Schmitz v. Comm'r of Internal Revenue

Decision Date02 December 1968
Docket NumberDocket Nos. 1881-67,1967-67.
Citation51 T.C. 306
PartiesJ. LEONARD SCHMITZ AND ALICE SCHMITZ, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTALBERT H. THRONDSON AND DORIS G. THRONDSON, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Richard Saveri and Stephen J. Schwartz, for the petitioners in docket No. 1881-67.

Michael Traynor, for the petitioners in docket No. 1967-67.

Robert M. Zimmerman, for the respondent.

Two dental surgeons working as partners had established and developed profitable practices at San Francisco and at San Rafael. The practice at San Rafael was more profitable and when the partnership was dissolved the doctor taking that practice paid $36,000 to the doctor taking the San Francisco practice, all of which was assigned to a covenant not to compete by their agreement. Held: The record demonstrates by strong proof that the assignment of consideration to the covenant by the agreement did not have any ‘independent basis in fact or * * * arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for * * *.’ Schulz v. Commissioner, 294 F.2d 52 (C.A. 9, 1961), affirming34 T.C. 235. Record demonstrates further, by strong proof, that the consideration was in fact paid for goodwill, entitled to capital gains treatment by payee and nondeductible by payor.

FORRESTER, Judge:

In these consolidated cases, respondent has determined deficiencies in petitioners' income taxes for the calendar year 1963 as follows:

+----------------------------------------------------------------------+
                ¦Docket No.  ¦Petitioners                               ¦Deficiencies  ¦
                +------------+------------------------------------------+--------------¦
                ¦            ¦                                          ¦              ¦
                +------------+------------------------------------------+--------------¦
                ¦1881-67     ¦J. Leonard Schmitz and Alice Schmitz      ¦$5,615.60     ¦
                +------------+------------------------------------------+--------------¦
                ¦            ¦                                          ¦              ¦
                +------------+------------------------------------------+--------------¦
                ¦1967-67     ¦Albert H. Throndson and Doris G. Throndson¦11,740.96     ¦
                +----------------------------------------------------------------------+
                

In docket No. 1967-67 a casualty loss adjustment, set forth in the statutory notice of deficiency, has been disposed of by agreement of the parties, consequently the sole remaining issue left for decision is whether the payment of $36,000 by J. Leonard Schmitz to Albert H. Throndson was for Throndson's covenant not to compete with Schmitz in the practice of oral surgery, for Throndson's sale of goodwill to Schmitz, or was attributable in part to each. The petitioners' respective contentions regarding the transaction are in direct opposition to one another.

Respondent has taken inconsistent positions. In the Schmitz case respondent has determined that there was a purchase of goodwill and in the Throndson case he has determined that there was a sale of a covenant not to compete. Respondent does not seek to sustain the deficiencies as to both parties in full. He seeks only to have the $36,000 paid to Throndson by Schmitz treated uniformly by both parties.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation and exhibits attached thereto are incorporated herein by this reference and adopted as part of our findings.

J. Leonard Schmitz (hereinafter sometimes referred to as Schmitz) and Alice Schmitz, petitioners in docket No. 1881-67, are husband and wife whose residence was Kentfield, Marin County, Calif., when their petition was filed. They filed a joint Federal income tax return for the 1963 calendar year with the district director of internal revenue, San Francisco, Calif.

Albert H. Throndson (hereinafter sometimes referred to as Throndson) and Doris G. Throndson, petitioners in docket No. 1967-67, are husband and wife whose residence was Woodside, San Mateo County, Calif., when their petition was filed. They also filed a joint Federal income tax return for the 1963 calendar year with the district director of internal revenue, San Francisco, Calif. Schmitz and Throndson are both dentists specializing in the practice of oral surgery. Both doctors belong to local and national professional dental societies. Throndson was 61 years old at the time of the trial herein in January 1968.

From 1946 through 1962, Throndson and Schmitz were equal partners in the practice of dentistry (hereinafter sometimes referred to as the partnership). A written partnership agreement was first consummated by them on May 15, 1951, and subsequently modified on September 21, 1955 and February 20, 1956.

The practice of the partnership was exclusively from referrals by other dentists, medical doctors, and from patients. Referral slips were printed up by the partnership for the convenience of the referring doctors. Patients were generally referred to the firm rather than to either of the individual doctors personally and any given patient might be treated by either doctor. If the procedure required more than one visit the patient was often treated by both Schmitz and Throndson on the successive occasions.

At the commencement of the partnership in 1946, both Schmitz and Throndson practiced in one office in San Francisco, Calif. Schmitz resided in San Francisco and Throndson resided in Woodside. In 1950 Schmitz moved to Kentfield in Marin County, Calif.

On or about June 8, 1953, the partnership opened an additional office on Greenfield Avenue, San Rafael, Marin County, Calif. This office was rented by the partnership. In December of 1957 Schmitz and Throndson purchased land and built an office building on Fifth Avenue in San Rafael, and the practice on Greenfield Avenue was then moved to the new building on Fifth Avenue. This building and the land upon which it was constructed was jointly owned by Schmitz and Mrs. Schmitz and Throndson and Mrs. Throndson at all times prior to the termination of the partnership in 1962.

Both Schmitz and Throndson treated patients at both the San Rafael and San Francisco offices. Since Schmitz lived in San Rafael he practiced 3 days of a 5-day week at the San Rafael office; the other 2 days he practiced at San Francisco. Throndson did exactly the opposite. All records relevant to the San Rafael practice were kept at the San Rafael office.

The net profits from both offices of the partnership for the years 1958 through 1962 were as follows:

+------------------------------------+
                ¦NET PROFIT             ¦            ¦
                +-----------------------+------------¦
                ¦Year  ¦¦San Francisco  ¦San Rafael  ¦
                +-------+---------------+------------¦
                ¦1962   ¦$15,079.45     ¦$33,968.38  ¦
                +-------+---------------+------------¦
                ¦1961   ¦14,728.94      ¦35,549.04   ¦
                +-------+---------------+------------¦
                ¦1960   ¦15,189.09      ¦31,836.31   ¦
                +-------+---------------+------------¦
                ¦1959   ¦14,685.03      ¦29,545.47   ¦
                +-------+---------------+------------¦
                ¦1958   ¦14,937.02      ¦28,393.53   ¦
                +------------------------------------+
                

Toward the end of 1962, Schmitz and Throndson had a disagreement over the effort being expended by each party and Throndson suggested an adjustment in their financial arrangement. An adjustment was unaccepted to Schmitz and he suggested that the partnership dissolve. As a result of this discussion Throndson retained Edward J. Reidy (hereinafter sometimes referred to as Reidy) as his attorney. Throndson did not execute either a power of attorney or a written contract of employment with Reidy. A covenant not to compete was never discussed between Throndson and Reidy.

Schmitz retained Joseph L. Alioto (hereinafter sometimes referred to as Alioto) as his attorney. Schmitz stated to Alioto that it was his ‘firm intention’ to continue practicing in Marin County.

On Tuesday, December 11, and Friday, December 14, 1962, both Schmitz and Throndson and their respective attorneys met in the offices of Alioto for the purpose of dissolving the partnership. At the December 11 meeting both Schmitz and Throndson expressed a desire for the Marin County practice in San Rafael. Alioto mentioned an agreement for Throndson not to practice in Marin County if Schmitz were to get the practice at San Rafael, but because Schmitz had previously stated that it was his ‘firm intention’ to continue to practice in Marin County, regardless of what happened, the parties did not discuss the matter further or attempt to negotiate a covenant not to compete. The December 11 meeting was inconclusive because of friction between the doctors. Neither at such meeting nor at any other time, did Throndson define the extent of Reidy's authority.

At the second meeting held in Alioto's office on Friday, December 14, Reidy did not take an active role in the discussions. For the purpose of negotiations Throndson had obtained appraisals on the San Rafael Medical Building supporting a value of $127,000 and a loan value of $80,000. Schmitz had obtained an appraisal supporting a value of $100,000 (a net value of $68,000, since the property was encumbered by a $32,000 mortgage) from the bank in which his brother-in-law was a manager.

Throndson stated at the December 14 meeting that he would allow Schmitz to take the entire building and the Marin County practice at San Rafael, on payment of $90,000, but that if Throndson were to take the entire building and the Marin County practice, he would only be willing to pay $50,000.

Throndson's explanation for the difference between these bid and asked prices was that Alioto had previously stated that: (1) His client, Schmitz, would under no circumstances leave Marin County or the practice of dentistry there; (2) had stated further that if Throndson were successful in outbidding Schmitz for such building and practice, Schmitz...

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