3 T.C. 396 (1944), 1429, Tower v. C. I. R.

Docket Nº1429.
Citation3 T.C. 396
Opinion JudgeHARRON, Judge:
AttorneyOscar E. Waer. Esq., and Frank E. Seidman, C.P.A., for the petitioner. Melvin S. Huffaker, Esq., for the respondent.
Case DateMarch 03, 1944
CourtUnited States Tax Court

Page 396

3 T.C. 396 (1944)




No. 1429.

United States Tax Court

March 3, 1944

Page 397

Oscar E. Waer. Esq., and Frank E. Seidman, C.P.A., for the petitioner.

Melvin S. Huffaker, Esq., for the respondent.

Prior to August 30, 1937, petitioner owned all but a few shares of stock of a corporation which carried on a business of manufacturing sawmill machinery. Petitioner had been the real operator of the business for ten years. In August of 1937 he decided to dissolve the corporation and transfer the assets and business to a partnership. Five days prior to the dissolution of the corporation, and in anticipation thereof, petitioner transferred some of his stock in the corporation to his wife, and two days prior thereto a partnership agreement was executed under which the wife was to be a limited partner. Thereafter the corporation's assets were transferred to the partnership. The wife did not contribute any services to the business. The business was conducted by petitioner after the changeover to a partnership in the same way as before, except that petitioner was not paid a salary and part of the earnings were credited to a capital account in the wife's name. Held, (1) that there was no bona fide gift of stock to the wife and that she did not contribute capital to the partnership; (2) that there was not a true partnership between petitioner and his wife for the conduct of a business, but a partnership for tax avoidance which can not be recognized.

Respondent determined deficiencies of $599.55 and $2,758.18 in petitioner's income tax returns for the respective fiscal years ended July 31, 1940, and July 31, 1941. Some of the adjustments are not in controversy here. The issue is whether the amounts of $6,661.16 and $13,958.57 which were credited in the taxable years to petitioner's wife as her distributive share of the net income of an alleged partnership are taxable to petitioner. In the alternative, respondent contends that the partnership was an association taxable as a corporation.

Petitioner resides in Greenville, Michigan, and filed his returns for the taxable years with the collector for the district of Michigan.


The R. J. Tower Iron Works, located at Greenville, Michigan, is engaged in the manufacture and sale of sawmill machinery and wood and metal stampings. Petitioner has been actively engaged in the business for the past 28 years and since the death of his father, R. J. Tower, in November 1927, petitioner has assumed the responsibility of carrying on the management and operation of the business. In the taxable years the business had an average of 40 to 60 employees, gross assets of approximately $200,000, and an average steel inventory on hand of approximately $50,000. The sawmill machinery was marketed through dealers and the stampings were sold directly to manufacturers of refrigerators and stoves.

On September 9, 1933, the business was incorporated under the name of ‘ The R. J. Tower Iron Works, Inc.,‘ hereinafter referred to as the corporation. The outstanding capital stock consisted of 500 shares of a par value of $100 per share, of which petitioner received 425 shares, Harvey A. Amidon received 50 shares, and H. J. Lawrance received 25 shares. The bylaws required that the directors hold stock in the corporation and the 3 stockholders were the directors. Petitioner was president, and Amidon was secretary and treasurer. Approximately 6 months after the corporation was organized, in the early part of 1934, petitioner purchased Lawrance's 25 shares of stock and Lawrance severed his connection with the corporation. Immediately after purchasing Lawrance's stock, petitioner made a gift of 5 shares to his wife,

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Hazel I. Tower, who was made a director and vice president of the corporation. After the gift of 5 shares to his wife, petitioner owned 445 shares, and Amidon owned 50 shares. The ownership of the shares remained the same until August 1937.

A tentative operating statement as of July 31, 1937, showed that the business of the corporation had been successful and that substantial profits had been realized in the year 1937. In July 1937, after having discussed the matter with his wife, petitioner talked with Amidon with regard to the advisability of dissolving the corporation and setting up a partnership. Amidon kept the books of the corporation under petitioner's supervision, and he had worked in the business for a long time. Amidon had no objection to the formation of a partnership and believed that the change would not create any great risk as far as he was personally concerned. Consultations in this respect were also held with petitioner's attorney and his accountant, who took care of petitioner's tax matters. They were all of the opinion that the formation of a partnership would result in a tax savings and alleviate the necessity of filing various corporate returns. It was decided that petitioner should transfer stock of the corporation to his wife so that she would be able to contribute a substantial share of the partnership capital.

On August 25, 1937, petitioner transferred to his wife 190 shares of the corporate stock owned by him. The transfer was conditional upon the wife's placing the corporate assets which the shares represented into the new partnership. The transfer was recorded on the corporate books and a new stock certificate was issued and delivered to petitioner's wife. Petitioner filed a gift tax return on March 15, 1938. He reported the 190 shares of stock transferred to his wife at a value of $57,114.60 and paid a gift tax of $213.44.

The corporation was completely liquidated on August 28, 1937, and it was dissolved on August 30, 1937. On August 28, 1937, petitioner, his wife, and Amidon executed a limited partnership agreement for the purpose of carrying on the business of the corporation, and all of the assets and liabilities of the corporation were transferred to the partnership.

The partnership agreement provided that the business would be carried on under the firm name of R. J. Tower Iron Works, for a period of 20 years, unless sooner terminated by a decision of a majority in interest of the partnership capital; that petitioner and Amidon would be general partners and petitioner's wife would be a limited partner; that petitioner's contribution to the partnership capital was $81,600, his wife's was $62,400, and Amidon's was $16,000; and that the partners would share profits and losses in proportion to their respective

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contributions to capital, except that petitioner's wife was not liable for losses in excess of her capital contribution. The agreement further provided, among other things, that the general partners were to have the exclusive voice in the management and control of the business and were authorized to determine the salaries of the general partners; that if a majority of the general partners were unable to agree, a majority of the general partners in capital interest would control; that accounts of the partnership business would be rendered to the partners each year; and that the net profits for each year would be distributed at such times and in such manner as the general partners might determine.

A certificate of limited partnership was filed with the clerk of the Circuit Court of Montcalm County on August 31, 1937. Notification of the liquidation of the corporation and the formation of the partnership was given to those banks with which the corporation had transacted business.

Under the partnership agreement petitioner's share of the partnership profits and losses amounted to 51 percent; his wife's share amounted to 39 percent; and Amidon's share amounted to 10 percent. Amidon had formerly been employed by the corporation as a bookkeeper and he continued to perform similar work for the partnership. In the early part of 1938 his responsibilities and duties increased as a result of an increase in the volume of business. Petitioner and his wife were of the opinion that Amidon was entitled to a larger share in the profits and, accordingly, his share in the profits was increased from 10 percent to 25 percent on September 1, 1938. The shares of petitioner and his wife were proportionately decreased and thereafter petitioner received 42 1/2 percent of the profits and petitioner's wife received 32 1/2 percent. The redistribution of profits was orally agreed upon between the parties, and the original agreement and the certificate of partnership on file with the county clerk were not formally amended. It was also orally agreed that petitioner and Amidon would not withdraw any future salary for their services. The original capital contributions of the parties remained the same.

Partnership accounts were maintained on an accrual basis for the fiscal year ending August 31. Capital accounts were opened on the books of the partnership, showing the amounts contributed by each party. Distributive shares of the profits of the parties were credited either to the capital account or to the drawing account of each individual party. The respective withdrawals of each party were charged to the drawing accounts. The share of profits and the aggregate net

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withdrawals of each of the parties for the fiscal years ended August 31, 1938, August 31, 1939, and August 31, 1940, were as follows:

Share of profits credited to individual capital or drawing accounts Withdrawals
Year ended 8/31/38 Year ended 8/31/39 Year ended 8/31/40 Year ended 8/31/38 Year ended 8/31/39 Year ended 8/31/40
Francis E. Tower $2,658.28 $8,374.32 $17,947.26 $5,394.78 $10,458.38 $4,973.25
Harvey A. Amidon 521.23 4,926.06 10,557.21 938.96 4,410.18 5,183.08
Hazel I. Tower 2,032.80

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