Commissioner of Internal Revenue v. Tower

• Decision Date: 25 February 1946
• Docket Number: No. 317,317
• Citation: 90 L.Ed. 670,327 U.S. 280,66 S.Ct. 532
• Parties: COMMISSIONER OF INTERNAL REVENUE v. TOWER
• Court: U.S. Supreme Court

327 U.S. 280

66 S.Ct. 532

90 L.Ed. 670

COMMISSIONER OF INTERNAL REVENUE

v TOWER.

No. 317.

Decided Feb. 25, 1946.

Argued Jan. 10, 11, 1946.

[Syllabus from pages 280-282 intentionally omitted] Mr.Arnold Raum, of Washington, D.C., for petitioner.

Mr. Oscar E. Waer, of Grand Rapids, Mich., for respondent.

Mr. Justice BLACK delivered the opinion of the Court.

The Commissioner of Internal Revenue determined that respondent's wife had in her income tax returns for 1940 and 1941 reported as her earnings, income that actually had been earned by her husband but had not been reported in his returns. A deficiency assessment was consequently levied against the respondent by the Commissioner. The particular earnings involved were a portion of net income attributed to a partnership, to which, according to its records, 90 per cent of the capital had been contributed by respondent and his wife, of this, 51 per cent had been contributed by the respondent and 39 per cent by his wife. If as respondent asserts, the circumstances surrounding the formation and operation of this partnership were such as to bring it within the meaning of Sections 181 and 182 of Title 26 of the United States Code, 26 U.S.C.A. Int.Rev.Code, §§ 181, 182, then the respondent and his wife are liable only for their respective individual share of the business' income. These sections provide that partners are liable for taxes on partnership income only in their 'individual capacity' and that each partner shall report 'his distributive share of the ordinary net income * * * of the partnership.' But Section 11 of Title 26 of the United States Code, 26 U.S.C.A. Int.Rev.Code, § 11, levies a tax on the 'net income of every individual', and the 'net income' is required to be computed on the basis of 'gross income' as defined in Section 22(a), which broadly includes all earnings of any individual from 'any source whatever.' And we have held that the dominant purposes of all sections of the revenue laws, including these, is 'the taxation of income to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid.' Helvering v. Horst, 311 U.S. 112, 119, 61 S.Ct. 144, 148, 85 L.Ed. 75, 131 A.L.R. 655. The basic question in deciding whether the Commissioner's deficiency assessment was proper, is: Was the income attributed to the wife as a partner income from a partnership for which she alone was liable in her 'individual capacity', as provided by 26 U.S.C. §§ 181, 182, 26 U.S.C.A. Int.Rev.Code, §§ 181, 182, or did the husband, despite the claimed partnership actually create the right to receive and enjoy the benefit of the income, so as to make it taxable to him under Sections 11 and 22(a)?

The respondent asked the Tax Court to review and redetermine the Commissioner's deficiency assessment, insisting that the income in question was not the respondent's but his wife's share in a partnership. The Commissioner urged in the Tax Court that the wife had contributed neither services nor capital to the partnership and that her alleged membership in the partnership was a sham. Respondent admitted that she had not contributed her services, but contended that she had made a contribution of capital as shown by the amount attributed to her on the partnership books and that she was a bona fide partner. Her alleged contribution consisted of assets which the husband claimed to have given to her three days before the formation of the partnership.

The Tax Court concluded that the respondent had never executed a complete gift of the assets which his wife later purportedly contributed to the partnership; that after the partnership was formed respondent continued to manage and control the business as he had done for many years before; that his economic relation to the portion of the partnership income which was attributed to his wife was such that it continued to be available to be used for the same purposes as before, including ordinary family purposes; that the effect of the whole partnership arrangement, so far as it involved respondent and his wife was a mere reallocation of respondent's business income within the family group; and that the dissolution of the corporation and the subsequent formation of the partnership fulfilled no business purpose other than a reduction of the husband's income tax. The Tax Court concluded that this family partnership income was in fact earned by the husband; that there was no real partnership between petitioner and his wife for purposes of carrying on a business enterprise; that the wife received a portion of the income 'only by reason of her marital relationship', and held that the entire income was, therefore, taxable to the respondent under 26 U.S.C. § 22(a), 26 U.S.C.A. Int.Rev.Code. § 22(a), 3 T.C. 396. The Circuit Court of Appeals for the Sixth Circuit reversed. 148 F.2d 388. he Circuit Court of Appeals for the Third Circuit Court sustained a holding by the Tax Court, 3 T.C. 540, based on facts in all material respects similar to the ones in this case, that all the income from a husband-wife partnership was taxable income of the husband under 26 U.S.C. § 22(a), 26 U.S.C.A. Int.Rev.Code, § 22(a). Lusthaus v. Commissioner, 149 F.2d 232. Other Circuit Courts of Appeals have also sustained similar holdings by the Tax Court.¹ As is indicated by numerous Tax Court decisions, attempts to escape surtaxes by dividing one earned income into two or more through the device of family partnerships have recently created an acute problem.² Because of the various views expressed as to controlling legal principles in the decisions discussing such arrangements, we granted certiorari both in this and the Lusthaus case.

A statement of some of the pertinent facts shown by the record and on which the Tax Court based its conclusion will cast some light on the problem. Broadly speaking, these facts follow a general patterm found in many of the 'family partnership' cases. The business here involved, R. J. Tower Iron Works, is located in Greenville, Michigan and has manufactured and sold sawmill machinery and wood and metal stampings. Respondent's participation in the business dates back twenty-eight years. He has managed and controlled the company since the death of his father in 1927. During the tax years in question the business had forty to sixty employees on its pay roll. From 1933 to 1937 the business was operated as a corporation. The respondent was the president of the corporation and owned 445 out of the 500 shares outstanding, ³ his wife was vice president and owned five shares, and one Mr. Amidon was the secretary, owning twenty-five shares. These three also constituted the Board of Directors, and while Tower managed the corporate affairs, Amidon acted as bookkeeper. Mrs. Tower performed no business services.

In 1937 substantial profits pointed to increased taxes. Respondent's attorney and his tax accountant advised him that dissolution of the corporation and formation of a partnership with his wife as a principal partner, would result in tax savings and eliminate the necessity of filing various corporate returns. The suggested change was put into effect. August 25, 1937, respondent transferred 190 shares of the corporation's stock to his wife on the condition that she place the corporate assets represented by these shares into the new partnership. Respondent, treating the stock transfer to his wife as a gift valued at $57,000, later paid a gift tax of $213.44. Three days after the stock transfer the corporation was liquidated, a limited partnership was formed and a certificate of partnership was duly filed for record as required by Michigan law. According to the books, the value of the donated stock became the wife's contribution to the partnership. The formation of the partnership did not in any way alter the conduct of the business, except that both Amidon and Tower ceased to draw salaries. By an agreement made shortly thereafter, a readjustment was made in the amount of profits each partner was to receive, under which Amidon's share became the equivalent of, if not more than, the amount of the salary he had previously drawn. Under the partnership agreement the respondent continued to have the controlling voice in the business, as to purchases, sales, salaries, the time of distribution of income, and all other essentials. Respondent's wife, as a limited partner, was prohibited from participation in the conduct of the business. So far as appears, the part of her urported share of the partnership business she actually expended was used to buy what a husband usually buys for his wife such as clothes and things for the family or to carry on activities ordinarily of interest to the family as a group.

We are of the opinion that the foregoing facts were sufficient to support the Tax Court's finding that the wife was not a partner in the business.⁴ A partnership is generally said to be created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses.⁵ When the existence of an alleged partnership arrangement is challenged by outsiders, the question arises whether the partners really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both. And their intention in this respect is a question of fact, to be determined from testimony disclosed by their 'agreement, considered as a whole, and by their conduct in execution of its provisions.' Drennen v. London Assurance Company, 113 U.S. 51, 56, 5 S.Ct. 341, 344, 28 L.Ed. 919; Cox v. Hickman, 8 H.L.Cas. 268. We see no reason why this general rule should not apply in tax cases where the government challenges the existence of a partnership for tax purposes.⁶ Here the Tax Court, acting pursuant to its authority in connection with the enforcement of federal laws, has found from...