Cagle v. C. I. R.

• Court: U.S. Court of Appeals — Fifth Circuit
• Citation: Cagle v. C. I. R., 539 F.2d 409 (5th Cir. 1976)
• Decision Date: 22 September 1976
• Docket Number: Nos. 75-1722 and 75-1723,s. 75-1722 and 75-1723
• Parties: 76-2 USTC P 9672 Jackson E. CAGLE, Jr. and Ann Cagle, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Charles L. WEBSTER, Jr., and Sylvia Webster, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Writing for the Court: Before GEWIN, GODBOLD and SIMPSON; SIMPSON

Page 409

539 F.2d 409

76-2 USTC P 9672

Jackson E. CAGLE, Jr. and Ann Cagle, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Charles L. WEBSTER, Jr., and Sylvia Webster, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 75-1722 and 75-1723.

United States Court of Appeals Fifth Circuit.

Sept. 22, 1976.

Robert S. Mizell, Robert C. Taylor, Dallas, Tex., for petitioners-appellants.

Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Act. Chief, App. Sec., Bennet N. Hollander, William S. Estabrook, III, John G. Manning, Attys., Tax Div., Dept. of Justice, Meade Whitaker, Chief Counsel, Internal Revenue Service, Washington, D. C., for respondent-appellee.

Appeals from the Decision of the Tax Court of the United States (Texas Cases).

Before GEWIN, GODBOLD and SIMPSON, Circuit Judges.

SIMPSON, Circuit Judge:

Taxpayers appeal from a ruling of the Tax Court upholding the Commissioner of Internal Revenue's finding of a deficiency in the federal income taxes for appellants. The findings of fact and opinion of the Tax Court are reported at 63 T.C. 86.

The sole issue presented on appeal is whether $90,000 paid by a partnership to its managing partner was a deductible expense under Section 707(c) of the Internal Revenue Code of 1954, Title 26, U.S.C., Section 707(c), ¹ or a capital expenditure under Section 263(a) of the Code, and hence not deductible as an ordinary and necessary business expense.

We affirm the Tax Court.

FACTS

Appellants Jackson E. Cagle, Jr. and Charles L. Webster ² are practicing physicians who practiced their profession and maintained legal residences in Fort Worth, Texas, at all times pertinent to this appeal. Each filed his federal income tax return, Form 1040, for the calendar year 1968 with the District Director of Internal Revenue, Dallas, Texas.

Taxpayers were partners in a partnership known as Parkway Property Company, formed by a partnership agreement dated August 1, 1968. They were the investor partners and John F. Eulich was the managing partner. The purpose of the partnership, as stated by the agreement, was "to construct, acquire by purchase, own, hold, deal in, mortgage, operate, manage, equip, lease, sell, exchange, transfer or in any manner dispose of warehouses, office buildings, and other commercial property, and to do and perform all things necessary or incidental or connected with or growing out of such business." Articles of Partnership, Trial Record (hereinafter cited as R.) 34.

A primary intent of the partnership was the development of an office showroom of approximately 80,000 square feet, to be built on 5.255 acres of land (known as Parkway Plaza). Eulich was to contribute the land to the partnership. He did so, subject to an outstanding loan commitment obtained by him.

The partnership agreement specified that all interest and ad valorem taxes to be paid on the contributed real estate and all commissions, management compensations, and other expenses during the period August 31, 1968, to December 31, 1969, would be allocated 100% to the investor partners pro rata, but not in excess of $150,000. The agreement further provided that the managing partner, Eulich, was authorized to make expenditures in his own name for interest, taxes, fees, commissions, and other expenses on behalf of the partnership and would be entitled to reimbursement for such expense, but such expenditures were not to exceed $150,000 during the period August 1, 1968, to December 31, 1969.

The investor partners contributed $200,000 in cash, pursuant to the agreement, during the period August 1, 1968 to December 31, 1969, with the understanding that such funds would be used either to pay the above expenses directly or to reimburse Eulich for such payment.

The net profits, net gains resulting from the sale or disposition of any property held by the partnership, and net losses were to be divided among the partners as follows: John F. Eulich, 50%; Jackson E. Cagle, Jr., 25%; Charles L. Webster, Jr., 25%.

As the managing partner of Parkway Property Company, Eulich had "the right, power and authority to negotiate and execute leases and subleases for the purpose of improving the partnership property, to execute and deal with mortgages, notes and other instruments of indebtedness in his own name on behalf of the Partnership, or in the Partnership name, and may pay expenses, fees and costs of the Partnership in his own name for which he shall be entitled to reimbursement from the Partnership." R. 38. No partner was to receive any salary for services rendered on behalf of the partnership in a capacity as partner.

On August 15, 1968, the partnership entered into a management agreement with John F. Eulich doing business as the Vantage Company (hereinafter Vantage). The agreement provided that Vantage would receive for its services, as well as for expenses incurred by it in the performance of such services, the amount of $110,000, which was to be paid $90,000 on or before December 31, 1968, and $20,000 on or before October 1, 1969. In essence, Vantage was to utilize its expertise in the development and management of properties in such a way as to benefit the partnership company. ³

Eulich testified at trial that he would not have agreed to form the partnership with appellants without payment of the $110,000 management fee. Vantage performed similar services for similar management fees for other partnerships investing in similar development projects.

The services performed for the partnership by Vantage included the following: A feasibility study of the office-showroom complex; work with the construction general contractors with respect to the cost of the project and coordination of the architecture and construction of the building; and the arrangement of financing using Eulich's own credit to some extent.

No portion of the management fee was for managing the property after it was completed. Rather, it was for work done at the inception and during the development of the office-showroom complex.

The development of the project went as follows: On September 24, 1968, Eulich purchased the 5.255 acres of land. On September 28, 1968, an architect firm was employed to draw up a plan for the complex and a photographer was hired to photograph the property. On October 31, 1968, a commitment letter for the construction loan was received. In November, 1968, several payments were made to the architect firm. On December 6, 1968, Eulich d/b/a Vantage borrowed $1,000,000 from the Prudential Insurance Company. On the same day a building permit was issued to the Dal-Tex Construction Company to construct the building shell, and a contract was awarded to the Van Company to finish the various suites of the office-showroom. By the end of 1968, there was no income-producing structure, and the first suite was not completed for occupancy until June, 1969, with the second suite being completed in July, 1969, the third suite in August, 1969, and two more suites in September, 1969.

There was no gross income reported on the Partnership's first return, covering the period from August 1, 1968, through December 31, 1969. The partnership deducted expenses totaling $105,972.51 which included the $90,000 paid to Vantage in 1968, listed on the partnership return as a "management fee". The $105,972.51 loss shown on the partnership return was distributed in accordance with the partnership agreement, with Cagle and his wife reporting a loss of $51,493, and Webster and his wife reporting a loss of $51,493.13, on their respective income tax returns for 1968. ⁴

The Internal Revenue Commissioner, in his notice of deficiencies to both petitioners, "determined that the $90,000 deduction claimed as management fee is not allowable because it has not been established that such amount was paid for ordinary and necessary business expenses or that the expenses were incurred in carrying on an existing trade or business." Exhibit A, R. 15.

DISCUSSION

As indicated above, the sole issue presented on appeal is whether the $90,000 paid to Eulich as managing partner was a deductible business expense to the partnership under Section 707(c) of the Code, or a capital expenditure not deductible as a business expense under Section 263(a) of the Code.

Taxpayers argue that Section 707(c) "results in deductibility regardless of the nature of the services performed or capital used if the payment involved is made without regard to partnership income." Reply Brief of Appellants, p. 2. We find this position untenable.

Section 707(c) reads as follows:

(c) Guaranteed payments. To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and section 162(a) (relating to trade or business expenses). Stat. 243.

Taxpayers stress the legislative history of Section 707(c) in support of their position, quoting Senate Committee Report, 83d Cong., 2d Sess., S.Rep.No.1622 (1954) 386, U.S.Code Cong. & Admin.News 1954, p. 5029, which, in relevant part, reads:

Subsection (c) provides a rule with respect to guaranteed payments to members of a partnership. A partner who renders services to the partnership for a fixed salary, payable without regard to partnership income, shall be treated, to the extent of such amount, as one who is not a partner, and the partnership shall be allowed a deduction for a business expense. The amount of such payment shall be included in the partner's gross income, and shall not be considered a distributive share of partnership income or gain. A partner who is guaranteed a minimum annual amount for his services shall be treated as receiving a fixed payment in that amount.

The House provisions were amended by your committee to accord the same treatment as that provided...