Heiner v. Mellon

• Decision Date: 16 May 1938
• Docket Number: Nos. 144,145,s. 144
• Citation: 82 L.Ed. 1337,304 U.S. 271,58 S.Ct. 926
• Parties: HEINER v. MELLON et al. (two cases)
• Court: U.S. Supreme Court

304 U.S. 271

58 S.Ct. 926

82 L.Ed. 1337

HEINER

v MELLON et al. (two cases).

Nos. 144, 145.

Argued March 8, 1938.

Decided May 16, 1938.

Messrs. Homer S. Cummings, Atty. Gen., and Golden W. Bell, Asst. Sol. Gen., for petitioner.

Mr. John G. Frazer, of Pittsburgh, Pa., for respondents.

Mr. Justice BRANDEIS delivered the opinion of the Court.

These cases, tried below in the federal court for Western Pennsylvania and argued together here, arise from the same facts and present the same questions of law. Each action was brought against D. B. Heiner, as former Collector of Internal Revenue and individually, to recover an amount paid under protest by the taxpayer in 1927 upon a deficiency assessment of his 1920 income tax. The amounts taxed as additional income were the distributive shares of certain profits alleged to have been earned by each in 1920 as a partner in two firms. Due demand for a refund was made. In No. 144 the taxpayer was A. W. Mellon; in No. 145, R. B. Mellon. Both having died, the suits are by their executors. In No. 144, the District Court entered judgment for $202,502.22 with interest (14 F.Supp. 424); in No. 145 for $187,787.17 with interest. These judgments were affirmed by the Circuit Court of Appeals, 3 Cir., 89 F.2d 141. Certiorari was granted because of alleged conflict as to applicable rules of law important in the administration of the revenue laws. 302 U.S. 672, 58 S.Ct. 21, 82 L.Ed. —-.

There is no dispute as to the relevant facts. Prior to December 12, 1918, A. W. Mellon, R. B. Mellon, and H. C. Frick each owned one-third of the entire capital stock of two distilling corporations—A. Overholt & Company and West Overton Distilling Company. On that day those three individuals formed two partnerships in which each partner was to have a one-third interest. In January, 1919, they caused to be transferred to the partnership called A. Overholt & Company all the assets of the corporation of that name; and to the partnership called West Overton Distilling Company, all the assets of that corporation. These assets included large whisky inventories in bonded warehouses. Neither corporation had distilled any whisky after 1916. Liquidation of the businesses of each had been started by the two corporations in 1918; and the partnerships had been organized for the purpose of liquidating them. The business of each partnership in 1920, had, like its business in 1919, consisted in the sale of whisky certificates and the storage, bottling, casing, and sale of the stock of whisky. It was not until 1925 that the assets of the partnerships then remaining were sold in bulk, and the proceeds distributed among those entitled thereto.

Frick died December 2, 1919; but throughout 1920 the businesses of A. Overholt & Company and of West Overton Distilling Company were conducted, and their books were kept, in the same manner as the businesses had been conducted and books had been kept by the partnerships in 1919, and by the corporations in 1918. For 1920 the partnership returns of the two concerns disclosed factsfr om which it appeared that substantial gains had been made from the sale of whisky. But the amounts were not reported as income of the partnerships; and neither A. W. Mellon nor R. B. Mellon included in their income tax returns for 1920 any amount on account of them. The Commissioner of Internal Revenue determined that these sums were distributive profits; that the returns of taxable income of A. W. Mellon and of R. B. Mellon for the year 1920 should have included one-third of the profits in that year of each firm from the sale of whisky; and made a deficiency assessment on A. W. Mellon of $190,419.70 and on R. B. Mellon of $175,259.70.

The Revenue Act of 1918¹ governs taxation of 1920 income. Section 218(a) of the Act provides that individuals carrying on business in partnership shall be liable in their individual capacities for the income tax on profits earned therein, and that in computing the net income of each partner there shall be included his distributive share, whether distributed or not, of the net income of the partnership for the taxable year. Section 224 provides that the partnership shall file an informational return setting forth the items of its gross income, the deductions allowed and the distributive share of net income to which each partner is entitled.

The two Mellons filed their individual returns for 1920, and also the informational partnership returns for that year. While the Mellons claimed that they were not taxable on their share of the profits from whisky sold in 1920, they recognized that they were taxable for their shares of these other profits of the concerns earned in 1920. The partnership returns in the case of each concern showed a gain arising from storage, bottling and casing operations, sales of barrels, interest and rentals. One-third of each of these profits was entered by each of the Mellons in his individual return as his distributive share of the profits of the two partnerships.

First. The primary question for decision is whether the net profits made by the two partnerships in 1920 from the sales of whisky were in their nature taxable income. Throughout 1920, A. Overholt & Company and the West Overton Distilling Company were engaged in business. The mere fact that the purpose of the partnerships was to liquidate the assets taken over from the corporations is not of legal significance. Profits made in the business of liquidation are taxable in the same way and to the same extent as if made in an expanding business. Nor is it of legal significance that the liquidation was not completed until 1925 and that until completion of the liquidation it could not be known whether the business venture, taken as a whole, had been profitable. The federal income tax system is based on an annual accounting.² Under that law the question whether taxable profits have been made is determined annually by the result of the operations of the year.

Purchasing real estate, subdividing and selling it in parcels is, in essence, a liquidating business. The claim has been repeatedly made that no income was realized until the investment was recouped; but the Board of Tax Appeals has uniformly held in accord with Article 43 of Regulations 45 (and later regulations) that the cost of the real estate must be apportioned among all the lots, and income returned upon the sales in each year, regardless of the number of lots remaining undisposed of at the cos e of the tax year.³ A like rule has been applied where the taxpayer had purchased personal property in a block and was engaged in selling it in parcels. The claim that there was no taxable income until the capital had been returned was rejected.⁴

The fact that it might prove that when the business was fully liquidated the profits of 1920 were offset by heavy loss of later years is immaterial. Losses suffered by a taxpayer in a later year may be deducted from profits, if any, earned by him in that later year; but the tax on a year's income may not be withheld because losses may thereafter occur. If A. Overholt & Company and West Overton Distilling Company had remained corporations they would have been obliged to make each year return of the profits made therein and pay taxes annually throughout the perid of liquidation although it might ultimately prove that the losses of the later years exceeded the profits of the earlier ones. ⁵ Likewise, if the concerns had each been owned by a single individual, the fact that his sole business was liquidating the concern would not have relieved him from paying annually taxes on the net profits No good reason is suggested why a different rule should apply to partnerships.

We conclude that gains from the sale of whisky in 1920 were income of that year. The amount of the income was determinable from the partnership books. Section 212(b) of the Revenue Act of 1918 provides that the net income shall be computed 'in accordance with the method of accounting regularly employed in keeping the books of' the taxpayer, and it is not shown that the method employed clearly failed to reflect net income.

Second. The fact that the partnerships had been dissolved by Frick's death before 1920 does not affect the liability of the Mellons as surviving partners for income taxes on their distributive shares of the net profits made in that year. Compare Rossmoore v. Anderson, D.C.S.D.N.Y., 1 F.Supp. 35, affirmed, 2 Cir., 67 F.2d 1009; Rossmoore v. Commissioner, 2 Cir., 76 F.2d 520. The business of A. Overholt & Company did not terminate on Frick's death. Although dissolved, the partnerships and the business continued, since, as stated in the Pennsylvania Uniform Partnership Act: 'On dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed.'⁶ Throughout the year 1920, the business of selling stock on hand and deriving income therefrom was carried on precisely as it had been theretofore, and for th § ame purpose. Article 424 of Regulations 45 recognizes that even in the hands of a receiver a partnership must file a return.

Third. The Mellons contend, and the court below held, that the partners' interests in the partnerships were capitalized upon dissolution, so that until the liquidation returned to them the cost of their interests, no taxable income was received; that Article 1570 of Regulations 45 so provides; and that this did not take place before 1925. But, as already pointed out, technical dissolution does not affect the liability of a partner under section 218 for taxes on his distributive share of the partnership's income; and Article 1570 does not establish any rule that dissolution capitalizes the interest of a partner in future partnership profits. The article provides: 'When a partner retires from a partnership, or it is dissolved, he realizes a gain or loss measured by the difference between the price received for his interest and the cost to him or...