Docket No. 7707.
Harold Cox, Esq., for the petitioners. Stanley B. Anderson, Esq., for the respondent.
1. BAD DEBTS.— Claimed bad debt deductions disallowed.
2. PARTNERSHIP.— Held, that a partnership in which father and son were members was bona fide for business purposes and recognized for Federal tax purposes. Harold Cox, Esq., for the petitioners. Stanley B. Anderson, Esq., for the respondent.
For the calendar year 1941 the respondent determined against petitioners, husband and wife, an income tax deficiency in the amount of $9,317.04, all of which is not in controversy, since certain adjustments made by the respondent's deficiency notice are not controverted.
Petitioners assign two errors, namely, (1) respondent's disallowance of a deduction of $930 claimed as bad debts alleged to have become worthless in 1941, and (2) the respondent's inclusion of an additional $19,004.65 in petitioner's income as the result of his determination that, for Federal tax purposes, no valid partnership existed in which Walter J. Runyon and his son were partners.
FINDINGS OF FACT.
The petitioners, Walter J. Runyon and his wife Ruth Runyon, are residents of Little Rock, Arkansas. Their joint income tax return for 1941 was filed with the collector of internal revenue for the Arkansas district. Walter J. Runyon, hereinafter referred to as petitioner, has been engaged in the contracting business for a period of thirty-five years.
Petitioner made a practice of making personal loans to various business acquaintances in need of ready cash and solely for their accommodation, with the expectation that such loans would be repaid, and most of them were repaid. He kept a pocket memorandum on such loans. During 1940 and 1941 petitioner made personal unsecured loans totaling $930 to nine individuals, who have never repaid him. None of those persons was employed by petitioner or by any firm in which he owned an interest, but most of them were working on some construction job in which petitioner was interested at the time such loans were made. The loans were as follows: In the summer of 1940 petitioner loaned a total of $255 to Hugh Carter, whom he had known for many years. Carter was a resident of Little Rock and at the time was an engineer on a construction job in north Arkansas. He needed the money to go back and forth to the job and he agreed to repay the loan upon completion of the job, which was finished in the fall of 1940. Petitioner did not know the financial condition of Carter at the time the loan was made no investigation as to that condition in 1940 or 1941. He did not know whether Carter's financial condition was worse or better in 1941 than in 1940. Petitioner did not ‘press‘ Carter for payment, but talked to him about it on ‘several occasions.‘ The loan was never repaid and Carter died in about 1943.
In February 1941 petitioner loaned $100 to Percy Kooney, an asphalt salesman of New Orleans, whom petitioner had met in 1940. Kooney was in Little Rock at the time and needed the money for travel expense. The loan was to be repaid as soon as Kooney returned to New Orleans or the next time petitioner saw him. Petitioner saw Kooney one time after that and requested repayment, but without success. Petitioner made no investigation of Kooney's financial condition at the time the loan was made, but he knew at that time that Kooney was ‘broke.‘ Kooney went into the Army after that and petitioner has not seen him since and the loan was never repaid.
In the early part of 1941 petitioner loaned $25 to one Galliger of Little Rock, whom he had known for some time. Galliger was unemployed at the time and promised to repay the loan as soon as he got a job. Galliger jot a job, but petitioner never say him thereafter and was never repaid.
In July 1941 petitioner loaned $45 to C. C. Azzy of Baton Rouge, Louisiana, whom he had known only a few months while Azzy was on a job at Alexandria, Louisiana. Azzy needed the money to go home because of sickness in his family and promised to repay the loan as soon as he returned to his work at Alexandria. Petitioner never saw him again and the loan never was repaid. Petitioner wrote Azzy letters, but never heard from him. Petitioner knew nothing about Azzy's financial condition in 1941, nor does the record disclose it.
In July and August 1941 petitioner loaned a total of $240 to one Felton of Alexandria, Louisiana, who was working for a contractor at Camp Livingston, Louisiana. The loan was used as a down payment on a truck purchased by Felton, who promised to give petitioner a mortgage on the truck to secure repayment at $50 per month, beginning in September 1941. Petitioner was not given the mortgage and in September 1941 Felton lost his job and went to Oklahoma in the truck. Petitioner made no investigation of Felton's financial situation, except that ‘everybody knew him there said he was responsible and he would do what he said he would do.‘ Petitioner wrote Felton several letters and some of them came back. Petitioner never has heard from him and never has been repaid.
In August 1941 petitioner loaned $20 to one Mills, a bond salesman of Little Rock. Mills then had a job, but needed the money until his next pay day two weeks later, when the loan was to be repaid. Petitioner did not see Mills again, except once in Mississippi, when he requested payment of Mills and Mills promised to repay, but never did.
During July and August 1941 petitioner made three $50 loans to George Bryan, whom petitioner had known for four or five months while Bryan was on a construction job at Alexandria. The money was to be used to bring Bryan's wife to Alexandria and was to be repaid the first of September 1941. Petitioner never investigated Bryan's financial situation, ‘but the fellows that seemed to know him said that he would pay when he had a pay day.‘ Bryan lost his job and disappeared and the loan never was repaid.
In August 1941 petitioner loaned a total of $60 to Eddie Caldwell, whom he knew as a worker at ‘the Camp.‘ The loan was to be repaid in two $30 payments out of Caldwell's next succeeding pay days, but never has been repaid.
In July 1941 petitioner loaned $35 to Frank Taylor, who was ‘broke‘ at the time. Petitioner requested repayment from Taylor several times, but he died shortly afterwards and the loan never was repaid.
In making up his 1941 tax return petitioner deducted the total of $930 as worthless debts, and he had collected no portion thereof up to the time of the hearing on this proceeding.
The petitioner has one son, Walter J. Runyon, Jr. During every year since about 1936 when Walter, Jr., was 14 years of age, he spent his entire three-month summer vacation from school in working on construction jobs with petitioner. Walter, Jr., liked construction work and during several years he and petitioner many times talked of forming a partnership as soon as Walter, Jr., was old enough. In April 1940 when Walter, Jr., became 18 years of age, he was a full grown, industrious young man, 5 feet 10 inches tall, weighing 175 pounds, and knew a great deal about petitioner's contracting business and ‘could perform any part of it himself.‘ At that time Walter, Jr., had one more year at high school.
In the early part of 1940 petitioner was contemplating entering a partnership with J. A. Gregory, Sr., and his sons, who had been engaged since 1910 in general contracting work, including the construction of roads, streets, sewers, waterworks, etc. At that time Gregory, Sr., had a partnership with his two sons. Petitioner stated that he wanted Walter, Jr., to be a partner in the proposed new partnership, and that was agreeable to J. A. Gregory, Sr., who was very favorably impressed with the ability and energy of Walter, Jr. Gregory, Sr., was particularly interested in securing advantage of the long experience of petitioner and the industriousness of Walter, Jr., in connection with the actual construction work of the proposed business enterprise.
In the middle of June 1940 petitioner and Walter, Jr., entered into an oral agreement of partnership to engage in the contracting business, with each having a 50 per cent interest in the profits and losses therefrom. There was no capital contribution made by either petitioner or Walter, Jr. Such partnership agreement was made at that time because petitioner was about to enter into a partnership with J. A. Gregory, Sr., and his sons and petitioner wanted the services of Walter, Jr., in the business of the contemplated partnership. At that time petitioner was worth between $15,000 and $20,000 and Walter, Jr., had no independent assets.
On July 1, 1940, at Little Rock, Arkansas, J. A. Gregory, Sr., petitioner, and Walter, Jr., in the presence of petitioner's wife, discussed and agreed upon the terms of an agreement forming a partnership known as the Mid-South Paving Co. (hereinafter referred to as the paving company), to engage in the contracting business and particularly asphalt paving work. The written memorandum of such agreement, prepared on the mezzanine floor of the Marion Hotel in Little Rock, Arkansas, in penciled long hand, by J. A. Gregory, Sr., who is not a lawyer, is as follows:
MEMORANDUM OF CONTRACT AGREEMENT
This memorandum of contract agreement by and between J. A. Gregory & Sons, of Newport, Ark., hereinafter known as the party of the first part, and W. J. Runyon & Son of Forrest City, Ark., hereinafter known as party of the second part, Witnesseth:
That the parties hereto desire to enter into a partnership for the purpose of doing certain asphalt paving and equipment rentals in the name of the Mid-South Paving Co., in the state of Ark., or such other states as may from time to time be agreed on.
It is understood and agreed that the party of the first part shall furnish such monies as may be needed to conduct this business, and that J. A. Gregory shall draw no salary.
It is further understood that W. J. Runyon shall devote all of his time to this business, and shall take no outside work unless agreeable to party of the first part; it is further understood that W. J. Runyon shall have a drawing account of two hundred fifty dollars per month, which said amount is to be deducted from his one half of the profits if any shall accrue to this partnership.
It is further agreed that the party of the first part shall receive six percent interest on all monies advanced. After return of all advances any monies and equipment remaining shall be owned equally by the two parties hereto. The party of the first part is to shape company policies and the party of the second part is to attend more particularly to actual construction.
Signed in duplicate this first day of July 1940.
J. A. GREGORY & SONS, By J. A. GREGORY, Partner W. J. RUNYON & SON, By W. J. RUNYON, Partner.
Walter, Jr., was present and joined with his father and J. A. Gregory, Sr., in consummating the agreement, but he did not sign the memorandum because it was understood that the agreement was between the partnership of J. A. Gregory & Sons and the partnership of W. J. Runyon & Son and accordingly the memorandum was signed by Gregory, Sr., and petitioner for each of those partnerships, respectively.
It was understood that the ultimate profits and losses were to be divided equally between J. A. Gregory & Sons and W. J. Runyon & Son. It was further understood that Walter, Jr., was a full partner with a 50 per cent interest in W. J. Runyon & Son and also a full partner with a 25 per cent interest in the profits and losses of the paving company. It was understood and agreed that petitioner and Walter, Jr., would contribute to the Mid-South Paving Co. services only in connection with the actual construction work and neither Walter, Jr., nor petitioner was to contribute any capital to the venture. The contract provision for petitioner's drawing account of $250 per month was intended for the benefit of both petitioner and Walter, Jr., and was to be charged against W. J. Runyon & Son's 50 per cent of any profits derived by the paving company.
The paving company immediately began business, and the partnership agreement was carried out according to its terms and all of the partners functioned as such. J. A. Gregory & Sons provided all the necessary capital and performed the office work, and petitioner and Walter, Jr., performed all the field or actual construction work which the partners were required to do by way of management, superintendence, etc. The partnership books did not set up any capital account for any of the partners at that time, but merely showed money contributions by Gregory and individual withdrawals made by the various partners. Immediately after making the agreement Gregory procured equipment and petitioner and Walter, Jr., left town on the same day, July 1, 1940, to work on the first job at Pine Bluff, Arkansas. Walter, Jr., worked every day the entire summer of 1940 at Pine Bluff and Gregory, Sr., was highly pleased with his ability and energy on that job.
The operations of the paving company on the Pine Bluff, Arkansas, job resulted in a small loss for the period of July 1 to December 31, 1940, and, since J. A. Gregory & Sons had advanced the operating capital, it took the loss and no information return was filed by the paving company for that period.
The paving company partnership agreement remained in effect throughout the year 1941. About July 1, 1941, the partnership started work on an asphalt job at Camp Livingston, Louisiana, which was completed in January or February 1942. Walter, Jr., had graduated from high school and worked every day during that entire period. He was in charge of the asphalt plant, the maintenance of equipment, and the crews of workmen, and his services proved to be more valuable to the paving company than the services rendered by petitioner, who was ill from a heart attack during several months in the latter part of 1941. While on that job Walter, Jr., at first drew $35 or $40 a week and later on a little more as salary for the extra services he performed. Such salary was agreed upon by all the partners as fair compensation to be charged to operating expenses and as in addition to the amount to be received by Walter, Jr., as a full partner having a 50 per cent interest in W. J. Runyon & Son and a 25 per cent interest in the paving company.
In July 1942, upon engaging in business in Mississippi, the Mid-South Paving Co. reported to the Employment Commission of that state that the parties comprising the partnership were J. A. Gregory, Jr., Clay Gregory, J. A. Gregory, Jr.; W. J. Runyon, Sr., and W. J. Runyon, Jr. The partnership then was comprised of the same members as was the case from July 1, 1940, to and through the taxable year.
For the year 1941 petitioner and Walter, Jr., made a fifty-fifty split of one-half of the paving company's earnings which accrued to them. Each reported his share of such earnings on his income tax return for that year and paid the tax shown to be due thereon. Except for withdrawals for living expenses and the payment of taxes, such earnings were left in the business of the paving company by both petitioner and Walter, Jr.
Sometime subsequent to the period in question Walter, Jr., entered the naval service and was still in the South Pacific at the time of the hearing on this proceeding. When Walter, Jr., became of age in April 1943 he ratified and confirmed the partnerships.
During 1941 the petitioner and his son Walter, Jr., were partners in a bona fide partnership of Mid-South Paving Co. and as such they each earned and owned 25 per cent of the distributable net income of that partnership.
On this return for 1941 petitioner reported the amount of $15,784.50 as his25 per cent share of the distributable net income of the paving company. The respondent determined that the net earnings of the paving company for 1941 which accrued to the petitioner amounted to $34,789.15, and the correctness of that figure as representing one-half of the paving company's net earnings is not now disputed by petitioner. In asserting the deficiency in dispute, respondent included the entire amount of $34,789.15 in petitioner's income.
The first issue is whether the facts herein entitle petitioner to the claimed bad debt deduction of $930 under the applicable provisions of section 23(k)(1) of the Internal Revenue Code as amended by section 124 of the Revenue Act of 1942 and section 113 of the Revenue Act of 1943, which amendments became effective for taxable years beginning after December 31, 1938, except that the last sentence of section 23(k)(1), as amended, with respect to nonbusiness debts became effective for the taxable years beginning after December 31, 1942.
SEC. 23 (I.R.C., as amended). DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(k) BAD DEBTS.—(1) GENERAL RULE.— Debts which become worthless within the taxable year; * * * This paragraph shall not apply in the case of a taxpayer, other than a bank, as defined in section 104, with respect to a debt evidenced by a security as defined in paragraph (3) of this subsection. This paragraph shall not apply in the case of a taxpayer, other than a corporation, with respect to a non-business debt, as defined in paragraph (4) of this subsection.
Each of the nine debts claimed by petitioner to have become worthless during 1941 was created by petitioner making an unsecured loan on a promise of repayment within a comparatively short time. One loan was made in 1940 and the other eight were made in 1941. When the loans were made to Taylor and Kooney it is obvious that they were worthless in that petitioner then had no reasonable expectation of repayment; that is to say, the debts then had no value, since both Taylor and Kooney were ‘broke‘ at the time, and there is nothing in the record to indicate at that time that such status would change. Under such circumstances, the petitioner is not entitled to deduction of the amount of either debt as one that became worthless in 1941. 5 Mertens Law of Federal Income Taxation, p. 367, Para. 30.11, and authorities cited.
If it be assumed that the other seven debts were not worthless when the respective loans were made, we are nevertheless of the opinion that petitioner has failed to sustain his burden of establishing that they, or any of them, became worthless in 1941.
With regard to the debts of Carter, Azzy, and Felton, it is shown that petitioner made no efforts to collect, except to make mere requests for repayment. This is not sufficient to qualify either of these debts as one that became worthless within the taxable year. 5 Mertens Law of Federal Income Taxation, p. 416, Para. 30.42, citing authorities. Moreover, petitioner did not know the financial condition in 1941 of either of these three persons; nor is it indicated anywhere in the record what that condition was.
With regard to the Mills, Bryan, Galliger, and Caldwell loans, the record fails to disclose that petitioner ever made any efforts to collect beyond the mere fact that as to the Mills loan he made one request for repayment at a time not shown. The record also affirmatively shows that petitioner never investigated Bryan's financial condition and it fails to show that petitioner ever investigated the financial condition of either Mills, Galliger, or Caldwell, and nowhere in the record is the financial condition in 1941 of Mills, Bryan, Galliger, or Caldwell shown.
The respondent's disallowance of the claimed bad debt deductions totaling $930 is approved.
The second issue involves the question of whether, for Federal tax purposes and for the taxable year 1941, recognition shall be given to the partnership agreement of petitioner and his son Walter, Jr., as equal partners under the name of W. J. Runyon & Son and also to the partnership agreement between J. A. Gregory & Sons and W. J. Runyon & Son whereby the latter acquired a 50 per cent interest in the earnings of the partnership of Mid-South Paving Co.
Respondent takes the view that there was no bona fide partnership between petitioner and his minor son or between them and J. A. Gregory, Sr., and his sons, but merely an attempted reallocation of family income consisting of 50 per cent (or $34,789.15) of the distributable net income of the paving company, all of which he asserts was earned by petitioner and accordingly must be taxed to him in its entirety.
Petitioner contends that the partnership agreements were bona fide and must be recognized for Federal tax purposes and that he is taxable on only his one-half of the $34,789.15 representing the net income of the paving company distributable to petitioner and his son for the year 1941.
In the instant case we do not have the type of family partnership where the interest of a wife or minor child in a purported partnership arrangement originates solely as a gift from the husband or father in the capital assets of his business enterprise and thereafter the donee of such interest does not contribute substantially to the management of the business and renders no vital additional services thereto, which type of arrangement is not recognized for Federal tax purposes. See Commissioner v. Tower, 327 U.S. 280; Lusthaus v. Commissioner, 327 U.S. 293; Ed Dubinsky Durwood, 6 T.C. 682; Floyd D. Akers, 6 T.C. 693; Abe Schreiber, 6 T.C. 707; W. A. Belcher, 7 T.C. 182; and John G. Scherf, 7 T.C. 346.
At the time the two partnership agreements here involved were entered into petitioner's son Walter, Jr., was a minor 18 years old and he became 19 years old in the spring of the taxable year 1941, but under the laws of Arkansas, Walter, Jr., was a competent person, in that his agreement was avoidable only at his own instance. After becoming of age Walter, Jr., ratified the agreements. The partnership agreement between petitioner and Walter, Jr., was made during June 1940 in view of the contemplated formation of the new partnership under the name of Mid-South Paving Co. and, while it was an oral agreement, it was made known to and was fully recognized by J. A. Gregory, Sr., who was anxious to secure the services of petitioner and also of Walter, Jr. The petitioner and J. A. Gregory, Sr., in the presence of Walter, Jr., had theretofore discussed engaging in the contracting business and, on July 1, 1940, the agreement was made and reduced to writing. Such written agreement was between the two partnerships of J. A. Gregory & Sons and W. J. Runyon & Son, and the interested parties recognized Walter, Jr., as an equal partner in W. J. Runyon & Son. Under the terms of the agreement, the Gregorys were to shape the company's policies and contribute the necessary working capital and the Runyons were to contribute services only by taking charge of the actual construction work in the field. The agreement between petitioner and his son Walter, Jr., and the subsequent agreement between J. A. Gregory & Sons and W. J. Runyon & Son, under which latter agreement petitioner and his son and J. A. Gregory, Sr., and his sons became partners, were business transactions made for the purpose of carrying on the partnership business of contracting work, particularly asphalt paving.
In Davie v. Padgett, 117 Ark. 544; 176 S.W. 333, the Supreme Court of Arkansas said: ‘The contract of an infant is not absolutely void but is only voidable at the instance of the infant himself. This court in Bozeman v. Browning, 31 Ark. 364 said: 'As a general rule, no one but the infant himself, or his legal representatives, executors, and administrators, can avoid the voidable acts, deeds, and contracts of an infant, for, while living, he ought to be the exclusive judge of the propriety of the exercise of a personal privilege intended for his benefit.’‘
Those agreements remained in full force and effect during part of 1940 and throughout the taxable year 1941.
Walter, Jr., rendered services to the paving company during 1940, but, since that year is not before us, we are not concerned with the value thereof, except as it reflects on the question of whether there was a bona fide partnership for tax purposes in the year 1941. From July 1941, when work was started on an asphalt job at Camp Livingston, Louisiana, until the end of the year and until the job was completed in 1942, Walter, Jr., devoted his entire time to the work. He was then a full grown, capable, and energetic young man; he was in charge of the asphalt plant, the maintenance of equipment, and the crews of workmen; and his services proved more valuable to the venture of the paving company than the services of petitioner, who was ill from a heart attack during part of 1941. By agreement of all of the partners in the Mid-South Paving Co., Walter, Jr., was paid a salary as fair compensation for extra services, the salary being in addition to his share of the profits as a full partner having a 25 per cent interest in the earnings of that company.
We think the facts clearly establish that during 1941 Walter, Jr., rendered ‘vital‘ additional services to the partnership of Mid-South Paving Co. within the rule of the Tower and Lusthaus cases, supra, and was entitled to 25 per cent of the distributable net income of that company for the year here involved.
We hold that petitioner was a partner in the Mid-South Paving Co. entitled to only a 25 per cent share of the distributable net earnings of that company for 1941, and that respondent erred in taxing to him more than one-half of the amount of $34,789.15.
Reviewed by the Court.
Decision will be entered under Rule 50.