Comm'r of Internal Revenue (In re Estate of Koen)

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Tax Court of the United States.Jun 30, 1950
14 T.C. 1406 (U.S.T.C. 1950)

Docket Nos. 21370 21380.



Murray G. Smyth, Esq., and Felix T. Terry, C.P.A., for the petitioners. John P. Higgins, Esq., for the respondent.

In 1940, L. O. Koen and the partnership of Hamill & Smith entered into an agreement to exploit Koen's device known as ‘Airstyr.‘ Hamill & Smith was to advance certain funds and Koen was to manage the business. The advances were first to be paid out of profits, but if the venture was not successful Koen was to pay back to Hamill and Smith its advances. The business was abandoned in 1943, and Koen, under his guaranty, paid Hamill & Smith the sum of $20,000, which amount he claimed as a loss deduction in the taxable year 1943. Respondent disallowed the claim loss in part, on the theory that Koen and Hamil & Smith were operating the business as a partnership or joint venture. Held:

1. Koen and Hamill & Smith operated such business as a joint venture.

2. Respondent properly disallowed as a deduction in the taxable year 1943 that part of the payment of $20,000 attributable to expenditures incurred and paid in the operation of such joint venture in the prior years 1941 and 1942. Murray G. Smyth, Esq., and Felix T. Terry, C.P.A., for the petitioners. John P. Higgins, Esq., for the respondent.

These proceedings involve income tax deficiencies for the year 9143, as follows:

+---------------------+ ¦L. O. Koen ¦$1,815.81¦ +-----------+---------¦ ¦Irene Koen ¦1,815.81 ¦ +---------------------+

L. O. Koen died in 1949, and Irene Koen, as administratrix of his estate, was substituted as petitioner herein.

L. O. Koen and his wife, Irene Koen, deducted $20,000 as a community loss on their returns for the taxable year 1943. Respondent disallowed part of this loss. The correctness of that action presents the only issue.

The case was submitted on oral testimony and exhibits.


L. O. Koen and Irene Koen were husband and wife, and resided in Houston, Texas. They filed separate income tax returns for the period involved with the collector of internal revenue for the first district of Texas, at Austin, Texas, on a cash basis of accounting.

L. O. Koen had a patented steering device called ‘Airstyr‘ which he desired to exploit. He went to his friend, R. E. Smith, for financial assistance. Smith, on behalf of the partnership of Hamill & Smith, signed and informal memorandum in the form of a letter to Koen, who accepted and agreed to the conditions therein. The letter reads as follows:




NOVEMBER 12, 1940.


Houston, Texas.

DEAR SIR: This letter is to serve as an agreement between us, whereby we will enter into the purchase of the rights to, manufacture and sale of a device known as ‘Airstyr‘, which is a power steering unit for trucks, etc.

1. I will furnish $10,000.00 cash for the operation of this venture and will own a full one-half interest in it.

2. You will furnish, in lieu of cash W. K. M. Co. stock in the amount of $20,000.00, counting the value of this stock at $20.00 per share.

3. When the operation of this company, which may be considered as a joint venture until such time as we decide to incorporate, have (sic) progressed to such a point that the value of my half interest in the company is worth $10,000.00, then, and at that time, you may withdraw the 1000 shares of W.K.M. stock which you have pledged, and each of us will then own a full one-half interest in the assets and benefits of this company or venture.

4. We may elect, at any time, to form a corporation, and if this is done, equal amounts of stock comprising the capital stock of the company will be issued, one half to you, and one half to me.

5. This venture will be supervised by and operated by you, and you may require of me any necessary assistance, which will be furnished.

Yours very truly,

(S) R. E. Smith R. E. SMITH


(S) L. O. Koen


The terms, as contained in this letter, were modified, changed and supplemented by mutual oral agreements. The understanding was that if the venture was a success, the firm of Hamill & Smith was then to become the owner of a one-half interest and if unsuccessful Koen was to repay the partnership of Hamill & Smith the moneys it advanced to exploit the device. Koen was not to share in any was to have charge of the operations of the venture.

Koen, under the contract, deposited with Hamil & Smith 1,000 shares of the . WK.M. stock. Hamill & Smith advanced funds aggregating $20,000. The venture was unsuccessful. In 1943 it was mutually determined to abandon further operations. In that year Koen, pursuant to his guaranty, paid Hamill & Smith the sum of $20,000 and received property which had been used in the venture of the fair market value of $737.50.

For the period November 12, 1940, to September 30, 1941, and the fiscal year October 1, 1941, to September 30, 1942, partnership returns in the name of ‘The Airstyr Company‘ were prepared by Seth A. Lowther, an auditor employed by Hamill & Smith, and were signed by R. E. Smith, and filed. Losses were shown on these returns, half of which were allocated to the partnership of Hamill & Smith and the other half to Koen. Smith, at least presumably, claimed his proportionate share of such losses on his individual returns for 1941 and 1942. Koen claimed no part of the losses shown on such partnership returns on his individual income tax returns for such years.

On their separate returns for 1943, L. O. Koen and his wife, Irene Koen, claimed a community loss in the amount of $20,000, representing a guaranty payment to Hamill & Smith. In determining the deficiencies involved herein, the respondent restored to their community income the amount of $10,368.75, which was determined as follows:

+-----------------------------------------------------------------------------+ ¦Total amount paid ¦ ¦$20,000.00¦ +------------------------------------------------------+-----------+----------¦ ¦Less: Fair market value of equipment received ¦ ¦737.50 ¦ +------------------------------------------------------+-----------+----------¦ ¦Balance, loss sustained ¦ ¦$19,262.50¦ +------------------------------------------------------------------+----------¦ ¦Less: Your pro-rata share of operating losses for fiscal years ¦ ¦ ¦1941 ¦ ¦ +------------------------------------------------------------------+----------¦ ¦and 1942— ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦1941 ¦$4,058.09 ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦1942 ¦5,573.16 ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦ ¦ ¦9,631.25 ¦ +------------------------------------------------------+-----------+----------¦ ¦Allowable loss, 1943 ¦ ¦$9,631.25 ¦ +------------------------------------------------------+-----------+----------¦ ¦Loss claimed, 1943 ¦ ¦20,000.00 ¦ +------------------------------------------------------+-----------+----------¦ ¦Amount restored to taxable income ¦ ¦$10,368.75¦ +-----------------------------------------------------------------------------+

Koen and his wife, Irene, in 1943 sustained a community loss in the amount of $9,631.25.


LEECH, Judge:

The contested deficiencies result from the respondent's determination that Koen and the partnership of Hamill & Smith were partners or joint adventurers in the exploitation of the ‘Airstyr‘ device, and that the disallowed portion of the community loss claimed by petitioners in the taxable year, 1943, was sustained in the prior years, 1941 and 1942.

Section 3797 of the Internal Revenue Code defines a partnership as including a joint adventure.

Petitioners argue that the venture was abandoned prior to the time when the parties were to become equally interested as partners or joint adventurers in the business, and that Koen sustained no loss until he reimbursed Hamill & Smith for its advances, pursuant to his guaranty. The necessary premise of this position is that the business was the sole proprietorship of smith or Hamill & Smith until its abandonment.

The issue then is the legal relationship of the parties in the venture as evidenced by the agreement and their conduct in its execution. Koen died prior to hearing in this proceeding, and we do not have the benefit of his testimony. Smith was a witness on behalf of petitioners. Even if we adopt his testimony, however, as to the agreement he made with Koen, the circumstances leading up to that agreement, and the manner in which it was to be performed, including his statement to the effect that he had no intention of entering into a partnership with Koen, the legal status of the business as a joint venture is not contradicted.

A joint venture has been defined to be a ‘special combination of two or more persons where, in some specific venture, a profit is sought v. Commissioner, 97 Fed.(2d) 396; Joring v. Harriss, 292 Fed. 974; Aiken Mills v. United States, 144 Fed.(2d) 23. The written evidence, in the form of the letter, characterizes the business as a ‘joint venture.‘ The record as a whole convinces us that the parties intended to and did in fact conduct the business of exploiting the ‘airstyr‘ device as a joint venture.

The respondent has allowed the losses incurred in the operation of the joint venture in 1943, the taxable year. The losses incurred by that venture in the prior years, 1941 and 1942, were properly disallowed.

Respondent's determination as to each petitioner is, therefore, sustained.

Reviewed by the Court.

Decisions will be entered for the respondent.

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