Ellsasser v. Comm'r of Internal Revenue (In re Estate of Ellsasser)

• Decision Date: 19 November 1973
• Docket Number: Docket No. 8047-71.
• Parties: ESTATE OF WILLIAM J. ELLSASSER, DECEASED, WILLIAM WARD ELLSASSER, AND ROBERT V. SCHNABEL, EXECUTORS AND CHARLOTTE C. ELLSASSER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

61 T.C. 241

ESTATE OF WILLIAM J. ELLSASSER, DECEASED, WILLIAM WARD ELLSASSER, AND ROBERT V. SCHNABEL, EXECUTORS AND CHARLOTTE C. ELLSASSER, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 8047-71.

United States Tax Court

Filed November 19, 1973.

Robert V. Schnabel, pro se.

Randolph D. Mason, for the respondent.

Sec. 1402(a) of the 1954 Code defines ‘net earnings from self-employment’ as including an individual's distributive share of income from a ‘trade or business carried on by a partnership of which he is a member.’ Held, these provisions were intended to apply to a limited partner, and such distributive share therefore constitutes ‘self-employment income’ subject to tax under sec. 1401.

OPINION

RAUM, Judge:

The Commissioner determined the following deficiencies in income tax:

+-------------+
                ¦Year¦Amount  ¦
                +----+--------¦
                ¦    ¦        ¦
                +----+--------¦
                ¦1967¦$215.93 ¦
                +----+--------¦
                ¦1968¦403.20  ¦
                +-------------+
                

At issue is whether the distributive share of partnership income allocable to a limited partner who contributes no services to the business of the partnership constitutes ‘net earnings from self-employment’ under section 1402(a) of the Internal Revenue Code of 1954. The facts have been stipulated.

At the time of his death on June 5, 1970, and at all times relevant herein, William J. Ellsasser was a resident of the District of Columbia, as was his wife, Charlotte C. Ellsasser, who has continued to remain such a resident, at least up to the time the petition herein was filed. The Ellsassers filed joint Federal income tax returns for 1967 and 1968 with the district director at Baltimore.

Prior to his retirement on June 30, 1966, William Ellsasser was a salesman for Milprint, Inc., a manufacturer of packaging materials. His wages from Milprint, Inc., exceeded $6,600 in 1966. In 1967 he received $3,226.04 in wages, consisting of $826.04 from Milprint (with respect to sales arranged prior to his retirement in 1966) and $2,400 from Ward Estates, Inc., a corporation wholly owned by him which owned and operated a small apartment building in the District of Columbia. In 1968 he received $1,500 in wages from Ward Estates, Inc.

From 1961 until his death in 1970, Ellsasser was a limited partner in Sade & Co., a partnership organized under the laws of the District of Columbia. Sade & Co. was engaged in a stock brokerage business with its principal office in Washington, D.C. During 1967 and 1968 it was a member of the New York Stock Exchange, the American Stock Exchange, the Philadelphia-Baltimore-Washington Exchange, and the National Association of Securities Dealers. Its activities were subject to regulation by the above exchanges, by the National Association of Securities Dealers, and by the United States Securities and Exchange Commission.

Ellsasser was not at any time during his life a member of an allied member of any stock exchange, nor had he attempted to take any examination conducted by the various exchanges or the National Association of Securities Dealers in order to qualify to work in Sade & Co. He was not licensed in any manner to engage in any part of the securities business. From 1961 to June 1970, he was not ‘employed’ by Sade & Co.; he performed no services for it: he had no desk at its office; and he had no obligation to devote, nor did he devote, time to its affairs in any capacity.¹

As a limited partner, Ellsasser received a share of Sade & Co's profits. The amount of such shares was determined in part by the ratio of his capital contribution to the total capital contributed by all of the limited partners; ² and in part through negotiation with the general partners with respect to the amount to be paid to all the limited partners. The general partners received a larger percentage of profits than did the limited partners on account of their active participation in the business. Nevertheless, it was recognized that capital was essential to the proper operation of Sade & Co. and the limited partners were treated accordingly.

Ellsasser's distributive share of Sade & Co.‘s profits was $13,521.24 in 1967 and $12,433.63 in 1968. On their joint income tax returns for 1967 and 1968, Ellsasser and his wife accurately reported these amounts as other income but without indicating any self-employment tax liability pursuant thereto. In his deficiency notice the Commissioner deemed Ellsasser's ‘distributive shares of partnership income from Sade & Co. for the taxable years 1967 and 1968 * * * (to be) self-employment income within the meaning of and subject to the tax provided in Chapter 2 of the Internal Revenue Code,‘ and he determined a deficiency for each year accordingly. We hold that his determination must be approved.

Section 1401(a) imposes a tax upon ‘self-employment income’ in respect of old-age, survivors, and disability insurance, and section 1401(b) imposes a companion tax also upon ‘self-employment income,‘ but in respect of hospital insurance. The combined rate for both taxes was 6.4 percent for both years, but the base to which that rate was to be applied was not the same for these 2 years. Thus, section 1402(b)(1)(D) defines ‘self-employment income’ for 1967 to mean ‘the net earnings from self-employment,‘ but only that portion which was not in excess of $6,600 minus the amount of wages paid to the individual during the year, while section 1402(b)(1)(E) expands the base for the 4 years subsequent to 1967 so as to exclude from ‘net earnings from self-employment’ that portion which was in excess of $7,800 minus wages paid. By treating Ellsasser's distributive share of Sade & Co.‘s income as ‘net earnings from self-employment,‘ the Commissioner determined that he had ‘self-employment income’ subject to tax in the amount of $3,373.96 ($6,600 minus wages of $3,226.04) for 1967, and $6,300 ($7,800 minus wages of $1,500) for 1968.

The critical statutory language here in dispute is the term ‘net earnings from self-employment,‘ with the petitioners contending that Ellsasser's distributive share of Sade & Co.‘s income cannot be treated as falling within that provision. If there were no more to the matter than a mere reading of these words, petitioners would have a strong case indeed, for, on the surface at least, passive income of the type which Ellsasser received as a limited partner of Sade & Co. does not fit comfortably within the phrase ‘net earnings from self-employment.’ The term ‘self-employment’ suggests activity of some kind on the part of the taxpayer, and here Ellsasser was merely the passive recipient of his share of distributive partnership income. There is involved, however, more than these naked words. We have before us a statutory definition of the critical language, together with a strong and clear legislative history, as well as applicable regulations, which make plain that an initial impression in petitioners' favor must give way to a contrary conclusion.

‘Net earnings from self-employment’ is a statutory concept and is defined in section 1402(a), in relevant part, as follows:

SEC. 1402. DEFINITIONS.

(a) NET EARNINGS FROM SELF-EMPLOYMENT.— The term ‘net earnings from self-employment’ means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(9)³ from any trade or business carried on by a partnership of which he is a member * * *

A literal reading of these provisions calls for the treatment of Ellsasser's distributive share of Sade & Co.‘s income as ‘net earnings from self-employment.’ By its clear language, section 1402(a) comprehends both gross income derived by an individual from a trade or business carried on by such individual plus a partner's distributive share of income from a trade or business carried on by a partnership. The gross income of an individual from his trade or business and a partner's distributive share of partnership income from its trade or business are distinct items, separately mentioned in the statute, and subject to different tests for their inclusion in an individual's net earnings from self-employment. Whereas an individual's active role in a trade or business is relevant to the first component of net earnings from self-employment, it is wholly immaterial to the qualification of income arising from a partnership's activities. What is relevant in that regard is (1) whether the partnership carries on a trade or business, and (2) whether the recipient of a distributive share is a ‘member’ of such partnership. And since an active business— i.e., a brokerage business— was carried on by Sade & Co., a partnership of which Ellsasser was a ‘member,‘ it would seem that the statutory definition explicitly requires the treatment of his distributive share of its income as ‘net earnings from self-employment.’ Nothing in the statutory definition suggests that a distinction must be drawn between general and limited partners, and the legislative history makes clear that none was intended.

Prior to the enactment of the Social Security Act aMendments of 1950; ch. 809, 64 Stat. 477, self-employed persons were not covered by the Federal Old-Age and Survivors System. Under the 1950 legislation Congress extended old-age and retirement benefits to self-employed persons, and in that connection section 104(a) of that Act (through an amendment adding section 211 to title II of the Social Security Act) defined the term ?net earnings from self-employment.' Concomitantly, section 208(a) of the same 1950 legislation added section 480 to the Internal Revenue Code of 1939, imposing a tax upon ‘self-employment income of every individual.’ At the same time it also added section 481(a) to the 1939 Code, which introduced the term ‘net earnings from self-employment’ to the Code and defined it in...