Comm'r of Internal Revenue

Tax Court of the United States.May 8, 1944
3 T.C. 746 (U.S.T.C. 1944)
3 T.C. 746T.C.

Docket No. 879.



Marion A. Ross, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent.

Under the facts a marital partnership between husband and wife is not recognized for income tax purposes. Marion A. Ross, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent.

Respondent has determined a deficiency in income tax for the calendar year 1940 in the mount of $2,114.34. Some of respondent's additions to income are not contested. The only question is whether all of the income of a business is taxable to petitioner. Petitioner contends that one-half of the income is taxable to his wife.

Petitioner resides in Columbus, Ohio, and filed his return for the taxable year with the collector for the eleventh district of Ohio.


Petitioner married Isabel M. Lorenz in June of 1927. They have six children, whose ages range from 4 to 15 years. Isabel Lorenz is a devoted wife and mother. During the taxable year and since her marriage her duties in the home have occupied substantially all of her time. She was graduated from high school in 1925 at the age of 17 years. While she was in school and until she was married she held positions in the offices of various business concerns, doing filing, typing, simple bookkeeping, and attending the cash register. During one brief period she played the piano at the Ohio State Fair. Prior to 1940 she did not render any services in her husband's business. During 1940 she did most of the housework, cleaning, and cooking. She hired someone to help her two days a week. At the beginning of 1940 she had a savings account in which there was a balance of $140. She did not own any securities and she had no other cash. The title to the home in which petitioner and his wife live is held in both their names jointly. At the beginning of 1940 the entire purchase price of the home was not yet paid. On January 10, 1940, petitioner entered into a partnership agreement with his wife, the terms of which are set forth hereinafter, under which she was made a partner in a business known as the Lorenz Equipment Co. Isabel Lorenz knew very little about the ‘business end‘ of that company. She went to the office of the company two days a week, on her ‘days off‘ from her household duties, and sat with the bookkeeper. He permitted her to total columns of figures. She was interested in learning how to make entries in the books and do bookkeeping. Her knowledge of bookkeeping was insufficient for her to keep the books. Also, she took phone calls at home relating to the business which came in after office hours and reported them later to petitioner, or to someone at the office the next day.

From 1927 until 1933 petitioner was employed as bookkeeper, stenographer, and finally as a salesman by the Consolidated Equipment Co. in Cincinnati, Ohio. He sold construction equipment and industrial machinery, such as concrete mixers, air compressors, steam shovels, hoists, pumps, and similar machinery. The buyers were contractors, public utility companies, and business concerns. In 1933 Consolidated became bankrupt. Thereafter, petitioner took office space and started in a modest way in business for himself as an authorized distributor for manufacturers of machinery and equipment of the type described above. He sold to customers from catalogues and the manufacturers made deliveries direct to the purchasers. He was paid a commission on his sales. Petitioner conducted his business under the name of Lorenz Equipment Co. as a sole proprietorship.

At some time during the year 1937 the above business was incorporated by petitioner and Verne Wheeler under the name of Lorenz-Wheeler Corporation. Petitioner and Wheeler each owned 50 percent of the stock. Petitioner's wife did not receive any stock or any interest in the business. In the early part of 1939 Wheeler withdrew from the business and the corporation was dissolved. Thereafter, the business was again conducted by petitioner as a sole proprietorship.

The balance sheet of the Lorenz Equipment Co. as of December 31, 1939, was as follows:

+--------------------------------------------------+ ¦ASSETS ¦ +--------------------------------------------------¦ ¦Current assets: ¦ ¦ ¦ +------------------------------+---------+---------¦ ¦Cash ¦$3,599.14¦ ¦ +------------------------------+---------+---------¦ ¦Certified check-deposit on bid¦1,000.00 ¦ ¦ +------------------------------+---------+---------¦ ¦Accounts receivable ¦8,399.86 ¦ ¦ +------------------------------+---------+---------¦ ¦Notes receivable ¦5,873.81 ¦ ¦ +------------------------------+---------+---------¦ ¦L.G. Gaty ¦105.00 ¦ ¦ +------------------------------+---------+---------¦ ¦Sales tax stamps ¦46.98 ¦ ¦ +------------------------------+---------+---------¦ ¦Merchandise inventory: ¦ ¦ ¦ +------------------------------+---------+---------¦ ¦Sullivan parts ¦$2,707.77¦ ¦ +------------------------------+---------+---------¦ ¦Miscellaneous parts ¦2,107.65 ¦ ¦ +------------------------------+---------+---------¦ ¦Allis-Chalmers parts ¦1,189.67 ¦ ¦ +------------------------------+---------+---------¦ ¦New machinery ¦7,053.61 ¦ ¦ +------------------------------+---------+---------¦ ¦Used machinery ¦3,750.25 ¦ ¦ +------------------------------+---------+---------¦ ¦ ¦ ¦16,808.95¦ +------------------------------+---------+---------¦ ¦Rental machinery ¦ ¦7,060.54 ¦ +------------------------------+---------+---------¦ ¦Total current assets ¦ ¦42,894.28¦ +------------------------------+---------+---------¦ ¦Fixed assets: ¦ ¦ ¦ +------------------------------+---------+---------¦ ¦Furniture and fixtures ¦1,692.30 ¦ ¦ +------------------------------+---------+---------¦ ¦Less reserve for depreciation ¦340.16 ¦ ¦ +------------------------------+---------+---------¦ ¦ ¦ ¦1,352.14 ¦ +------------------------------+---------+---------¦ ¦Truck ¦535.20 ¦ ¦ +------------------------------+---------+---------¦ ¦Less reserve for depreciation ¦401.40 ¦ ¦ +------------------------------+---------+---------¦ ¦ ¦ ¦133.80 ¦ +------------------------------+---------+---------¦ ¦Total assets ¦ ¦44,380.22¦ +--------------------------------------------------+

LIABILITIES Current liabilities: Accounts payable $4,968.15 Notes payable 349.87 Notes payable 1,556.10 Deferred rental income 850.00 Total liabilities 7,724.12 Investment account: Frank J. Lorenz-capital 36,656.10 Total liabilities and capital 44,380.22

In January of 1940 petitioner told his wife that he wanted to make her a gift of a 50 percent interest in the tangible assets of the Lorenz Equipment Co. The audit of the books for the year 1939 had not been completed and so petitioner made an estimate of the value of the 50 percent interest which he desired to give his wife, and he placed a value of $20,000 upon such interest. There was no written instrument of gift or assignment of an interest in the business. Petitioner filed a gift tax return reporting that he made a gift in January 1940 of an interest in the Lorenz Equipment Co. of a value of $20,000 at the date of gift. Until the alleged gift of an interest in the business was made, Isabel Lorenz did not own any interest in the business. Petitioner did not consider that she did.

On January 10, 1940, articles of copartnership between petitioner and his wife were executed by them. The agreement recited that petitioner and his wife owned a one-half interest each in the assets of the business and that they contributed all of said interests to the capital of the partnership. The agreement recited that the business would be carried on under the name of ‘The Lorenz Equipment Company,‘ as a partnership, effective as of January 1, 1940; that petitioner would devote his entire time to the business and that Isabel Lorenz would be required to devote only her available time to the business; that either party could make contracts on behalf of the partnership business and could employ and discharge employees; that profits and losses should be shared equally between the partners; that complete books of account should be kept, but that the keeping of the books should be under the supervision of petitioner; that petitioner should have a drawing account and that the drawing account should be charged to the capital account of each partner, equally; that profits should be divided at the end of each year; that upon a termination of the partnership the assets should be appraised and the partnership dissolved in accordance with law.

The partnership agreement was not filed in any public office. Petitioner orally informed a bank and several others that his wife was a partner in the business.

On the books of the Lorenz Equipment Co. there was a capital account in the name of petitioner. After the partnership agreement was executed and as of January 1, 1940, a capital account was opened in the name of Isabel Lorenz, and entries were made debiting petitioner's account $20,000 and crediting the wife's account $20,000.

On the books of the company there was a drawing account in the name of petitioner. No drawing account was opened in the name of petitioner's wife.

During 1940, according to the books, petitioner withdrew cash in the total amount of $9,391.11. Petitioner was not paid any salary, as such. He withdrew from the business what he needed. Petitioner's wife did not withdraw any sum. At the end of the year, however, the capital account of the wife was debited $4,690.55 with the explanation, ‘To charge money withdrawn in 1940‘; and the capital account of petitioner was debited $4,690.56, with the same explanation.

The net profit of the business for the year 1940 was $24,506.04. At the end of 1940 the capital account of petitioner was credited with $12,253.02, profit for 1940, and the capital account of the wife was credited with $12,253.02, profit for 1940. None of the profit was distributed to the wife. One-half of the net profit for 1940 was reported by petitioner, and one-half was reported by his wife in their separate income tax returns for 1940.

Petitioner's actual withdrawals from the business in 1940 totaled $9,358.46. The book figures reflecting withdrawal contained an error of about $20. He used the withdrawals in the following way:

+-----------------------------------------------------------------+ ¦Attorney's fees ¦$425.00 ¦ +--------------------------------------------------------+--------¦ ¦Payment on note of petitioner for purchase of automobile¦697.79 ¦ +--------------------------------------------------------+--------¦ ¦Repair to a driveway at home ¦96.00 ¦ +--------------------------------------------------------+--------¦ ¦Income tax ¦874.94 ¦ +--------------------------------------------------------+--------¦ ¦Premiums on life insurance, Isabel Lorenz beneficiary ¦3,379.73¦ +--------------------------------------------------------+--------¦ ¦Cash items ¦3,885.00¦ +--------------------------------------------------------+--------¦ ¦Total ¦9,358.46¦ +-----------------------------------------------------------------+

Out of the ‘cash items‘ totaling $3,885, petitioner gave his wife $720. The balance of the cash was deposited by petitioner in his own checking account. He paid the current household bills by his personal checks. He gave his wife about $30 a week cash to cover household expenses, which was in addition to the $720.

During 1940 there were 8 persons employed in the Lorenz Equipment Co.— 3 salesmen, 3 servicemen, and 2 office employees. Petitioner has at all times been the general manager of the business and the principal salesman. During 1940 the gross profit of the business was $55,059.10, which was derived as follows: Profit on sales, $37,322.80; commission on direct sales, $3,480.50; rental machinery income, $13,647.09; shop income, $608.71.

After the partnership arrangement was made, there was no charge in the conduct of the business, and petitioner continued to operate the business in exactly the same way as before.

Petitioner has always discussed his business affairs with his wife, and she has always assisted him by taking telephone calls at home and keeping him advised of such messages. Petitioner's wife has always been a thrifty help meet in domestic affairs. The partnership arrangement resulted in no change in the wifely assistance which petitioner's wife gave him.

In determining the deficiency respondent held that no bona fide partnership for income tax purposes existed between petitioner and his wife, and that, consequently, the entire distributable income of the Lorenz Equipment Co. was taxable to petitioner. The notice of deficiency was mailed on December 7, 1942. The petition to this Court was filed on March 2, 1943.

On February 20, 1943, petitioner's wife commenced an action in the Court of Common Pleas of Franklin County, Ohio, for a declaratory judgment that the partnership between herself and petitioner was bona fide and that in the taxable year she was entitled to share in one-half of the profits of the partnership. At the trial of the action petitioner did not deny that there was a bona fide partnership between himself and his wife, and the court thereupon entered judgment in favor of petitioner's wife. In that action there was no real controversy between petitioner and his wife.


HARRON, Judge:

Partnerships between husband and wife in the conduct of a business which has been conducted previously by the husband as a sole proprietorship must be scrutinized closely with a view to determining whether the partnership is bona fide and is a partnership within the provisions of the revenue act applying to the taxation of partnership income. A partnership itself is not taxable, and the ‘Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.‘ Sec. 181, Internal Revenue Code. The statute contemplates that members of a partnership ‘carry on‘ a business. To support the claim that a husband and wife are taxable as partners upon the profits of a business, ‘there must be more than the husband's mere self-serving statement that a partnership existed or was intended to exist. See James L. Robertson, 20 B.T.A. 112. There must be credible evidence of acts, facts, and circumstances demonstrating the alleged partner's actual participation in the business and assumption of its responsibilities to those with whom the business is transacted. While husband and wife and other members of a family may be recognized as eligible to conduct themselves as a partnership, it is not lightly to be assumed or established that they do.‘ W. M. Buchanan, 20 B.T.A. 210.

Whether or not a husband and wife carry on a business so as to be taxable individually upon the profits thereof presents a problem of fact, and each case stands upon its particular facts. In some instances we have held that the spouses were carrying on a business as partners. See Walter M. Moyer, 35 B.T.A. 1155, where the evidence that the wife exercised ownership over an interest in a business which the husband gave her supported the contention that the wife owned an interest in the business. In other instances, we have not recognized the spouses as partners. See Thomas M. McIntyre, 37 B.T.A. 812; Harold G. Parker, 39 B.T.A. 423; Francis Doll, 2 T.C. 276.

We have said that ‘One of the essential elements of a partnership is the contribution by each member of either property or services.‘ Thomas M. McIntyre, supra. See Meehan v. Valentine, 145 U.S. 611. In this case, the wife contributed no services and she, admittedly, knew nothing about the ‘business-end of the business,‘ as she described the point. Her wifely interest in her husband's business as demonstrated by taking telephone messages at home is not sufficient to meet the statutory reference to ‘carrying on a business.‘ See Penziner v. United States,— Fed. Supp.— U.S. Dist. Ct., N. Dist. Calif., S.D., Jan. 25, 1944. There remains the question whether or not she contributed capital or property to the business.

Petitioner's wife had no property of her own except a savings account containing $140. Her alleged contribution of property to the business is out of the alleged gift to her by petitioner of a one-half interest in the business which was made simultaneously with the creation of the alleged partnership. The essential elements of a bona fide gift are: (1) A donor competent to make the gift; (2) a donee capable of taking the gift; (3) a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti; (4) the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor can exercise no further act of dominion or control over it; (5) a delivery by the donor to the donee of the subject of the gift or of the most effectual means of commanding the dominion of it; (6) acceptance of the gift by the donee. Edson v. Lucas, 40 Fed.(2d) 398, and authorities there cited.

Petitioner did not divest himself of the chief attribute of ownership of interests in property, namely, control over income. Taxation, a practical matter, is more concerned with the command of a taxpayer over income than with considerations of technical transfers of title. Corliss v. Bowers, 281 U.S. 376; Burnet v. Wells, 289 U.S. 670. We have held that a transfer of all of the interest in the contract, productive of income, by a husband to his wife was ineffective to relive him from tax upon the income produced, where he received the payments and used a large portion of them to discharge his personal obligations and also gave his advice and consent regarding the investment of other portions. See John S. Gullborg, 5 B.T.A. 628.

Here, under the partnership agreement, petitioner alone was to have a drawing account. His wife had none. Petitioner was to devote his entire time to the business, but no provision was made to pay him a salary. Presumably, his salary was to be covered, to some extent at least, by his withdrawals each month. But one-half of his withdrawals was to be charged against the wife's capital account. Thus, at the end of the year the half of net profits credited to the wife's capital accounts would be reduced in fact by the total charges to that account for petitioner's withdrawals during the year. If his withdrawals were only for salary, the effect of this arrangement would be to determine net profits allocable to each partner. But there was no limitation upon the amount of petitioner's withdrawals each year, nor upon the purposes for which he could withdraw funds. Petitioner had the power to withdraw the profits of the business each month, if he so decided, so that at the end of the year the total charges against the wife's capital account for one-half of his withdrawals would offset the credit at the end of the year for one-half of the profits. We notice that the amount of petitioner's withdrawals was to be agreed upon by petitioner and his wife, but we have no evidence to show that petitioner's wife would be fortified against petitioner's will in the matter of deciding upon the amounts of his withdrawals. The partnership agreement itself provides no restraint upon petitioner's demands, and in the intimate family relationship it is to be presumed that the wife would acquiesce in petitioner's demands, rather than otherwise.

What was actually done during the taxable year is important. No payments were made to petitioner's wife, as a partner, of any of the profits. All withdrawals were made by petitioner and were deposited in his own bank account. Petitioner drew out $9,358, of which $3,379 was used to pay premiums on his life insurance. Petitioner's use of the withdrawals is set forth in the facts and need not be repeated. Out of cash to cover general expenses, in the amount of $3,885, the wife received $720, but just what use she made of that sum is not shown. Petitioner gave his wife $30 a week, or about $1,500 during the year, to cover cash household expenses. He paid other household expenses by checks drawn on his own account. Substantially all of the amount which petitioner withdrew during the taxable year was used to pay his personal obligations, including his obligation to support his family and pay the premiums on his insurance. See Douglas v. Willcuts, 296 U.S. 1. Under such facts, the credit to the wife's account at the end of the year of one-half of the net profits of the business was not a true allocation to her of one-half of the profits, free from petitioner's dominion and control. See Mead v. Commissioner, 131 Fed.(2d) 323; certiorari denied, 318 U.S. 777, where the husband-partner had complete control over withdrawals from the business and gave his wife money to cover household expenses out of his withdrawals. There it was concluded that the wife received a portion of the profits, not as a partner, but only by reason of her marital relationship. While other factors, in addition to the husband's control over the income of the business, in the Mead case probably contributed to the above conclusion, we have in this case a close similarity with respect to the one factor, namely, the control over income. There can not be any doubt, under the facts in this case, that the wife of petitioner received only a small portion of the profits of the business, and that what she did receive came to her by virtue of the marital relationship. See also, H. S. Richardson, 42 B.T.A. 830, 839; affd., 121 Fed.(2d) 1, which does not involve a marital partnership, but discusses the element of control by the husband.

The facts here do not show that petitioner's wife exercised any control over the subject matter of petitioner's alleged gift to her, and, upon the facts, this case is distinguishable from Walter W. Moyer, supra.

It is concluded that petitioner did not make a bona fide gift of a one-half interest in the business of the Lorenz Equipment Co. because of his failure to divest himself of all of the economic incidents of ownership thereof. Francis E. Tower, 3 T.C. 396. Under all of the facts, the various bookkeeping entries are not controlling. Sitterding v. Commissioner, 80 Fed.(2d) 939. It follows that petitioner's wife did not make any actual contribution to the capital of the partnership.

From the evidence before us, we are unable to conclude that the business in question was conducted as a partnership, whether or not the arrangement constituted a valid partnership under Ohio law. Nor are we precluded from considering and deciding the question presented by the decree entered by the Common Pleas Court of Franklin County, Ohio. See Francis Doll, supra.

Respondent's determination is sustained.

Reviewed by the Court.

Decision will be entered for the respondent.

VAN FOSSAN, J., dissents.

BLACK, J., dissenting: The general facts in these proceedings do not appear to be in dispute. Based on the general findings of fact which the majority has made, I would find as ultimate facts at the conclusion of these general findings as follows:

Petitioner Frank J. Lorenz in January of 1940 made a gift of a 50 per cent interest in the business which he was at that time conducting as a sole proprietorship under the name of Lorenz Equipment Co. to his wife, Isabel M. Lorenz. On January 10, 1940, the petitioner formed a valid, legal partnership with his wife, Isabel M. Lorenz, to carry on the business of ‘The Lorenz Equipment Company‘ as a partnership. Petitioner contributed, as his one-half share of the capital of the partnership, the one-half interest which he had retained and Isabel M. Lorenz contributed, as her share of the partnership capital, the one-half interest which had been given to her by her husband. The earnings of the partnership thereafter allocable to the respective partners under the terms of the partnership agreement were the income of the respective partners to whom allocable.

This being my construction of what the facts show, it of course follows that I do not agree with the conclusions reached in the majority opinion, which are typified by the concluding part of the opinion, reading in part as follows:

It is concluded that petitioner did not make a bona fide gift of a one-half interest in the business of the Lorenz Equipment Company because of his failure to divest himself of all of the economic incidents of ownership thereof. Francis E. Tower, 3 T.C. 396. Under all of the facts, the various bookkeeping entries are not controlling. Sitterding v. Commissioner, 80 Fed. (2d)939. It follows that petitioner's wife did not make an actual contribution to the capital of the partnership.

There is a well settled line of cases holding that a husband engaged in a mercantile or manufacturing business can make his wife a partner in the business by making a bona fide gift to his wife of an interest in the business and then entering into a partnership agreement with the wife, she giving as her contribution to the capital of the partnership the interest given to her by her husband. Some of these cases are Richard H. Oakley, 24 B.T.A. 1082; Kell v. Commissioner, 88 Fed. (2d)453; Rose v. Commissioner, 65 Fed.(2d) 616; Jasper Sipes, 31 B.T.A. 709; Walter W. Moyer, 35 B.T.A. 1155. In the Moyer case we said:

* * * The question to be determined, therefore, is whether the petitioner actually made a gift to his wife of an interest in the business in the amount of $100,000. If he did make a gift to his wife, she made a contribution to the business and hence had an interest in the partnership. * * *

As I have already stated, I think the evidence shows that in the instant case the petitioner did make a bona fide gift to his wife of an interest in the business and a legal, valid partnership was formed. Therefore, I think the line of cases which I have cited above controls. Clearly the instant proceeding is distinguishable from that line of cases holding that a husband whose earnings are from personal services such as fees from medical practice, attorney fees, accounting fees, insurance commissions, or engineering fees may not make his wife a partner and have his personal service earnings taxed as partnership income. Among such cases are Mead v. Commissioner, 131 Fed. (2d) 323; Schroder v. Commissioner, 134 Fed.(2d) 346, Earp v. Jones, 131 Fed. (2d) 292; Tinkoff v. Commissioner, 120 Fed.(2d) 564, affirming Board of Tax Appeals memorandum opinion; Thomas M. McIntyre, 37 B.T.A. 812; Harry C. Fisher, 29 B.T.A. 1041; affd., per curiam, 74 Fed.(2d) 1014.

The earnings of the ‘Lorenz Equipment Company,‘ a partnership, during the taxable year here involved were not personal service earnings. That fact appears from the following findings in the majority opinion: ‘Curing 1940 the gross profit of the business was $55,059.10, which was derived as follows: Profit on sales $37,322.80; commission on direct sales, $3,480.50; rental machinery income, $13,647.09; shop income, $608.71.‘ Therefore, in the instant proceeding I think the decision should be for the petitioner as to this issue and I dissent from the view that the entire partnership earnings are taxable to petitioner.

ARUNDELL, LEECH, and DISNEY, JJ., agree with this dissent.