First Security Bank v. United States, Civ. No. 2149.

• Decision Date: 22 January 1963
• Docket Number: Civ. No. 2149.
• Parties: FIRST SECURITY BANK, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Montana

213 F. Supp. 362

FIRST SECURITY BANK, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. No. 2149.

United States District Court D. Montana, Havre-Glasgow Division.

January 22, 1963.

Thomas Dignan, Glasgow, Mont., and Hugh D. Galusha, Jr., Peter Meloy, and Robert C. Johnson, Helena, Mont., for plaintiff.

Louis F. Oberdorfer, Asst. Atty. Gen., Edward S. Smith, Fred J. Neuland, and Burton A. Schwalb, Dept. of Justice, Washington, D. C., and Moody Brickett, U. S. Atty., Butte, Mont.

JAMESON, District Judge.

Plaintiff seeks recovery of deficiencies in income taxes for the years 1952 to 1955, inclusive. Plaintiff is a bank incorporated under the laws of Montana. During the taxable years in question it operated at Glasgow, Montana, under the name of Farmers-Stockgrowers Bank. Its name was changed to its present form in 1957.

The primary questions presented are (1) whether plaintiff's stockholders created a partnership which operated an insurance business; and (2) if so, whether it was a partnership recognizable for tax purposes as an independent tax entity separate and apart from plaintiff. The facts are not essentially in dispute and many have been stipulated.

Plaintiff was incorporated in 1916 and has been engaged in the banking business continuously since that date. In 1942 its stock was purchased by a group of persons who are still, except for minor changes, the stockholders of the bank. After the purchase, it was discovered that one of the former stockholders had operated an insurance agency in connection with the bank. This business was taken over by the bank, although the insurance business was known as Farmers Stockgrowers Insurance Agency, and the insurance contracts and licenses were held in the names of two individual stockholders acting for the agency. It is admitted that from 1942 through 1945 the insurance business was operated by the bank, and that the bank was taxable on the income received from the insurance business during that time.

In 1944 or 1945 attorney stockholders¹ recommended the formation of a separate entity to conduct the insurance business, for the reason that it was apparently unlawful for the bank to engage in this business.² Subsequently officers of the plaintiff were also informed by representatives of various insurance companies that the bank could not itself sell insurance.³

During the latter part of 1945 the stockholders consulted the bank's attorney and were advised that the bank could not legally operate the insurance agency. The attorney suggested the formation of either a partnership or separate corporation to operate this agency. The stockholders concluded to form a partnership. Articles of co-partnership were prepared by the bank's attorney and signed by all of the stockholders residing in Glasgow, including the attorney himself.

On December 26, 1946, C. H. Brocksmith, vice president of plaintiff, wrote O. R. Rubie, a stockholder residing at Havre, Montana, as follows:

"We are getting ready to disperse the funds in the Farmers-Stockgrowers Insurance Agency and enclosed herewith are Articles of Co-Partnership prepared by Thomas Dignan. I suggest that you check it over carefully and if satisfactory have the various stockholders in Havre, sign it and return it to us. Likewise, any further suggestions or comments you may have on this deal would be appreciated."

This letter and the articles of co-partnership were taken by Rubie to O. R. Hauge, Havre attorney and stockholder. Hauge testified that he read the articles and made notations of the contents; that he and his wife signed the articles, and he then returned them to Rubie, with the understanding that Rubie would mail them back to Brocksmith. Brocksmith testified that the articles were not returned, but he first became aware of the fact that he did not have them when this tax question arose.⁴ Another official of the bank went to Havre to ascertain whether Rubie had the articles. He did not get them from Rubie.⁵ After Rubie's death, the same official made further inquiry of Rubie's sons, one of whom was executor of his father's estate, but did not obtain the written articles.

It is clear that the articles of co-partnership prepared by the bank's attorney were signed by all of the stockholders residing in Glasgow and by two of the stockholders residing in Havre, and that the signed articles were delivered to O. R. Rubie. As noted supra, Mr. Rubie is now deceased. It cannot be determined whether the articles were in fact signed by Rubie and other members of his family who were stockholders in the corporation.

The parties stipulated that during the years 1952 to 1955 all contracts with insurance companies and the state insurance licenses were executed in the name of "Farmers-Stockgrowers Insurance Agency", with "C. H. Brocksmith and J. E. Brown denominated as co-partners";⁶ that a bank account was kept for the "agency" in plaintiff's bank; that the stockholders of the plaintiff shared in the proceeds from the insurance business in the same proportion as their stockholdings in the plaintiff bore to the total stock issued by plaintiff.

Partnership returns were filed by the agency, beginning in 1946 and continuing through the years in question, except for 1954.⁷ Four stockholders testified that they were partners in a partnership composed of all of the stockholders of the bank, that the partnership operated the insurance business, and that the profits were distributed to the members of the partnership.

Plaintiff concedes that it has failed to prove that the articles of co-partnership were signed by all of the partners. It relies upon an oral agreement existing among the partners and argues that the evidence of the history of the written articles was submitted in corroboration of the other testimony, showing that a partnership did in fact exist. There is no question in my mind that the stockholders of the bank intended to create a partnership and understood that they were operating the insurance business as a partnership during the years in question.

No consideration was paid to the bank for the alleged transfer of the insurance business to the partnership, which earned in excess of $10,000 per year for each of the tax years in question. Nor was any so-called partner required to contribute either capital or services to the agency, but received his interest solely by reason of his stock ownership in the bank. Capital, however, is not an important requirement of an insurance agency. When certain stockholders died, the partnership was not formally dissolved, and the interest of the decedent stockholder in the agency passed to heirs or legatees with the bank stock.

A separate set of books was kept to reflect the business of the insurance agency. Correspondence and other communications relative to the insurance business were in the name of the partnership on stationery and forms bearing the agency name. Most of the stationery and other supplies were furnished by the insurance companies represented by the agency, and the balance by the bank.

Brocksmith, Brown and Tvedt handled the insurance business, which was conducted on the bank's premises. Often banking and insurance overlapped, e. g., persons coming in to talk banking also talked insurance and vice versa. Loans to finance premium charges were made regularly by the bank, as they were to insureds of other agencies. The only separate facilities of the insurance agency were a desk, files and the books, and these were furnished by the bank. The agency did not pay any of its expenses nor did it pay rent or a share of the bank's overhead. It had no separate telephone listing. There was no sign outside the bank showing that an insurance business was being carried on, but there was one inside the bank.

From time to time employees of the bank kept records or performed other services for the agency. Their salaries were paid by the bank. No salaries were paid by the agency, not even to Brown, Brocksmith or Tvedt. They received only their regular bank salaries and their proportionate share of the agency's earnings.⁸

Each year the bank filed its corporate tax return and deducted the entire amount of salaries, including salaries paid to persons who performed services for the agency, and also the expenses incurred in operating the agency, although they were not large. The agency did not deduct any of the expenses in its own tax return.

Funds of the agency were sometimes used in "participating" in loans in excess of the amount the bank itself could legally loan. While interest was paid to other "participants", no interest was paid the agency for the use of its funds.

All income from the insurance business was included in the partnership returns and no part of it in the bank's return. The net proceeds of the insurance business were distributed through checks drawn on the agency and mailed separately from any dividend checks mailed by the bank.

Eight stockholders, who were the directors of the bank, purchased the insurance business in 1956 or 1957 for $10,500. This amount and the 1956 net proceeds of the agency were used by plaintiff to pay the tax deficiency. Subsequent to the sale, Brocksmith and Tvedt received 30% of the net proceeds of the agency, and their salaries as officers of the bank were reduced.

Defendant contends (1) that plaintiff has failed to prove that the stockholders did in fact form a partnership; and (2) that if the court finds that the stockholders did create a partnership which operated the insurance agency, the income from that agency is still taxable to the bank, since it was not a partnership recognizable for tax purposes as an independent taxable entity separate and apart from the plaintiff.

It is my conclusion that plaintiff has assumed its burden of showing that a partnership did in fact exist, whether or not the written articles of co-partnership were executed by all of the partners, and that the partnership did in fact operate the...