Docket No. 8782.
Hughes Roberts, Esq., for the petitioner. D. D. Smith, Esq., for the respondent.
Petitioner, a woman without business training or experience, owned an office building and other real estate rented to tenants and, in addition thereto, a 25 1/2 per cent interest in a partnership doing a large and active business, in which her brother owned the remaining 74 1/2 per cent and devoted all of his time to the management of its affairs. The brother, who received no compensation from the partnership for these services, needed assistance and advice in the conduct of the business. Petitioner, being unable personally to render such services, employed and paid her husband, an experienced business man, to manage her rental properties and render services for her in carrying on the partnership business. Held, these payments for such services constituted ordinary and necessary business expenses, deductible by petitioner under section 23(a)(1)(A), I.R.C. Hughes Roberts, Esq., for the petitioner. D. D. Smith, Esq., for the respondent.
Respondent has determined a deficiency in income and victory tax for the calendar year 1943 in the amount of $2,904.74. For that year the so-called ‘forgiveness feature‘ requires the computation of the tax by comparison with the tax for the prior year and thus necessitates the ascertainment of the correct tax liability for both 1942 and 1943. The general issue is whether petitioner can deduct in each of those years the sum of $3,600 which petitioner paid her husband for services rendered in those years. The deduction is claimed, under section 23(a) of the Internal Revenue Code, as either a business or a nonbusiness expense. There is a related question which arises from the fact that the salary in each instance was not paid until after the close of the year in which the services were rendered.
FINDINGS OF FACT.
Petitioner resides in Atlanta, Georgia, where she maintains a home for herself and her husband, Ben F. Noble. They were married in 1906. Petitioner filed separate income tax returns for 1942 and 1943 with the collector for the district of Georgia. She is the owner of separate property which yields substantial income. This amounted to $40,675.66 in 1942 and $43,535.10 in 1943, before deductions for tax purposes.
Ben F. Noble owned some securities. His income from these was $325 in 1942 and $250 in 1943. His only other income was a salary of $3,600 per year paid to him by petitioner under the agreement entered into in 1942 as hereinafter mentioned.
Until 1933 of 1934, Ben F. Noble operated a business of his own, specializing in the sale of securities issued by utility holding companies. In 1933 or 1934 the special class of securities which he sold was practically off the market, so he discontinued this business. After that, until the arrangement here involved, he was not engaged in any business.
Petitioner has had no business experience or training. Her activities are those of a wife, mother, and homemaker. All of petitioner's properties were inherited. Her real estate is situate in Atlanta and consists of the following: (1) The entire fee in property at 106-8 Forsyth Street, an office building in the business section of the city; (2) a one-fourth interest in property at Spring and Cain Streets; and (3) a one-fourth interest in property at West Peachtree and Simpson Streets. Petitioner's brother has a three-fourths interest in the Spring Street property and a one-fourth interest in the West Peachtree Street property. All of these are rent-producing properties.
The item of much the greatest value among petitioner's properties is a 25 1/2 per cent interest in the firm of H. M. Patterson & Son, which carries on a large undertaking business. The greater part of petitioner's income is derived from her interest in this business. Petitioner's brother, Fred Patterson, owns the remaining 74 1/2 per cent interest in H. M. Patterson & Son, and conducts the business for the partnership. Petitioner has never rendered any service in the business.
In 1939 petitioner's brother, Fred Patterson, was concerned about a threat to the undertaking business in Georgia from anticipated organization of certain so-called burial societies similar to some which had been organized and were doing a large business in Alabama. These companies sold a form of industrial insurance guaranteeing the furnishing of a funeral at a specified costs. The terms of the policies, however, gave control of the employment and payment of the undertaker to the insurance company. The system was to require the undertaker to purchase the items necessary for the funerals from the insurance company at exorbitant prices. Under this form of insurance, the major part of the profit from the funeral was taken by the insurance company, the undertaker getting little, if any.
To meet this danger, Fred Patterson in 1939 organized and incorporated under the laws of Georgia the Family Fund Life Insurance Co. to write industrial burial insurance under policies which guaranteed the burial at a reasonable cost and under which the above objectionable features of the policies being written by the Alabama companies were eliminated. It was his plan that the stock in this company would be held by undertakers located over the State of Georgia. In the organization of this company, petitioner's husband, Ben F. Noble, was consulted and gave helpful advice. He had been in the insurance business at one time for a period of 3 years. H. M. Patterson & Son invested $82,000 in the Family Fund Life Insurance Co. in 1939, representing one-third of its issued stock. Subsequently the Alabama Casket Co. acquired one-third of the stock, and the remaining one-third was disposed of among 189 funeral directors located over the State of Georgia. The organization of this insurance company has prevented the aforementioned Alabama burial societies from operating in Georgia.
In 1935 petitioner's husband received offers of employment from a brokerage firm in Atlanta at a monthly salary of $300, which offer he declined. In 1939 this offer, at the same salary, was renewed. He then discussed the matter with petitioner and her brother, who both objected to his accepting the offer. It was their idea that if Ben F. Noble refused this offer and devoted his time to the management of petitioner's business properties, including her interest in H. M. Patterson & Son and the Family Fund Life Insurance Co., her interests would be benefited to an extent largely in excess of the $300 per month which had been offered to him. Fred Patterson took the position that it was petitioner's duty to furnish assistance in the carrying on of the business of H. M. Patterson & Son and, since she was without business experience and accordingly could not furnish the services and assistance herself, she should pay individually the cost incurred in obtaining such services. Fred Patterson devoted all of his time to the business, but received no salary for it. He received from the partnership only the proportion of earnings allocable to his three-fourths interest. Petitioner, on the other hand, although contributing nothing to the business by way of assistance in its management, received her full share of the profits on her one-fourth interest.
As a result of the discussion of the matter by these three petitioner's husband was employed to take full charge and control of the management of his wife's properties. His activities were to and did include such assistance in the business of H. M. Patterson & Son and the Family Fund Life Insurance Co. as a partner would normally render. A contract was executed by petitioner in early 1942, the pertinent parts of which are set out in the margin.
‘In consideration for services rendered, it is hereby mutually agreed upon, and this contract entered into confirming such agreement, that the undersigned Mrs. Claude Patterson Noble shall pay to her husband, Ben F. Noble, the sum of Three Hundred Dollars ($300.00) per month, as compensation for his services rendered in attending to and operating her business affairs, particularly with reference to H. M. Patterson & Son, a partnership of which said Mrs. Claude Patterson Noble owns twenty five and one half percent (25 1/2%), said compensation to be effective as of January 1st, 1942.‘
Following the execution of this contract petitioner's husband took entire control of her business affairs, kept her accounts and handled all of her banking matters. He did not have authority to draw checks against her bank account, but prepared all checks for her signature, and made decisions as to when payments were to be made. He collected rents, maintained the necessary contacts with tenants, and saw to the repair and maintenance of petitioner's properties. During 1942 and 1943 petitioner's husband attended meetings of the directors of the Family Fund Life Insurance Co., although he was not a director or employee of that company. He held meetings with funeral directors who were interested in the company or whose interest it was seeking. He discussed with them the problems relating to selling insurance policies of the company and handling claims under the policies. In this work he traveled over the state. During this time he was also active in consulting with and aiding Fred Patterson in matters with respect to the business of H. M. Patterson & Son and the services thus performed were materially beneficial to that business. With Patterson he managed the investment of the partnership funds.
No payment was made by petitioner to her husband during 1942 for the services rendered by him during that year, but on March 4, 1943, her husband prepared a check for $3,600 payable to him for those services, which she signed and gave to him. At the close of the year 1942 the funds in petitioner's bank account were largely in excess of the amount of this check. Likewise, during 1943 petitioner did not make any payment to her husband for services performed during that year, but on February 18, 1944, she signed a check for $3,600, payable to her husband for those services and prepared by him for her signature, which she then gave him. At the close of the year 1943 her bank account was largely in excess of the amount of this check. Both checks were cashed when received.
For the year 1942 petitioner and her husband filed separate returns on the cash basis, as they had done for the two preceding years. On petitioner's return for that year a deduction was taken of the $3,600 payment made to her husband on March 4, 1943. Petitioner's husband on his return for 1942 reported this payment as income received for 1943. Petitioner and her husband filed separate returns for 1943. On her husband's return no statement was made as to whether it was on the cash or accrual basis. On petitioner's return for 1943 it was stated that it was made upon the accrual basis. On this return petitioner took a deduction for the $3,600 paid her husband on February 18, 1944. Petitioner's husband on his return for 1943 reported this payment as income received for that year. Petitioner had never received permission from the Commissioner to change the method of reporting her income from the cash basis to the accrual basis. In 1943, as in 1942, all of petitioner's income was derived from dividends, rents, and the earnings of H. M. Patterson & Son partnership. In that return she deducted only actual cash disbursements made in 1943, with the one exception of the $3,600 salary paid her husband on February 18, 1944.
Petitioner contends that the $3,600 annual salary paid to her husband for services rendered in each of the years 1942 and 1943 is deductible in each of those years either as a business expense under section 23(a)(1)(A), or as a nonbusiness expense under section 23(a)(2) of the Internal Revenue Code. Respondent contends only that part or all of these salaries are not so deductible because they are not ordinary and necessary. Under these circumstances it is unnecessary for us to consider the question of reasonableness.
The first inquiry is upon the question of whether such portion of the salary paid by the petitioner to her husband as may be allocable to the services rendered by him in managing and collecting rents from her real estate, constituted business expenses deductible by her. The answer to this question turns on whether petitioner, in her ownership and operation of those properties for the production of income, was ‘carrying on business.‘ The established rule is that such ownership and operation do constitute the ‘carrying on of business.‘ John D. Fackler, 45 B.T.A. 708; affd., 133 Fed.(2d) 509; George S. Jephson, 37 B.T.A. 1117; N. Stuart Campbell, 5 T.C. 272; Kay Kimbell, 41 B.T.A. 940; Edwin Vosburgh, 23 B.T.A. 780. In John D. Fackler, supra, after reviewing the authorities, we said:
The rule deducible from the above decisions is that, where the owner of depreciable property devotes it to rental purposes and exclusively to the production of taxable income, the property is used by him in a trade or business and depreciation is allowable thereon. * * *
Our most recent case in point on this question is Leland Hazard, 7 T.C. 372. In that case we held that a residence owned and formerly occupied by an attorney, but which had been rented by him to a tenant for several years, was property used by him in trade or business.
We hold that petitioner in her ownership and operation of properties rented for the production of income was carrying on business, and that the compensation paid by her to her husband for ordinary and necessary services in managing such properties and collecting rentals constituted business expenses. Sec. 23(a)(1)(A), I.R.C.
It may also be said that if we had been unable in the present case to hold that these properties were used by petitioner in carrying on business, the only possible alternative result would be that compensation was a ‘nonbusiness expense,‘ as one incurred in the ‘management, conservation, or maintenance of property held for the production of income.‘ Sec. 23(a)(2), I.R.C.
As to that part of the compensation paid for the service rendered by petitioner's husband in his participation in the management of the partnership business of H. M. Patterson & Son and the Family Fund Life Insurance Co., the answer is equally clear. Petitioner was a partner in the firm of H. M. Patterson & Son and this partnership was the owner of one-third of the stock in the insurance company. A partnership, of course, is not a taxable entity as is a corporation. But its several members are. Thus petitioner's individual activities in carrying on this partnership through her husband we think constituted the carrying on of a business. Cf. Alfred Le Blanc, 7 B.T.A. 256. It would follow that an ordinary and necessary expense thereof is deductible under section 23(a)(1)(A).
We think that the expense in question was both ordinary and necessary. In the carrying on of business it is a usual and customary procedure to employ and pay for trained services which benefit and increase the earnings thereof. Here the necessity for this expenditure by petitioner is demonstrated by the fact that she lacked any training or experience in business affairs.
Since, therefore, we have decided that the salaries, in toto, giving rise to the present controversy were ordinary and necessary, under section 23(a)(1)(A) of the code, it becomes unnecessary to allocate the amounts thereof as between those paid for the services of the husband in connection with the real estate of the petitioner and those relating to her partnership interest.
This brings us to the question as to whether petitioner is entitled, for the years 1942 and 1943, to deduct payments made her husband for services rendered in those years. The petitioner reported her income on the cash basis. She has never received permission to change to the accrual basis. Her deductions, accordingly, must be taken on the cash basis. East Coast Motors, Inc., 35 B.T.A. 212; Regulations 111, sec. 29.41-2. No payment was made in 1942 by petitioner to her husband for his services, but the payment for services rendered in that year was made in 1943. Likewise the payment for 1943 services was not made until February 1944. It is argued that the custom was the petitioner's husband prepare all checks for her signature and that had he seen fit to do so, he could have received payment of the full amount of the salary at the close of each year for which the service was rendered. Thus it is said to follow that petitioner constructively paid and her husband constructively received payment of the salary for 1942 and 1943 at the close of each of those years. The fact remains, however, these checks were not prepared, signed, or delivered until after the close of those respective years. Accordingly, there was no such payment or receipt in either case until after the close of the year. Massachusetts Mutual Life Insurance Co. v. United States, 288 U.S. 269; Martinus & Sons v. Commissioner, 116 Fed.(2d) 732; Cox Motor Sales Co., 42 B.T.A. 192; Sanford Corporation v. Commissioner, 106 Fed.(2d) 882.
It follows that petitioner is not entitled to a deduction in 1942 for the salary of $3,600 paid to her husband for services rendered in that year. She is, however, entitled to the deduction of this amount for the year 1943, since the payment for 1942 was actually made on March 4, 1943. The fact that the services for which this payment was made were rendered earlier than the year of payment is not material. Lucas v. Ox Fibre Brush Co., 281 U.S. 115.
Reviewed by the Court.
Decision will be entered under Rule 50.
HARRON, J., dissenting: The majority conclusion is that petitioner was engaged in business. This means, as I understand the conclusion, that she was engaged in two separate businesses, because the Forsyth Street property had no relation to the H. M. Patterson undertaking business. I understand, also, that the deduction claimed is allowed as a deduction for salary under section 23(a)(1)(A). I must respectfully dissent from the view that the issue presented does not necessitate considering the question of the reasonableness of the salary. Respondent clearly contends, on brief, that the sum in question, $3,600, must be allocated to each class of service given by Noble. I understand this contention to mean that petitioner must show what respective amounts represent a reasonable allowance for compensation for services given to the Forsyth Street property and to the undertaking business. The pertinent section provides that only a reasonable allowance for compensation for services is deductible.
Petitioner has failed to allocate the total amount of the salary between the two businesses she claims to have been conducting, and she has failed to show what the reasonable compensation for the service given to each business was. If this Court can make the determination of the respective allowances, it should do so. Cohan v. Commissioner, 39 Fed.(2d) 540.
The record falls short of showing clearly what Noble's services were worth in the business of renting the office building, for he did little more than collect two-thirds of the rents. An agent, Adams-Cates Co., was employed to collect the remainder of the rents. The most minor repairs were made in the taxable years, costing $36 and $22, and no new leases were made (the evidence showing only that Noble negotiated some new leases in 1946.) Noble collected about $4,000 of rents in each taxable year. The question which I think must be decided is, What constitutes reasonable compensation for the services performed under the facts?
The same question needs to be answered with respect to Noble's work relating to the business of H. M. Patterson & Son in the taxable years. The record does not show clearly what Noble did in the taxable years in looking after the interest of petitioner in the partnership. It shows only that he gave some ‘advice,‘ the nature of which is not stated; and that he attended some meetings of stockholders or directors of the Family Fund Life Insurance Co., the number of meetings not being shown. The evidence is general and vague on the point of just what Noble did in the taxable years to look after petitioner's interest in H. M. Patterson & Son and Family Fund Life Insurance Co., and upon such limited evidence it would be difficult to determine what constituted a reasonable allowance for such services.