Lusthaus v. Comm'r of Internal Revenue, Docket No. 112702.

• Citation: 3 T.C. 540
• Decision Date: 29 March 1944
• Docket Number: Docket No. 112702.
• Parties: A. L. LUSTHAUS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

3 T.C. 540

A. L. LUSTHAUS, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 112702.

Tax Court of the United States.

Promulgated March 29, 1944.

HUSBAND AND WIFE PARTNERSHIP.— Petitioner entered into a partnership agreement with his wife in 1940, purporting to make her an equal partner in a furniture business which he had operated for a number of years. He gave her $50,000, which she immediately returned to him, with her promissory notes for $55,000 and a negligible amount of her own funds, in payment for her one-half interest. Thereafter, she contributed no additional capital and rendered only casual services to the business, as she had always done. Held, that all of the profits of the business are taxable to petitioner as his individual earnings. W. A. Seifert, Esq., William Wallace Booth, Esq., Jos. W. Ray, Jr., Esq., Paul E. Hutchinson, Esq., and A. G. Wallerstedt, C.P.A. for the petitioner.

W. J. McFarland, Esq., for the respondent.

The respondent has determined an income tax deficiency of $22,419.98 for 1940. The principal amount, and contested portion, of the deficiency results from the inclusion in petitioner's gross income of all of the profits of a furniture business which petitioner and his wife reported in equal shares as partnership income.

FINDINGS OF FACT.

Petitioner is a resident of Uniontown, Pennsylvania. He filed his income tax return for 1940 with the collector if internal revenue for the twenty-third district of Pennsylvania.

For several years prior to 1940 petitioner operated as a sole proprietorship a retail furniture business at Uniontown, Pennsylvania. There were two stores, one known as Household Furniture Co. and one as Furniture Outlet Store.

During 1939 petitioner had several conferences with an accountant and an attorney of Uniontown to discuss the matter of making his wife an equal partner in his furniture business. It was decided in the latter part of that year that petitioner would ‘sell‘ to his wife a one-half interest in the business and make her an equal partner as of January 1, 1940. Petitioner instructed his accountant to determine the value of the business and make the necessary changes in the books of account and instructed the attorney to prepare the necessary legal papers.

The net worth of the business, based on book value of all physical assets and inventory but not including good will, was determined to be $230,000. It was decided that petitioner would withdraw $20,000 from the business, leaving a net worth of $210,000; that he would make his wife a gift of $50,000, which she would use as part payment for her one-half interest, and that for the balance, $55,000, she would give petitioner her promissory notes payable $5,000 annually. Petitioner told his wife of the plan and she agreed to it.

The formalities of the transfer were delayed, first by the illness of petitioner's attorney in December 1939, then by the absence of the attorney while he and his wife were on a visit to Mexico in January and February 1940, and finally by the absence of petitioner and his wife while they were on a visit to Florida in March and April 1940. A bill of sale was executed by petitioner on June 4, 1940. A few days later petitioner borrowed $25,000 from the bank and gave his wife a check for $50,000. This check was drawn against the funds previously withdrawn from the business and those borrowed from the bank. Petitioner's wife then gave petitioner her check dated June 18, 1940, for $50,253.81. She also executed and delivered to him eleven promissory notes for $55,000, as previously agreed upon, in payment of the balance of the purchase price for her interest in the partnership. At that time petitioner's wife owned her home, valued at $25,000 or $30,000, and about $20,000 or $25,000 of securities. A certificate authorizing petitioner and his wife to carry on business under the fictitious name of Household Furniture Co. was issued by the Commonwealth of Pennsylvania on July 31, 1940.

Petitioner filed a gift tax return for 1940 in which he reported a gift to his wife of $50,000 on January 1, 1940.

Petitioner's furniture business was conducted in substantially the same manner after the consummation of the partnership arrangements as before. Petitioner continued to manage the business, as he was authorized to do under the partnership agreement. His wife helped out at the stores— or one of them—whenever she was needed, just as she had always done. She took no active part in the management of the business. She never received any compensation for her services.

Prior to 1940 petitioner and his wife maintained a joint bank account. Sometime in 1940 they opened separate accounts. A separate account was maintained for the business in the name of Household Furniture Co. During 1940 petitioner withdrew $4,604.76 from the business and his wife withdrew $59.61. In 1941 petitioner withdrew $19,198.69 and his wife $16,317.86. At the close of each year the profits of the business were credited on the books to petitioner and his wife equally.

A partnership return was filed in the name of Household Furniture Co. for 1940, showing a net profit of $80,280.20. Petitioner and his wife each reported one-half of that amount (less partnership contributions of $1,135.99) in their individual returns for 1940.

Petitioner's wife has paid three of the eleven promissory notes which she gave petitioner under the partnership agreement as they became...