was approximately $60,000.

The central office of Johnson & Greene in 1941 was petitioner's home in Whitmore Lake. The firm, however, maintained a trailer as a working office, which it moved around from job to job.

During 1940 Johnson & Greene owned machinery and equipment consisting of graders, tractors, scrapers, trucks, and power shovels which were used in its business. In addition it rented other trucks and equipment for the approximate sum of $10,500. In 1941 Johnson & Greene paid about $72,500 as rental for equipment. More than $68,000 of this amount for equipment rental was paid to the Alliance Equipment Co., the income of which company gives rise to the present controversy.

In the latter part of 1940 and in the early part of 1941 Johnson & Greene submitted bids for several large construction jobs. By the early part of 1941 the firm had been awarded contracts for construction work at contract prices totaling well over $600,000. Petitioner conceived of the idea of having his wife and present partner, Johnson, form a new partnership for the purpose of having the new partnership buy and lease to Johnson & Greene, the machinery and equipment which Johnson & Greene needed to perform the construction contracts already obtained for the year 1941. Johnson & Greene at that time had an open line of credit in the amount of $100,000 with the State Savings Bank and there was no reason why Johnson & Greene, itself, could not have purchased the necessary equipment, other than petitioner's desire to have the new partnership formed for that purpose.

Thereafter petitioner consulted a certified public accountant concerning the organization of a partnership between petitioner's wife and Johnson. Neither Johnson nor petitioner's wife, the alleged partners, consulted the accountant. Subsequently the accountant prepared the 1941 income tax returns of petitioner, his wife, and the partnership which ultimately was formed between petitioner's wife and Johnson. The accountant's information was furnished solely by petitioner. The accountant, however, did not prepare the income tax returns of the firm of Johnson & Greene.

On April 3, 1941, petitioner's wife and Johnson entered into an agreement for the formation of a partnership which was to engage in the business of buying, selling, and leasing new and used road equipment. Johnson entered into the partnership agreement because petitioner thought it was a good idea for petitioner's wife to be in business. The name of the new partnership was ‘The Alliance Equipment Company,‘ hereinafter referred to as Alliance. The partnership agreement provided that petitioner's wife and Johnson were to own an equal interest in the partnership property and were to share profits and losses in equal proportions. It was also agreed that there should be an annual accounting of the business and that the partnership should continue until it was mutually terminated. At the time of termination, the assets were to be distributed in an equitable manner as mutually agreed upon. It was further provided that the funds of the partnership would be deposited in the State Savings Bank and that they could be withdrawn upon the signature of either partner or by such other person as the partners should jointly designate. Petitioner was so designated by the partners to have authority to withdraw the funds of Alliance from its bank account.

At the time of the formation of Alliance, Johnson and petitioner's wife each contributed $7,500 to the new venture. The wife borrowed from petitioner the $7,500 which she contributed to Alliance. For the loan from petitioner, the wife gave petitioner her noninterestbearing promissory note. The loan was repaid in 1942 by three installment payments of $2,500 each out of the profits of Alliance.

At the time of the formation of Alliance, petitioner ordered the equipment which Johnson & Greene needed to fulfill its contracts and which Alliance was to purchase and immediately lease to Johnson & Greene. As one of the financial arrangements relating to the purchase of this equipment by Alliance, petitioner and Johnson arranged for a loan of $55,000 from the State Savings Bank. Johnson signed the application for the loan for Alliance. Petitioner's wife entered into no negotiations with respect to the loan. The bank advanced Alliance $30,000 on May 2, 1941, and $25,000 on May 15, 1941. The loans were to be paid back within 90 days. Johnson executed the note which Alliance gave to the bank for the $55,000. Johnson & Greene, per petitioner, endorsed the note, Johnson & Greene then had an open line of credit with the bank to the extent of $100,000. The bank did not require a financial statement, security, or collateral from Alliance, nor did it investigate the credit standing of Alliance. It made the loan on the strength of Johnson's interest in Johnson & Greene and the endorsement of Alliance's note by Johnson & Greene. At the time of the negotiations for the loan, the equipment which petitioner had ordered was already enroute from the manufacturer.

The new equipment which Alliance purchased was received by Alliance some time prior to April 28, 1941, on which date Alliance leased to Johnson & Greene all of the equipment. This equipment consisted of tractors, scrapers, and generators. It cost Alliance $69,080.41. Although Alliance received only $15,000 from Johnson and petitioner's wife at its inception, and did not receive the $55,000 loan from the bank until May 2, and May 15, 1941, Alliance paid the manufacturer for this equipment $8,664.34 by a check dated April 23, 1941, $36,545.39 by a check dated April 30, 1941, and $23,270.68 by a check dated May 14, 1941. These three checks were Alliance's own checks and were signed by Johnson.

Alliance owned no property whatsoever except the above mentioned equipment. It had no office. It had no employees.

On April 28, 1941, Alliance leased to Johnson & Greene all the equipment which it had purchased. Petitioner and Johnson arranged the lease between themselves. Petitioner's wife was no consulted. Johnson signed the lease for Alliance, petitioner signed for Johnson & Greene. The equipment was used by Johnson & Greene on a 24-hour rate leasing schedule. Throughout the taxable year 1941 all of the equipment was leased to Johnson & Greene, with the exception of the rental to a third party of one tractor and scraper in the fall of 1941 at a rate of $1,615.13. Alliance charged Johnson & Greene rates approved by the Associated Equipment Dealers as limited by the O.P.A. maximum price regulations. For equipment which cost Alliance $69,080.41, Alliance received in 1941 in the form of rentals, $69,620.63, of which all but $1,615.13 came from Johnson & Greene.

In the middle of 1941 Alliance borrowed from Johnson & Greene approximately $21,500 in addition to the $55,000 borrowed from the bank. With the proceeds of the rents received and the money borrowed from Johnson & Greene, Alliance repaid its $55,000 loan, with interest, to the bank within the 90-day time limit. Petitioner's wife signed one of Alliance's 2 checks to the bank. Petitioner signed the other. By the end of 1941 Alliance repaid the $21,500 loan, with interest, to Johnson & Greene. Petitioner's wife also signed one of these checks.

Petitioner kept the books, signed checks, and arranged financial details for Alliance. Petitioner never received any compensation for services rendered to Alliance.

Alliance made no distribution of earnings to Johnson and petitioner's wife during the taxable year 1941. The first distribution received by petitioner's wife was made on January 10, 1942. During its existence Alliance distributed the total sum of $94,250 to petitioner's wife. Alliance discontinued active business at some time in 1944, when all of the equipment which it had purchased, except one or two generating plants, was sold. Until the equipment was sold, it had continuously been leased to and used by Johnson & Greene.

The money withdrawn by petitioner's wife from Alliance was either deposited in her account in the State Savings Bank or used by her to buy Government bonds and notes. On many of the Government bonds which petitioner's wife purchased, petitioner was designated the joint owner or given the right of survivorship on the death of the wife.

During 1941 petitioner deposited in his wife's account $1,300, from which, as mentioned previously, she paid many household and common expenses. From January 1 to May 25, 1942, petitioner deposited $800 in his wife's account. Thereafter he made no more personal deposits. After May 25, 1942, petitioner's wife used the money she withdrew from Alliance and deposited in her bank account to pay the household expenses and her income taxes, and to purchase investments and personal belongings.

Petitioner's wife never participated in any way in the business, management, or control of Alliance with the exception of signing two checks. The $7,500 she initially contributed to Alliance was loaned to her by petitioner for that express purpose and was repaid to petitioner by the wife out of the profits of Alliance.

Alliance fulfilled no business purpose other than an attempted reduction of petitioner's income tax liability.

Issue 2.— On March 3, 1941, the Valvoline Oil Co. conveyed to petitioner and his wife a certain lot of land, hereinafter referred to as the Texaco property. Title to the Texaco property was taken in the names of ‘Paul G. Greene and Margaret C. Greene, husband and wife.‘ Petitioner paid to the Valvoline Oil Co. out of his own funds the purchase price of $15,000. Petitioner subsequently improved the Texaco property at a cost of approximately $10,000. Petitioner's wife did not contribute any of her separate funds either to the cost of the property or to the cost of the improvements.

As of May 1, 1941, the Texaco property was leased to the Texas Co. for use as a gasoline service station at a monthly rental of $200. Petitioner and his wife, as husband and wife, executed this lease as lessors. Checks of the Texas Co. for the rent were drawn to the order of petitioner and his wife. Petitioner deposited these checks in his own bank account. During the year 1941 petitioner deposited the sum of $1,233.35 which was received as rents from the Texaco property. Petitioner intended to pay to his wife at the end of the year one-half of the rents received, but he had not done so by the end of the year 1941.

At the trial it was admitted that the amount of net rental income includible for income taxation purposes from the Texaco property was $862.31. Respondent has sought to tax petitioner on all of this $862.31.

During the taxable year 1941 petitioner and his wife owned the Texaco property as tenants by the entireties.


HARRON, Judge:

Issue 1.— The main question presented in this case is whether petitioner, and not his wife, was taxable in 1941 on one-half of the income of the Alliance Equipment Co. In name, petitioner was not a partner in Alliance. He and Hollis L. Johnson were partners in the construction firm of Johnson & Greene. But Johnson and petitioner's wife were the partners of record of Alliance. And petitioner himself conceived of the idea of organizing Alliance for the admitted purpose of purchasing and leasing to Johnson & Greene road construction equipment which Johnson & Greene needed to fulfill its construction contracts and which Johnson & Greene would have purchased itself had Alliance not been formed.

The net income distributable to petitioner from Johnson & Greene in 1941 was around $30,000. About the same amount was distributable to petitioner's wife in 1941 from Alliance. Johnson's share was, of course, derived in almost equal amounts of $30,000, each, from Alliance and Johnson & Greene. Since approximately 98 per cent of Alliance's 1941 gross income consisted of rents paid by Johnson & Greene for the leased equipment, the net effect for 1941 of the creation of Alliance was to allocate to petitioner's wife one-half of the income which petitioner otherwise would have received from Johnson & Greene.

There could be no doubt that if Johnson & Greene itself had purchased the road equipment and if petitioner merely had given his wife his own interest in the equipment, constituting her, as it were, a one-fourth partner in the firm of Johnson & Greene, the transaction would have been completely ineffective to relieve petitioner of the burden of paying income tax on one-half of the distributable income of Johnson & Greene. See Grant v. Commissioner, 150 Fed.(2d) 915. For, to carry the analogy further with the facts disclosed in this record, the wife would then have contributed no capital originating with her, would have contributed absolutely nothing to the management and control of the business, and would have performed no services whatsoever except the signing of two checks. The result would have been nothing more than the mere paper reallocation of income among the family members, ineffective to relieve from tax the person, in this case petitioner, who earned or created the income. Commissioner v. Tower, 327 U.S. 280.

But petitioner did not form the traditional family partnership with his wife. He conceived of the idea of forming and did form a new and allegedly separate partnership. Instead of petitioner being a partner with his wife, he had Johnson, his partner in the construction firm, become his wife's partner in the new firm. It mattered not to Johnson that he had to go through the motion of forming a new partnership with petitioner's wife, since Johnson would have been taxable on exactly the same amount of income whether he received it only from Johnson & Greene or in approximately equal shares from both Johnson & Greene and Alliance. But, for tax purposes, it mattered to petitioner. The new partnership was to engage in an activity which was an essential factor and working part of the business of Johnson & Greene. It was to purchase the exact road construction equipment which Johnson & Greene needed to fulfill its construction contracts and to immediately lease it for that purpose to Johnson & Greene. The financial details for the purchase were arranged on the credit and security of Johnson & Greene. In fact, it is difficult to see the financial purpose of the bank loan to Alliance, since Alliance paid for the equipment by checks dated prior to the time the bank deposited the loan in Alliance's bank account. The checks must have been issued, therefore, with only the financial backing of Johnson & Greene. A new business entity was thus set up, having as its partners petitioner's partner and petitioner's wife, and organized to perform an essential function which Johnson & Greene could have performed itself had it so wished. The new business had no office. It had no employees. it had nothing but the equipment which it purchased and immediately leased to Johnson & Greene. Whatever work was required petitioner thereafter performed. His wife was completely incapacitated with tuberculosis and was confined to a sanitarium during the last three months of the taxable year 1941. There is a suggestion in the record that petitioner was unable adequately to provide for the security of his wife by life insurance on his own life, since he too suffered from an arrested condition of tuberculosis, and that, therefore, he wished to establish a separate estate for the wife in the form of an interest in a nonhazardous business. But Alliance's business success was completely dependent upon Johnson & Greene. If Johnson & Greene was a hazardous business, as petitioner stated, so was Alliance. Moreover, Alliance is no longer in active existence. It sold all of its equipment in 1944. Instead of receiving an interest in a nonhazardous business, the wife really received cash as distributions from Alliance in the amount of $94,250, a sum which taxpayer himself periodically could have given her. She purchased with some of this money Government bonds and notes, of many of which taxpayer is the joint owner or has the right of survivorship, and has made investments identical with the kind she would have had the opportunity of making had taxpayer made periodic gifts of cash to her equal to the distributions she received from Alliance. Prior to the time Alliance made distributions of its earnings to the wife, petitioner deposited in her account $1,300 in 1941 and $800 in the first part of 1942. She extensively drew upon her account for household expenses, personal expenses, and expenses of her illness. After Alliance began to distribute its earnings to the wife, petitioner made no more personal deposits in his wife's account. She used in exactly the same way as the money which petitioner had been accustomed to give her, the distributions which she received from Alliance, expending them for household expenses and other expenses of the type which petitioner previously had paid for before Alliance was formed. Under these circumstances, can the form which the transaction took— the separate partnership as distinguished from the typical family partnership— change the legal consequences of the economic situation as it actually existed and render petitioner immune from the tax which he would have had to pay had Alliance not been formed?

It is axiomatic that the reach of the income tax law is not to be circumscribed by refinements of legal title. The rule finds expression in the oft repeated admonitions that taxation is an intensely practical matter, concerned with economic realities; that tax consequences flow from the substance of a transaction rather than from its form; and that command over property or enjoyment of its economic benefits marks the real owner for income tax purposes. Commissioner v. Court Holding Co., 324 U.S. 331; Helvering v. Clifford, 309 U.S. 331; Gregory v. Helvering, 293 U.S. 465; Corliss v. Bowers, 281 U.S. 376. A familiar corollary to these principals is the one that an anticipatory assignment of income, however skillfully devised, is ineffective to relieve the donor of tax liability. Harrison v. Schaffner, 312 U.S. 579; Helvering v. Horst, 311 U.S. 112; Burnet v. Leininger, 285 U.S. 136; Lucas v. Earl, 281 U.S. 111. Accordingly, mere passage of title to income-producing property through devices which are valid under state law will not relieve the transferor from tax on the future income unless the passage of legal title is accompanied by a complete shift of economic benefits of ownership, direct and indirect. Helvering v. Clifford, supra. Thus the transferor may remain liable for tax on income even though title to the property from which it has been derived or to the income itself has ‘vested‘ in another under state law. Lucas v. Earl, supra; Commissioner v. Harmon, 323 U.S. 44. And where, as in the present case, an intra family transition is involved, ‘special scrutiny of the arrangement is necessary lest what is in reality but one economic unit be multiplied into two or more by devices which, though valid under state law, are not conclusive so far as section 22(1) is concerned.‘ Helvering v. Clifford, supra, p. 335.

Family partnership arrangements are not immune from the operation of these basic principles. Commissioner v. Tower, supra. Although a partnership agreement may be valid under state law, the arrangement is without tax significance if in substance and practical effect it amounts to an attempted reallocation of the taxpayer's income. Earp v. Jones, 131 Fed.(2d) 292; Grant v. Commissioner, supra. It is immaterial in this connection whether the business income sought to be reallocated is derived from the taxpayer's personal services, from capital of which he remains the substantial owner, or from a combination of both sources. Commissioner v. Tower, supra; Lusthaus v. Commissioner, 327 U.S. 293.

The application of these fundamental principles sometimes requires that the independent existence of legally created business entities be disregarded for income tax purposes where they serve merely to shift tax liability. Gregory v. Helvering, supra: Griffith v. Commissioner, 308 U.S. 355; Higgins v. Smith, 308 U.S. 473; Commissioner v. Tower, supra. As the Supreme Court stated in Higgins v. Smith, supra, pp. 477-478:

* * * The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statute. To hold otherwise would permit the schemes of taxpayers to supersede legislation in the determination of the time and manner of taxation. It is command of income and its benefits which marks the real owner of property.

And it makes no difference that such command ‘may be exercised through specific retention of legal title or the creation of a new equitable but controlled interest or the maintenance of effective benefit through the interposition of a subservient agency.‘ Griffith v. Helvering, supra.

It is, of course, true that a husband and wife may for tax purposes, as well as for other purposes, enter into a valid and effective partnership arrangement. Commissioner v. Tower, supra. But a husband can not, as petitioner attempted to do here, effectuate a severance of the normal functions of a going business and divide single tax earnings into two units by the simple expedient of drawing up papers. Thus, we have specifically recognized that such paper reallocation is totally ineffective to relieve the husband from the tax, even where the deflection of income is cast in the form of a separate business entity of which the husband nominally is not a member. Wade Allen, 6 T.C. 899; Robert E. Werner, 7 T.C. 39. With the wife contributing neither separate capital nor services, petitioner could not have made her a member of the partnership of Johnson & Greene for tax purposes. Nor, under the circumstances present here, could he exalt artifice and achieve the same result by the creation of any empty, though nominally separate, appendage to Johnson & Greene. ‘A given result at the end of a straight road,‘ as the Supreme Court said in Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613, ‘is not made a different result because reached by following a devious path.‘ In accordance with the language used in the Griffith case, petitioner exercised his command over the income-producing road construction equipment of Alliance through the ‘creation of a new equitable but controlled interest or * * * the interposition of a subservient agency.‘ And we are empowered to disregard such a creation for tax purposes. Gregory v. Helvering, supra; Griffith v. Helvering, supra; Higgins v. Smith, supra.

Petitioner's wife was allowed to enter Alliance only by the grace of petitioner. She received the income for no other reason. Alliance was nothing more than petitioner's anticipatory device to allocate to his wife his income for tax purposes.

We hold, therefore, that petitioner's wife and Johnson did not intend to, nor did they, carry on the business of Alliance as a partnership to be recognized for income taxation purposes. The income of Alliance distributable to the wife in 1941 was created and earned by petitioner and on him the tax must fall.

Issue 2.— The question presented under issue 2 is whether petitioner was taxable on all of the net rental income derived from the Texaco property during the taxable year 1941. The property had been purchased with funds which belonged to petitioner alone. He also expended considerable sums of his own money in improving the property. Petitioner's wife did not contribute any of her separate funds either for the purchase of the property or for the improvements erected thereon. However, the deed of conveyance of the property by the grantor was made to petitioner and his wife as husband and wife.

In Michigan the common law rule that a conveyance to a husband and wife creates a tenancy by the entirety has persisted. Commissioner v. Hart, 76 Fed.(2d) 864. It is immaterial that the consideration for the conveyance of the property comes from one of the spouses alone. In the present case the grantor expressly conveyed the Texaco property to petitioner and his wife as husband and wife. Petitioner and his wife, as husband and wife, executed the lease of the property to the Texas Co. The checks for the rent were drawn to the order of petitioner and his wife. We hold, therefore, that petitioner and his wife owned the Texaco property during the taxable year 1941 as tenants by the entireties.

It is well settled that, where property from which income is derived is owned by husband and wife in the State of Michigan as tenants by the entireties, one-half of the income is taxable to each of them. Commissioner v. Hart, supra; Herman Gessner, 32 B.T.A. 1258; G.C.M. 19143, 1937-2 C.B. 223. If an actual tenancy by the entirety exists in the property from which income is derived, it is immaterial, for purposes of taxing the income equally to the husband and wife, that the income is received by one of the spouses alone. See Harrison v. Schaffner, supra.

At the hearing there was some question whether petitioner would press his claim that only one-half of the net rents received from the Texaco property was taxable to him alone. Respondent, therefore, did not discuss the issue on brief, but stated merely that he would endeavor to meet whatever contentions petitioner would make on this issue by way of reply brief. Petitioner, in his brief, has, and we think rightfully so, advanced the argument that only one-half of the rental income from the Texaco property was taxable to him. Respondent has not filed a reply brief. It would seem, therefore, that respondent intends to admit the merit of petitioner's contention.

We hold that petitioner is taxable on only one-half of the net rentals derived from the Texaco property during the year 1941.

Decision will be entered under Rule 50.