Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Mar 29, 1944
3 T.C. 540 (U.S.T.C. 1944)

Docket No. 112702.



W. A. Seifert, Esq., William Wallace Booth, Esq., Jos. W. Ray, Jr., Esq., Paul E. Hutchinson, Esq., and A. G. Wallerstedt, C.P.A. for the petitioner. W. J. McFarland, Esq., for the respondent.

HUSBAND AND WIFE PARTNERSHIP.— Petitioner entered into a partnership agreement with his wife in 1940, purporting to make her an equal partner in a furniture business which he had operated for a number of years. He gave her $50,000, which she immediately returned to him, with her promissory notes for $55,000 and a negligible amount of her own funds, in payment for her one-half interest. Thereafter, she contributed no additional capital and rendered only casual services to the business, as she had always done. Held, that all of the profits of the business are taxable to petitioner as his individual earnings. W. A. Seifert, Esq., William Wallace Booth, Esq., Jos. W. Ray, Jr., Esq., Paul E. Hutchinson, Esq., and A. G. Wallerstedt, C.P.A. for the petitioner. W. J. McFarland, Esq., for the respondent.

The respondent has determined an income tax deficiency of $22,419.98 for 1940. The principal amount, and contested portion, of the deficiency results from the inclusion in petitioner's gross income of all of the profits of a furniture business which petitioner and his wife reported in equal shares as partnership income.


Petitioner is a resident of Uniontown, Pennsylvania. He filed his income tax return for 1940 with the collector if internal revenue for the twenty-third district of Pennsylvania.

For several years prior to 1940 petitioner operated as a sole proprietorship a retail furniture business at Uniontown, Pennsylvania. There were two stores, one known as Household Furniture Co. and one as Furniture Outlet Store.

During 1939 petitioner had several conferences with an accountant and an attorney of Uniontown to discuss the matter of making his wife an equal partner in his furniture business. It was decided in the latter part of that year that petitioner would ‘sell‘ to his wife a one-half interest in the business and make her an equal partner as of January 1, 1940. Petitioner instructed his accountant to determine the value of the business and make the necessary changes in the books of account and instructed the attorney to prepare the necessary legal papers.

The net worth of the business, based on book value of all physical assets and inventory but not including good will, was determined to be $230,000. It was decided that petitioner would withdraw $20,000 from the business, leaving a net worth of $210,000; that he would make his wife a gift of $50,000, which she would use as part payment for her one-half interest, and that for the balance, $55,000, she would give petitioner her promissory notes payable $5,000 annually. Petitioner told his wife of the plan and she agreed to it.

The formalities of the transfer were delayed, first by the illness of petitioner's attorney in December 1939, then by the absence of the attorney while he and his wife were on a visit to Mexico in January and February 1940, and finally by the absence of petitioner and his wife while they were on a visit to Florida in March and April 1940. A bill of sale was executed by petitioner on June 4, 1940. A few days later petitioner borrowed $25,000 from the bank and gave his wife a check for $50,000. This check was drawn against the funds previously withdrawn from the business and those borrowed from the bank. Petitioner's wife then gave petitioner her check dated June 18, 1940, for $50,253.81. She also executed and delivered to him eleven promissory notes for $55,000, as previously agreed upon, in payment of the balance of the purchase price for her interest in the partnership. At that time petitioner's wife owned her home, valued at $25,000 or $30,000, and about $20,000 or $25,000 of securities. A certificate authorizing petitioner and his wife to carry on business under the fictitious name of Household Furniture Co. was issued by the Commonwealth of Pennsylvania on July 31, 1940.

Petitioner filed a gift tax return for 1940 in which he reported a gift to his wife of $50,000 on January 1, 1940.

Petitioner's furniture business was conducted in substantially the same manner after the consummation of the partnership arrangements as before. Petitioner continued to manage the business, as he was authorized to do under the partnership agreement. His wife helped out at the stores— or one of them—whenever she was needed, just as she had always done. She took no active part in the management of the business. She never received any compensation for her services.

Prior to 1940 petitioner and his wife maintained a joint bank account. Sometime in 1940 they opened separate accounts. A separate account was maintained for the business in the name of Household Furniture Co. During 1940 petitioner withdrew $4,604.76 from the business and his wife withdrew $59.61. In 1941 petitioner withdrew $19,198.69 and his wife $16,317.86. At the close of each year the profits of the business were credited on the books to petitioner and his wife equally.

A partnership return was filed in the name of Household Furniture Co. for 1940, showing a net profit of $80,280.20. Petitioner and his wife each reported one-half of that amount (less partnership contributions of $1,135.99) in their individual returns for 1940.

Petitioner's wife has paid three of the eleven promissory notes which she gave petitioner under the partnership agreement as they became due.

The respondent determined in his deficiency notice that no bona fide partnership existed between petitioner and his wife in 1940 and that petitioner is taxable on all of the profits from his furniture business for that year. Those profits, with certain adjustments made in the deficiency notice which are not in controversy, amounted to $84,443.42.

In her individual income tax return for 1940 petitioner's wife claimed all of the personal exemption of $2,000 and petitioner claimed none in his return. Her return shows a gross income of $41,113.12, of which $40,140.10 was partnership income. Petitioner now contends that the entire amount of the personal exemption of $2,000 should be allowed to him instead of to his wife.


SMITH, Judge:

We think that the respondent has correctly determined that petitioner is taxable on all of the profits from his furniture business in 1940. The evidence here discloses another of those superficial arrangements whereby a husband undertakes to make his wife a partner in his business for the obvious, if not the sole, purpose of reducing his income taxes.

The picture here is plainly drawn for us. About 1939 petitioner found himself confronted with the prospect of large earnings from his furniture business and the certainty of large income taxes. The matter of the taxes caused him concern. In his travail he sought the help of his accountant. Together they evolved the plan for the husband and wife partnership. Petitioner would ‘sell‘ to his wife a one-half interest in the business. He would make her a ‘gift‘ of a part of the purchase price and take her promissory notes for the balance. She could pay off the notes from her share of her profits of the business. He could raise the money for the gift to her by withdrawing some of the surplus cash from the business and borrowing the balance from the bank. He could repay the bank out of her payments on the notes and his share of the partnership profits. An attorney was engaged to look after the legal phases of the plan. Finally, the partnership emerged from the metamorphosis clothed in the outer garment of legal respectability, but inwardly perhaps a little uneasy over the flimsiness of its under garment of income tax alleviation.

The formalities of executing the partnership agreement and registering the business with the Pennsylvania authorities as a partnership did not change petitioner's economic interest in the business. The wife acquired no separate interest of her own by turning back to petitioner the $50,000 which he had given her conditionally and for that specific purpose. The evidence shows that she had very little to do with the formation of the partnership. She testified that ‘On the advice of counsel I did what he told me to do.‘

On facts similar to those in the present case we denied the existence of a partnership status for income tax purposes between a husband and wife in Francis Doll, 2 T.C. 276. Cf. Francis E. Tower, 3 T.C. 396.

In Schroder v. Commissioner, 134 Fed.(2d) 346, the court referred to a comparable factual situation as ‘another of those efforts to make future returns from personal services taxable to some one other than the real earner of them.‘ The income there resulted largely from the taxpayer's services and abilities as a mechanical and electrical engineer. Here the income resulted largely from petitioner's services and ability as manager of his furniture business and the employment of his capital in the business. The question of the validity of the partnership under the laws of the state of its creation (Alabama) was not considered important in that case.

Whether or not the arrangement which petitioner made with his wife constituted a valid partnership under the laws of Pennsylvania, we do not think that it should be given recognition for Federal income tax purposes.

Petitioner now claims the right to the personal exemption of $2,000 which was claimed by his wife in her separate return for 1940. Neither the petitioner nor the respondent refers to this claim in the brief filed by each.

The pertinent provision of section 25(b)(1) of the Internal Revenue Code provides: ‘ * * * If such husband and wife make separate returns, the personal exemption may be taken by either or divided between them.‘

We do not have the petitioner's wife before us in this proceeding. Since on her separate return she claimed a personal exemption of $2,000, whereas the petitioner claimed none, and since the petitioner's wife had not waived claim to a personal exemption of $2,000 against her income tax liability for 1940, the determination of the respondent that the petitioner is not entitled to a personal exemption of any part of the $2,000 is approved.

Decision will be entered for the respondent.

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