Flannery v. United States

• Decision Date: 12 December 1938
• Docket Number: No. 6090.,6090.
• Citation: 25 F. Supp. 677
• Parties: FLANNERY et al. v. UNITED STATES.
• Court: U.S. District Court — District of Maryland

25 F. Supp. 677

FLANNERY et al. v. UNITED STATES.

No. 6090.

District Court, D. Maryland.

December 12, 1938.

Caesar Aiello and George E. Elliott, both of Washington, D. C., for plaintiffs.

Bernard J. Flynn, U. S. Atty., and G. Randolph Aiken, Asst. U. S. Atty., both of Baltimore, Md., James W. Morris, Asst. Atty. Gen., and Thomas G. Carney, John G. Remey, and Andrew D. Sharpe, Sp. Assts. to Atty. Gen., for the United States.

CHESNUT, District Judge.

This is an income tax suit in which the executors of a taxpayer are suing, after proper procedure, to recover an alleged overpayment of income taxes by their decedent for the year 1929 in the amount of $7,730.56 (consisting of $6,923.33 tax and $807 interest) with interest thereon since the dates of payment. As the taxes were paid to a former Collector, not now in office, the suit is against the United States as authorized by 28 U.S.C. § 41(20), 28 U. S.C.A. § 41(20).¹ The case has been tried without a jury. The facts are stipulated but for the purposes of discussion the statement of them may be shortened and simplified.

On March 20, 1929 a partnership (of which the taxpayer was a member) engaged in the banking and stock brokerage business in Washington, D. C., under the name of W. B. Hibbs & Co., sold a one-quarter interest in a seat on the New York Stock Exchange, which was a partnership asset, for $109,500. The question in the case is what taxable income resulted therefrom to the taxpayer. The acquisition of this fractional interest in the seat came about in the following way. On and before March 1, 1913, W. B. Hibbs, the taxpayer, and one W. W. Spaid composed a partnership in the same business, and held as an asset thereof a whole seat on the New York Stock Exchange, the cost basis of which to the firm as of March 1, 1913 was $48,000. This latter firm continued in business until September 30, 1928, although from time to time after March 1, 1913 there were changes in the respective proportionate interests of Hibbs and Spaid in the partnership. On September 30, 1928, Hibbs had a two-thirds and Spaid a one-third third interest in the firm. Its capital was then $1,333,000. On October 1, 1928 the firm was reorganized to continue the same business under the same name, in accordance with new articles of partnership. Two new partners were admitted who contributed $750,000 of new capital, and Hibbs withdrew $388,666, reducing his capital interest to $500,000 and his proportionate interest in profits being reduced to two-sevenths. The Stock Exchange scat then held by the old firm was contributed to the new firm at its then market value of $415,000. On January 24, 1929 the New York Stock Exchange increased the authorized seats upon the Exchange by one-fourth, thus giving the new firm without added cost, a one-fourth interest in an additional seat.

The Commissioner determined that the value to the firm of one-fourth seat interest, based on the market value of the whole seat as of October 1, 1928, at $415,000 (plus subsequent capitalized dues of $400) was $83,080, which, deducted from the sale price of $109,500, resulted in a net profit to the firm of $26,420 realized from the sale. The taxpayer's portion of this profit (two-sevenths) was $7,548.57. There is no dispute between the parties as to this amount; but the Commissioner determined a much larger amount of profit to the taxpayer by computing his individual profit, in addition to his interest in the partnership profit, on the excess of his interest in the seat when contributed to the new firm in 1928 at $415,000, over the cost basis to him of his interest therein as of March 1, 1913. It is not necessary here to state the whole computation in detail, but sufficient to note that the Commissioner allocated to the taxpayer as additional individual income for the year 1929 (over and above his proportionate interest in the partnership income) attributable to the sale the sum of $55,386.67 as profit for the period March 1, 1913 to September 30, 1928. The result of this addition to income was to increase the tax by $6,923.33, which is the principal of the sum sought to be recovered in this suit. The precise question that we have to deal with is whether the Commissioner was justified in increasing the taxpayer's income for the year in the amount of $55,386.67. Stated abstractly the question is this — when a partnership sells an asset at a profit over and above the cost basis to it, which asset has been contributed to the partnership by one of the partners at a valuation greater than the cost to the partner, is the partner's individual income to be computed by adding to (1) his proportionate share of the partnership profits (2) his individual profit based on the excess of the amount at which he contributed the asset to the partnership over his cost basis for the asset.

There was no specific statutory rule upon the subject until Congress answered the question in a somewhat different way by section 113(a) (13) of the Revenue Act of 1934, 26 U.S.C.A. § 113(a) (13),² which provided that the basis (to the partnership) for the determination of profit on the sale of a partnership asset should be that of the transferor of the asset to the partnership. This amendment of the law was not made retroactive, although the House and Senate Committee Reports on the Bill³ contained statements to the effect that "the Committee believes that this provision simply makes specific the correct interpretation of the general provisions of the present law". Whether this view is correct depends upon the proper construction of the applicable provisions of the Revenue Act of 1928. The controlling provisions are section 111(a) and (c)⁴ reading:

"Sec. 111. Determination of amount of gain or loss.

"(a) Computation of gain or loss. — Except as hereinafter provided in this section, the gain from the sale or other disposition of property, shall be the excess of the amount realized therefrom over the basis provided in section 113, and the loss shall be the excess of such basis over the amount realized. * * *

"(c) Amount realized. — The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received." (Italics supplied.)

In considering the application of this section to the sale of a partnership asset it should steadily be kept in mind that the profit is not taxable unless the taxpayer receives from the sale, in cash "plus the fair market value of the property (other than money) received", an excess over cost basis. Thus where the consideration received for the article sold is not represented by money only (and the money does not exceed the cost basis), it is necessary that the consideration other than money must have a determinable "fair market value", in order to "realize" the profit, and make it taxable as income. We must also keep in mind the provisions of the income tax laws affecting partnerships. They are not directly taxed but the distributive shares of the partners, whether distributed or not, in the net income of the partnership for the taxable year, are taxed; and for the purpose of determining such distributive shares the partnership is required to make a return of partnership income for the year.⁵

The legal history of the controlling sections of the Revenue Act of 1928, and of similar provisions in prior Revenue Acts, furnishes no support to the Government's contention. This history, from 1918 to May 14, 1934, was reviewed by Circuit Judge Learned Hand in Helvering, Commissioner, v. Walbridge, 2 Cir., 70 F.2d 683, 684, as follows:

"Ever since the Act of 1918 the Regulations had provided that only upon dissolution of the firm did the partner individually `realize' any gain or loss on firm transactions, and at that time his gain was the difference between his liquidating dividend and the original cost to him of his contribution. Article 1570, Regulations 45, Act of 1918; article 1570, Regulations 62, Act of 1921; article 1603, Regulations 65, Act of 1924; article 1603, Regulations 69, Act of 1926; article 604, Regulations 74, Act of 1928. Indeed if the liquidating dividend was in kind, no gain was `realized' until the property distributed was sold, a provision of doubtful validity except perhaps in cases where the dividend did not itself have any `fair market value.' In the face of such long continued departmental interpretation we should be slow to construe the statute otherwise; indeed we would not do so at all unless the statute flatly required it. It does not."

The contrary view now contended for by the Government was first advanced by the Commissioner in 1932 on the basis of a ruling designated as General Counsel Memorandum 10092.⁶ The Commissioner applied this contrary view in the determination of the taxpayer's income for 1929. This ruling was first legally tested in the case of Archbald v. Com'r, 27 B.T.A. 837, and there rejected by the Board of Tax Appeals, whose decision was affirmed by the Second Circuit, Helvering v. Archbald, 70 F.2d 720, and likewise in Helvering v. Walbridge, 2 Cir., 70 F.2d 683. See, also, Chisholm v. Commissioner, 2 Cir., 79 F.2d 14, 101 A.L.R. 200. Certiorari was denied in all three cases. 293 U.S. 594, 55 S.Ct. 109, 79 L.Ed. 688; Helvering v. Chisholm, 296 U.S. 641, 56 S.Ct. 174, 80 L.Ed. 456. And this principle has been consistently adhered to in subsequent decisions of the Board. Planters Gin Co. v. Commissioner, 28 B.T.A. 22; Donner v. Commissioner, 32 B.T.A. 364; Eaton v. Commissioner, 37 B.T.A. 715. There are no decisions to the contrary. In connection with the expression in the House and Senate Reports on the Revenue Act of 1934, above referred to, it may be noted that these Reports were made prior to May 10, 1934, while the decisions in the Walbridge and Archbald Cases in the Second Circuit were made on May 14, 1934, and therefore the Congressional Committees did not have these...