Empey v. United States

• Decision Date: 31 August 1967
• Docket Number: Civ. A. No. 66-C-373.
• Parties: Lawrence G. EMPEY, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Colorado

272 F. Supp. 851

Lawrence G. EMPEY, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 66-C-373.

United States District Court D. Colorado.

August 31, 1967.

Drexler & Wald, Ellis J. Sobol, and Stanley L. Drexler, Denver, Colo., for plaintiff.

Lawrence M. Henry, U. S. Atty., District of Colorado, Denver, Colo., Mitchell Rogovin, Asst. Atty. Gen., Jerome Fink and Kenneth L. MacCardle, Attys., U. S. Dept. of Justice, Washington, D. C., for defendant.

Davis, Graham & Stubbs, Howard W. Rea, Denver, Colo., for the Colorado Bar Assn., as amicus curiæ.

MEMORANDUM OPINION AND ORDER

CHILSON, District Judge.

This is a civil action for refund of federal income tax paid by the plaintiff for the calendar year 1965.

The Court has heard the evidence, argument of counsel and has considered the briefs filed by the parties and the Colorado Bar Association as amicus curiæ.

The parties have filed a statement of agreed facts which the Court adopts as its Findings of Fact insofar as the agreed facts are material to a determination of the issues.

The broad question here involved is whether or not professional men such as lawyers and doctors can organize in such a way as to be taxed as a corporation for federal tax purposes.

More precisely, the question is whether or not Drexler and Wald Professional Company (hereafter called Drexler and Wald) which was incorporated under the laws of the State of Colorado to engage in the practice of law, should be taxed as a corporation or a partnership for federal income tax purposes.

If taxed as a corporation, plaintiff, who was an employee of Drexler and Wald, prevails. If taxed as a partnership, the claim for refund fails.

The Treasury Department takes the position that because of the nature of the relationship between doctor and patient and lawyer and client they cannot by organizing or incorporating achieve the status of a corporation for federal tax purposes.

The background leading to this position starts with the unsuccessful attempt of the Treasury Department to tax certain unincorporated associations of doctors as partnerships rather than as corporations. See United States v. Kintner, 216 F.2d 418 (C.A. 9th-1954); Galt v. United States, 175 F.Supp. 360 (N.D. Tex.-1959).

The Internal Revenue Service announced that it would not follow the Kintner decision, (Rev.Rul. 56-23, 1956-1; Cum.Bull. 598) and in 1960, the Treasury adopted regulations designed to offset the effect of the Kintner and Galt cases and to make it as difficult as possible for unincorporated organizations to be taxable as corporations. (Unlike the 1965 regulations, the 1960 regulations do not appear to be directed at (incorporated organizations).

As a result, self-employed professional people sought from the state legislatures laws allowing them to incorporate and thereby obtain benefits of taxation as corporations under the federal income tax laws or, as in the case of the Colorado Bar, appealed to the rule-making authority for amendments permitting the practice of law by corporations. Some 34 states adopted statutes designed to permit professional men to obtain "association" or "corporation" status for federal tax purposes and the Colorado Supreme Court adopted Rule 265 permitting lawyers to form professional service corporations for the practice of law.

The 1965 Treasury Regulations involved in this proceeding were made

"In response to an outpouring of state legislation authorizing the formation of professional service corporations or professional service associations aimed at providing professional men, such as lawyers or doctors, with the means of achieving corporate or association status for federal tax purposes." (Page 12 defendant's trial brief.)

In essence, the regulations provide that an organization of professional men, incorporated or unincorporated, cannot be taxed as a corporation unless "* * the corporate characteristics are such that the organization more nearly resembles a corporation than a partnership or a trust." (Treasury Regulations, Section 301.7701-2(a)).

The purpose of the 1965 regulations is stated at page 18 of defendant's trial brief to be:

"* * * an administrative explanation of why professional men cannot, absent a much more severe departure from the norms of professional regulation enforced by the States and the traditional mode of organization and operation permitted professionals joined together in a mutual enterprise, achieve the status of `corporations' or `associations' under the Federal taxing statute." (Emphasis supplied.)

VALIDITY OF REGULATIONS

As just noted, the regulations require that Drexler and Wald, even though formally incorporated, be taxed as a partnership unless its corporate characteristics are such that it more nearly resembles a corporation than a partnership.

The classification of an incorporated organization as a partnership is inconsistent with the statutory definitions of partnerships and corporations found in Sec. 7701(a) of the 1954 Internal Revenue Code, which reads as follows:

"(2) PARTNERSHIP AND PARTNER. —The term `partnership' includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term `partner' includes a member in such a syndicate, group, pool, joint venture, or organization. (Emphasis supplied)

"(3) CORPORATION—The term `corporation' includes associations, joint-stock companies, and insurance companies."

There has been no substantial change in these statutory definitions since the Revenue Act of 1932 and they are identical to the definitions in the 1939 Code.

An examination of the foregoing statutory definition of a "partnership" reveals that the definition refers only to "unincorporated" organizations. By this definition "incorporated" organizations are necessarily excluded. The defendant has cited no cases and we have found none which has construed the term "partnership" to include an "incorporated" organization, nor has the defendant referred to any legislative history which would indicate a Congressional intent to do so. Even if the partnership definition permitted the inclusion of incorporated organizations, neither the statute nor the case law supports the Treasury's position that organizations of professional men such as doctors and lawyers must be taxed as partnerships and not as corporations.

There is no such provision in the statute and judicial construction of the statute is to the contrary.

In 1936 in Pelton v. Commissioner, (C.A.-7th) 82 F.2d 473, the Court upheld the Commissioner's contention that an unincorporated association of doctors should be treated for...