Docket Nos. 36396 36397.
Carl A. Morring, Jr., Esq., for the petitioners. Homer F. Benson, Esq., for the respondent.
Carl A. Morring, Jr., Esq., for the petitioners. Homer F. Benson, Esq., for the respondent.
1. Petitioner and his partner each had a 50 per cent interest in a partnership engaged in the furniture business which reported sales on the installment basis. Petitioner sold his interest in the partnership, including his interest in outstanding installment obligations, to his partner. This translation resulted in a disposition of the petitioner's installment obligations within the meaning of section 44(d) of the Internal Revenue Code, and the petitioner realized gain thereon as computed under that section.
2. Ordinary and necessary business expenses incurred in operation of a farm for profit determined.
The respondent has determined deficiencies of $1,952.23, $3,618.70, and $979.97 in the income tax liability of the petitioner Rhett Woody for the taxable years ended December 31, 1945, 1946, and 1947, respectively, and a deficiency of $2,901.66 in the joint income tax liability of the petitioners Rhett Woody and Inez Woody for the taxable year ended December 31,1948. The respondent has also determined 5 per cent negligence penalties in the amounts of $97.61 and $180.94 against the petitioner Rhett Woody for the taxable years 1945 and 1946, respectively.
The petitioners assign as error the determination that in the taxable year 1946 gain resulted to the petitioner Rhett Woody upon the disposition of installment obligations, the disallowance of several deductions for the taxable years 1946 through 1948, and the determination of negligence penalties for the taxable years 1945 and 1946. Aside from the negligence penalty, no error is assigned to the determination of a deficiency for the taxable year 1945.
FINDINGS OF FACT
The petitioners Rhett Woody and Inez Woody are husband and wife and, for all years pertinent to the proceedings herein, were resident citizens of Huntsville, Alabama.
The petitioner Rhett Woody (hereinafter referred to as the petitioner) filed an individual income tax return for each of the taxable years 1945, 1946, and 1947 and he and his wife filed a joint income tax return for the taxable year 1948. The returns were prepared on the cash receipts and disbursements method of accounting and were filed with the collector of internal revenue for the district of Alabama at Birmingham.
During 1945 and the period January 1 to May 31, 1946, Rhett Woody was one of two partners in the Woody-Mitchell Furniture Company, Huntsville, Alabama (hereinafter referred to as the partnership), a partnership engaged in the retail furniture business. Rhett Woody owned a one-half interest in the partnership and was entitled to one-half of the net income.
During the years 1943 through 1945, the petitioner and his partner elected to compute and report their installment sales on the installment basis of accounting. On May 31, 1946, the uncollected balance in the partnership's installment accounts receivable totaled $47,154.56. The unrealized gross profit represented by this balance totaled $17,958.51. The remainder of the balance, or $29,196.05, represented the cost of the goods sold to those debtors, which cost had not entered into the computation of the cost of goods sold for the years in which the sales occurred.
On May 31, 1946, the petitioner sold his one-half interest in the partnership, including his interest in the installment obligations, to his co-partner. In consideration of the transfer, the petitioner received $35,000. The fair market value of the petitioner's interest in the installment obligations on May 31, 1946, was $23,577.28. The basis to the petitioner of his interest in the installment obligations was $14,598.03. Of the $35,000 received by the petitioner for his entire interest in the partnership, there should be attributed to the installment obligations the sum of $23,577.28. The petitioner realized a gain of $8,979.25 on the disposition of the installment obligations.
Some time in June 1946, Rhett Woody purchase for $16,000 a farm which included three houses and two barns. One-half of the purchase price was allocable to the buildings. The buildings had a remaining useful life of 10 years at the date of purchase. The farm, together with the buildings, was sold some time in the latter part of 1948.
During the taxable years 1946 through 1948, a reasonable allowance for depreciation sustained on the farm buildings was $433, $800, and $600, respectively. During the year 1946, Rhett Woody expended $230 in wages for picking cotton on the farm, and $150 in automobile expenses in traveling from his place of business to the farm and back for the purpose of inspecting and supervising the farming operations. These were all ordinary and necessary business expenses incurred in the operation of a farm for profit.
The adjustments in the determination of the deficiency in the petitioner's 1945 income tax liability consisted of an addition of $4,883.87 as unreported partnership income and the disallowance of $750 as an excessive deduction for a capital loss. The petitioner's 1945 income tax return did not refer to the $4,883.87 sum or make any disclosure that could reasonably be expected to put the Commissioner's agents on notice as to the omission.
The deficiency in the petitioner's 1946 income tax liability was due in part to misplaced reliance on the advice of a public accountant who was fully apprised of the facts and at the time was recognized in the community as one qualified in the making of tax returns and the giving of tax advice. The remainder of the deficiency was due to the disallowance of deductions, all of which were adequately identified and disclosed in a profit and loss statement attached to the 1946 return.
No part of the deficiency in the petitioner's income tax liability for the taxable year 1946 was due to negligence.
The first issue arises from the following facts: During the years 1943 through 1945, the petitioner and another, doing business as partners, made installment sales of merchandise which they reported under the installment basis provisions of section 44(a) of the Internal Revenue Code. On May 31, 1946, the balance of the installment obligations totaled $47,154.56, of which $17,958.51 represented unrealized gross profits from the installment sales. On May 31, 1946, the petitioner disposed of his interest in the installment obligations by selling his partnership interest to his partner. The respondent has added to the petitioner's 1946 income as ordinary gain one-half of the unrealized gross profits.
SEC. 44. INSTALLMENT BASIS.(a) DEALERS 'IN PERSONAL PROPERTY.— Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price.
The petitioner contends his only gain was a capital gain realized on the sale of his partnership interest. He refers to authorities setting forth the general rule that a partnership interest is a capital asset regardless of the nature of the partnership properties. Swiren v. Commissioner, 183 F.2d 656, certiorari denied 340 U.S. 912; Commissioner v. Smith, 173 F.2d 470, certiorari denied 338 U.S. 818, affirming 10 T.C. 398; Commissioner v. Estate of Daniel Gartling, 170 F.2d 73; McClellan v. Commissioner, 117 F.2d 988, affirming 42 B.T.A. 124; Stilgenbaur v. United States, 115 F.2d 283; Helvering v. Smith, 90 F.2d 590.
From these authorities, the petitioner concludes that the disposition of the installment obligations and the unrealized profits they represented should be treated no differently than the disposition of the remaining assets. That is, he urges us to regard the entire transaction as merely the sale of a capital asset and compute the gain accordingly.
The petitioner's argument is contrary to the express provisions of the Code governing the disposition of installment obligations. The provisions of section 44(a) permitting a taxpayer to report as gross income only a portion of the cash received from installment sales create a privilege. However, that privilege is subject to the condition imposed by section 44(d), which provides that gain or loss shall result from the disposition of installment obligations and sets forth in detail how that gain or loss is measured, and in addition provides that ‘Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.‘ Cf. F. E. Waddell, 37 B.T.A. 565, affd. 102 F.2d 503; Goldberg's Estate v. Commissioner, 189 F.2d 634, affirming 15 T.C. 10; Doyle J. Dixon, 16 T.C. 1016. The property in respect of which these installment obligations were received was a non-capital asset, namely, merchandise or stock in trade.
(d) GAIN OR LOSS UPON DISPOSITION OF INSTALLMENT OBLIGATIONS.—If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange— the amount realized, or (2) in case of distribution, transmission, or disposition otherwise than by sale or exchange— the fair market value of the obligation at the time of such distribution, transmission, or disposition. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. * * *
The cases relied upon by the petitioner are ones where there is no express provision of the Code for the determination of the amount and nature of the gain. They are not determinative here. We hold, pursuant to section 44(d), that a gain resulted from a disposition of installment obligations and that since the installment obligations were received for merchandise or stock in trade, the gain constitutes ordinary income. Cf. F.E. Waddell, supra; Goldberg's Estate v. Commissioner, supra; Doyle J. Dixon, supra.
The amount of the gain is computed by the formula set forth in section 44(d). It is the difference between the basis of the installment obligations and the amount realized upon their disposition. We have found that to be $8,979.25. This is the figure used by the Commissioner in making his determination and we have been furnished with no evidence which would warrant our adopting a different figure.
Section 44(d) provides that ‘The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.‘
Adjustment of the basis and sales price to g)ve effect to this determination can be made under Rule 50.
The facts relating to depreciation on farm buildings, farm costs and travel expenses are set out in our findings. The record fully justifies their deduction as ordinary and necessary business expenses. Section 23(a)(1)(A); section 23(l).
The petitioner Rhett Woody did not contest the respondent's determination that for the taxable year 1945 his net income was $13,153.42 rather than $7,519.55 as reported. The difference of $5,633.87 consisted of unreported partnership income in the amount of $4,883.87 and an excessive deduction for a capital loss that was reported as an ordinary loss. The failure to contest or explain the items or to offer any excuse about them warrants sustaining the respondent's determination of a negligence penalty for 1945.
SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.(a) NEGLIGENCE.— If any part of any deficiency is due to negligence, or intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency, except that the provisions of section 272(i), relating to the prorating of a deficiency, and of section 292, relating to interest on deficiencies, shall not be applicable.
We do not think the negligence penalty as determined for 1946 should be sustained. The larger part of the deficiency results from the petitioner's treatment of the sale of his partnership interest and the disposition of installment obligations. While we have found petitioner's treatment erroneous, he followed the advice of a qualified public accountant conversant with tax return. Cf. Hatfried v. Commissioner, 162 F.2d 628; Davis v. Commissioner, 184 F.2d 86; Haywood Lumber & Mining Co. v. Commissioner, 178 F.2d 769; Joe W. Scales, 18 T.C. 1263; cf. Pullman, Inc., 8 T.C. 292; Davis Regulator Co., 36 B.T.A. 437.
Reviewed by the Court.
Decisions will be entered under Rule 50.