37 T.C. 430 (1961), 80064, Campbell County State Bank, Inc. v. C. I. R.

Docket Nº:80064, 80065.
Citation:37 T.C. 430
Opinion Judge:TRAIN, Judge:
Attorney:Orville W. Robbins, Esq., for the petitioner. William Theodoros, Esq., for the respondent.
Case Date:December 11, 1961
Court:United States Tax Court

Page 430

37 T.C. 430 (1961)




Nos. 80064, 80065.

United States Tax Court.

December 11, 1961

Orville W. Robbins, Esq., for the petitioner.

William Theodoros, Esq., for the respondent.

1. The stockholders of a bank formed a partnership to engage in the insurance business, rather than use their bank for that purpose, because State law forbade banks to engage in other than banking activities. The partnership did engage in the insurance business. Held, the bank corporation and the insurance partnership are separate entities for Federal income tax purposes. Held, further, respondent may not, under section 482 of the Internal Revenue Code of 1954, disregard the separate existence of the insurance partnership by allocating to the bank all of the partnership's ‘ net’ income.

2. Held, on the facts, respondent's allocation of deductible expenses between the partnership and the corporation is sustained except for minor adjustments.

TRAIN, Judge:

Respondent determined deficiencies in income taxes of petitioner as follows:

Docket No. Year Deficiencies
80065 ( 1954 $4,391.99
( 1955 6,480.16
( 1956 5,562.62
80064 1957 5,533.50

Page 431 The issues are: (1) Whether respondent correctly determined that the income of the Herreid Insurance Agency is taxable to the Campbell County State Bank, Inc.; and (2) If not, whether respondent correctly determined that certain amounts deducted by the Campbell County State Bank, Inc., are properly deductions of the Herreid Insurance Agency and, if so, what those amounts should be. FINDINGS OF FACT. Some of the facts have been stipulated and are hereby found as stipulated. Petitioner Campbell County State Bank, Inc., of Herreid, South Dakota (hereinafter sometimes referred to as Bank), was organized and chartered under the laws of the State of South Dakota on March 19, 1944.[1] Its principal place of business is in Herreid, South Dakota. Corporate income tax returns of petitioner were filed with the district director of internal revenue for the district of South Dakota for the taxable years 1954 through 1957. Early in 1944, several of the organizers of Bank approached William Block (hereinafter sometimes referred to as Block) to ask him to buy stock in Bank and be its cashier. They also stated they were organizing a partnership to engage in the insurance business and asked Block if he would manage that business. Block said he would. At that time Block, in partnership with a man named Herboldt, was operating his own insurance agency at Herreid in the name of Herreid Insurance Agency. Block was also manager of the Herreid branch of the Eureka State Bank. When the incorporators of Bank received their charter to operate in Herreid, the Eureka State Bank was obliged to discontinue the operation of its Herreid branch.[2] In the spring of 1944 several of the incorporators of Bank requested legal advice from Paul O. Kretschmar (hereinafter sometimes referred to as Kretschmar), a South Dakota attorney, regarding the insurance business. Kretschmar, who had represented the Eureka State Bank, advised them that South Dakota law forbade banks from engaging in the insurance business. He suggested that, if they wished Page 432 to engage in the insurance business, they should create a separate partnership or corporation for that purpose. Articles of copartnership were drawn up by Block and executed by the 25 incorporations of Bank on June 13, 1944, creating the Herreid Insurance Agency (hereinafter sometimes referred to as Insurance). The articles provided as follows: ARTICLES OF AGREEMENT, made and concluded this 13th day of June in the year 1944 between the undersigned partners. The undersigned parties have agreed to associate themselves as partners for the purpose of carrying on the Herreid Insurance Agency of Herreid, South Dakota. The name, title and style of such partnership shall be the Herreid Insurance Agency of Herreid, South Dakota, which Agency is to conduct and carry on a general Insurance business. The said Agency shall be directed and supervised by the Bank Directors, who shall appoint the agents to operate the agency and said Bank Directors, shall have the supervision of the finances of said agency, regulate the agency, and make the necessary reports or that same be made by their direction to the partners herewith associated. Be it further stipulated and agreed that any stockholders selling his bank stock also sell his interest or share in the Herreid Insurance Agency to same purchaser at book value. IN WITNESS WHEREOF, we have hereunto set our hands and seals the day and year above written. On June 13, 1944, Bank and Insurance were controlled by the following persons who each owned 12 shares of stock in Bank and a one twenty-fifth interest in Insurance: R.B. White . . . William Jahraus . . . Edwin Bollinger . . . J. J. Rieker . . . Edward Beck . . . Jacob G. Hofer . . . George E. Bickel . . . Joseph J. Seiler . . . Fred Scherle . . . Joe Wolf . . . Alex Kurtz . . . John Traxinger . . . Andrew Huber . . . Matt Seiler . . . William Block . . . John K. Wiest . . . Louie Stellflug . . . Esther J. Werner . . . Jacob Schmidt . . . Dave Huber . . . Karns A. White . . . W. O. Olsen . . . Herman Klaudt . . . John Vojta . . . Henry P. Ochsner At the time Insurance was formed, its partners agreed that each of the 25 partners was to share equally the profits and losses of Insurance. On March 22, 1944, 3 days after the incorporation of Bank, the shareholders (except for John Traxinger) agreed that each would give the other shareholders first option to purchase any interest in Bank that any shareholder put up for sale, the price to be determined by a formula set forth in a document executed on March 22, 1944. Since June 13, 1944, the partners in Insurance were also stockholders of Bank (with one exception, set out below) and the interest of each person equaled the interest of each other partner-stockholder. Unless stated otherwise, ‘ stockholders' hereinafter refers to stockholders Page 433 of Bank and ‘ partners' hereinafter refers to partners of Insurance. In January of 1951 the 24 other stockholder-partners purchased John Traxinger's interest in Insurance for $200 and his stock in Bank for $4,373.16. They contributed personal funds in equal shares to Insurance's Special Account (described below) from which account checks were issued to Traxinger. They caused the acquired Traxinger bank stock to be registered in the name of Herreid Insurance Agency. At the same time they bought Traxinger's interest in the Herreid Realty Company. The next change in interest in Bank and Insurance came about as a result of the death of R. B. White in the fall of 1955. Prior to his death, White had assigned all of his assets to his wife, Anna. The White heirs were concerned about the effect of the restrictive sale provisions in the partnership agreement and shareholders agreement of March 22, 1944, upon the transfer of his bank stock and interest in the partnership, and inquired about the matter in early November 1955. The stockholder-partners discussed the effect of the restrictive transfer agreements at their annual meeting in January 1956. They then orally agreed that neither agreement would operate on transfers to heirs and agreed to admit Anna White as an equal stockholder-partner. Anna White died October 26, 1956; William Jahraus died in 1956; and Edwin Bollinger died on February 23, 1957. In each case the decedent's Bank stock was transferred to his heirs who were admitted to the partnership in the place of the decedent and received their shares of subsequent partnership distributions of income, all in accordance with the general policy adopted at the January 1956 meeting. The board of directors of Bank, on September 12, 1944, decided to purchase the Herreid Insurance Agency (the agency Block had operated with Herboldt prior to the creation of Insurance) from Block at an agreed price of $375, instructed Bank's secretary to draw a check for that amount, payable to William Block, from the Insurance Account, discussed the matter of purchasing the Schirber Insurance Agency; and appointed a committee of W. O. Olsen, R. B. White, and Joe Wolf to contact Mary Brandner and discuss the purchase of that agency. Block was paid the $375 from Insurance's Special Account on December 11, 1944. On December 12, 1944, Bank's board of directors approved the purchase of the Schirber Insurance Agency from Mary Brandner for the agreed price of $125. She had been paid by a check dated November 21, 1944, signed ‘ INSURANCE ACCOUNT, Wm. Block.’ The partners did not contribute capital to Insurance. Capital is not a significant requirement in an insurance agency of the sort run by Insurance. Other than Block, the partners did not contribute Page 434 time or ‘ know-how,‘ except that some of them did give Block and Insurance's employees leads as to possible customers. Bank's board of directors on January 9, 1945, approved and adopted the following salaries for its officers:

Bank salary Insurance compensation
William Block $200 per month 10% of insurance commissions.
H. P. Ochsner 175 per month 7 1/2% of insurance commissions.
Esther J. Werner 150 per month 7 1/2% of insurance commissions.

From March 1944 to the beginning of 1945, Bank's board of directors managed and directed Insurance. In December...

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