Lusthaus v. COMMISSIONER OF INTERNAL REVENUE

• Decision Date: 11 April 1945
• Docket Number: No. 8697.,8697.
• Citation: 149 F.2d 232
• Parties: LUSTHAUS v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

149 F.2d 232 (1945)

LUSTHAUS v. COMMISSIONER OF INTERNAL REVENUE.

No. 8697.

Circuit Court of Appeals, Third Circuit.

Argued December 7, 1944.

Decided April 11, 1945.

Paul E. Hutchinson, of Pittsburgh, Pa. (W. A. Seifert, William Wallace Booth, and Reed, Smith, Shaw & McClay, all of Pittsburgh, Pa., and Joseph W. Ray, Jr., of Uniontown, Pa., on the brief), for petitioner.

Meyer Rothwacks, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and A. F. Prescott, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before GOODRICH and McLAUGHLIN, Circuit Judges, and FAKE, District Judge.

McLAUGHLIN, Circuit Judge.

The question presented is whether the asserted partnership of the taxpayer and his wife should be so recognized for federal income tax purposes. The year involved is 1940.

It is conceded for the petitioner that the facts as found by the Tax Court are substantially correct. Briefly these are: For several years prior to 1940, the petitioner owned and operated a retail furniture business, consisting of two stores, both in Uniontown, Pennsylvania. In 1939 petitioner conferred several times with an accountant and an attorney and it was decided that he would "sell" to his wife a one-half interest in his business and make her an equal partner as of January 1, 1940. The net worth of the business, excluding goodwill and after a withdrawal of $20,000 by petitioner, was determined to be $210,000. Petitioner decided to make a gift to his wife of $50,000 so that she would have it as part of the purchase money for the one-half interest. After some delay, in June, 1940, the petitioner executed a bill of sale to his wife for a one-half undivided interest in his furniture business. The stated consideration was $105,253.81, representing one-half of the estimated value of the business on December 31, 1939. Mrs. Lusthaus, at or about the same time, executed a partnership agreement. A few days later the petitioner borrowed $25,000 from a bank. He gave his wife a check for $50,000, which sum was made up from the proceeds of the loan and from money previously withdrawn from the business. Then Mrs. Lusthaus gave petitioner her check for $50,253.81 together with eleven promissory notes totalling $55,000, as the purchase price. At that time Mrs. Lusthaus owned her own home valued at $25,000 and at least $20,000 of securities. On July 31, 1940, a certificate authorizing the petitioner and his wife to carry on business under the fictitious name of "Household Furniture Co." was issued by the Commonwealth of Pennsylvania. A gift tax return for 1940 was filed by the petitioner and this reported a gift to his wife of $50,000 on January 1, 1940.

Thereafter the business proceeded in much the same fashion as prior to the partnership transaction. Petitioner, as always, managed the business. Such management was specifically provided for in the partnership agreement. The wife who had assisted in the store, or stores, prior to the partnership arrangement, continued that practice. She received no salary at any time. Prior to 1940 Mr. and Mrs. Lusthaus had maintained a joint bank account. In 1940 they opened separate accounts. There was a third account for the Household Furniture Co. In 1940 the petitioner withdrew $4,604.76 from the business and the wife withdrew $59.61. In 1941 the petitioner withdrew $19,198.69 and the wife $16,317.86. The profits of the business were credited equally at the close of each year. Mrs. Lusthaus has paid three of the promissory notes. In 1940 a partnership return was filed in the name of "Household Furniture Co." showing a net profit of $80,280.20. Petitioner and his wife each reported one-half of that amount less partnership contributions, etc., in their individual returns for 1940.

On these facts the Tax Court found that the petitioner is taxable on all of the profits from the said furniture business in 1940. That Court said: "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."

On behalf of the petitioner it is asserted that the Tax Court erred as a matter of law in so concluding from the facts. It is urged that the facts show a legitimate, operating partnership business under general law and under the Partnership Act of the Commonwealth of Pennsylvania. 59 P.S. § 1 et seq. Even assuming that the arrangement more or less complied with the formalities of the Pennsylvania law, that would not necessarily be binding for tax purposes. The cases hold that the status must be genuine, with a change in economic interest. Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, 97 A.L.R. 1355; Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788; Higgins v. Smith, 308 U.S. 473, 60 S.Ct. 355, 84 L. Ed. 406; Griffiths v. Commissioner of Internal Revenue, 308 U.S. 355, 60 S.Ct. 277, 84 L.Ed. 319. It is well settled that taxation is a practical matter in which substance controls the form. Harrison v. Schaffner, 312 U.S. 579, 61 S.Ct. 759, 85 L.Ed. 1055; United States v. Phellis, 257 U.S. 156, 42 S.Ct. 63, 66 L.Ed. 180; Weiss v. Stearn, 265 U.S. 242, 44 S.Ct. 490, 68 L.Ed. 1001, 33 A.L.R. 520.

The one real problem is whether there was substantial evidence to support the Tax Court's conclusion. If there was, then we are not at liberty to re-weigh the evidence or to choose between conflicting inferences. Commissioner of Internal Revenue v. Scottish American Investment Co., Limited, 65 S.Ct. 169; Dobson v. Commissioner of Internal Revenue, 320 U.S. 489, 64 S.Ct. 239, 88 L.Ed. 248, rehearing denied 321 U.S. 231, 64 S.Ct. 495, 88 L.Ed. 691.

It could be inferred from the evidence that there was no real contribution of capital by Mrs. Lusthaus. The circumstances surrounding the $50,000 incident, with the money immediately returned to the petitioner, could be construed as indicating that the latter had not divested himself irrevocably of the subject matter of the gift. Mrs. Lusthaus' services to the partnership were virtually the same as she had rendered in the stores prior to 1940. The testimony could be taken to indicate that the conduct of the parties with reference to the furniture company did not change. In Earp v. Jones, 10 Cir., 131 F.2d 292, certiorari denied, 318 U.S. 764, 63 S.Ct. 665, 87 L.Ed. 1136, the Court said at page 294:

"One may not merely change the form but do business in substantially the same way. An essentially new and different economic unit must be formed."

Other evidence not specifically set out in the findings of fact tends to justify the Tax Court's decision. For example, the bank with which the company had its account was not given the right to accept Mrs. Lusthaus as a partner of the concern with authority to draw checks until 1943. The petitioner continued to file social security tax returns as owner of the business through 1940 and up until June of 1941.

As the Supreme Court says in its Scottish American opinion, supra 65 S.Ct. 172, "Our examination of the record convinces us that the factual inferences and conclusions of the Tax Court are supported by substantial evidence * * *." We cannot say here that the Tax Court's conclusion to the effect that the alleged partnership was not bona fide, is unreasonable. The decision of the Tax Court is, therefore, affirmed.

FAKE, District Judge (dissenting).

This is not the first time a partnership between husband and wife has been dealt with by the Federal Courts as bearing on the payment of income taxes. If, however, there is any one sphere wherein the axiom should be followed that every case must be decided upon its own peculiar facts, it is in this complicated and elusive sphere.

A careful study of the cases cited in the briefs, together with some independent research, fails to disclose any other case wherein the pertinent evidentiary factors of the instant case are all met with. In short, nothing has been found on all fours with the problem here. While it is true that certain basic principles are spelled out in the cases and the rule requiring substantial evidence has become more or less fixed, much is yet to be desired before the lower courts can function on the subject with certainty. So also counsel, learned in the law, are placed in the same dilemma in advising their clients on the subject.

The uncontradicted evidence in this case discloses that the petitioner and his wife had given considerable thought to the question of a business partnership between them and endeavored to embark upon such a relationship. To this end petitioner retained counsel familiar with the law and also a public accountant skilled in the pertinent tax problems and the necessary actuarial factors to be considered. As a result of conferences between the petitioner and his wife and in the light of the advice of the accountant and counsel, the following steps were taken to the end that a partnership might be established:

(1) The value of petitioner's business was ascertained from a statement made up from the books of the business and fixed at $230,507.62, as of January 1, 1940.

(2) On January 12, 1940, petitioner withdrew $20,000 in cash from the business, thus reducing the value of the assets to $210,507.62.

(3) On June 4, 1940, a partnership agreement was entered into between petitioner and his wife, taking effect retroactively on January 1, 1940, wherein the value of the assets is fixed at $210,507.62, because of the withdrawal of $20,000 as above mentioned.

(4) On the same day, to wit, June 4, 1940, the petitioner executed and delivered to his wife a bill of sale transferring to her an undivided one-half interest of, in and to the assets of the business in consideration of the sum of $105,253.81.

(5) Petitioner made his wife a present of $50,000, evidenced by his check, to be applied by her to the purchase price above mentioned and paid a gift...