Foster v. United States

• Decision Date: 31 March 1964
• Docket Number: No. 258,Docket 28533.,258
• Citation: 329 F.2d 717
• Parties: Thomas Browne FOSTER, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

329 F.2d 717 (1964)

Thomas Browne FOSTER, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 258, Docket 28533.

United States Court of Appeals Second Circuit.

Argued January 10, 1964.

Decided March 31, 1964.

David Sachs, New York City (White & Case, New York City, on the brief), for plaintiff-appellant.

Robert Arum, Asst. U. S. Atty. (Robert M. Morgenthau, U. S. Atty. for the Southern District of New York, on the brief), for defendant-appellee.

Before LUMBARD, Chief Judge, and KAUFMAN and MARSHALL, Circuit Judges.

MARSHALL, Circuit Judge:

In this suit for refund of income taxes paid for the years 1953 and 1954, taxpayer appeals from a judgment for the Government entered after trial without jury. It will be seen from an examination of Judge Levet's opinion below, 221 F.Supp. 291, that the principal issue on the trial was whether appellant's monthly drawing account, which he received while in Saudi Arabia as a partner in the firm of Emerson Engineers, was a salary, therefore "earned income from sources without the United States" within the meaning of sections 116(a) of the Internal Revenue Code of 1939 and 911 of the Internal Revenue Code of 1954, and hence excludible from gross income; or was part of his distributive share of the partnership income, and hence taxable to the extent that the partnership as a whole realized income from sources within the United States. The court resolved this issue in the Government's favor.

On this appeal, however, the taxpayer has abandoned this line of argument. Conceding that the entire amount received from the partnership was part of his distributive share, the taxpayer now argues that it is nevertheless wholly excludible from his gross income. He asserts that under sections 911(b) of the 954 Code, and 116(a) of the 1939 Code, income from a personal service partnership is included in the statutory definition of "earned income," i.e., "wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered." Hence, he says there is no need to take into account the partnership provisions of the 1939 Code, which are applicable to both years in suit.¹ Even if these provisions are taken into account, however, appellant asserts that the "conduit" principle, which generally requires a partner to include in his gross income his distributive share of different items of partnership income, deductions and credits, does not apply to this situation. These contentions are wholly different from the points raised in the court below, but since only a question of law is involved, we will proceed to consider them.

Although the first part of taxpayer's argument, that his distribution consisted of foreign earned income regardless of what the partnership provisions may say, is ingenious, we cannot accept it. We think it is impossible not to consider the partnership provisions of the statute in any case where the tax liability of a partner is at stake, without doing violence to the statutory scheme. Furthermore, the argument is inconsistent with the specific provisions of the articles of partnership. The partnership agreement gave appellant a right to 4.0816% of the total net profits, and required him to sustain the same proportion of net losses. Thus, if the Saudi Arabian operations in which he was engaged sustained a loss, he would still have received a share of the profits if the rest of the business was profitable and the converse is also true. Whatever compensation he received depended on the overall operations of the firm. We think, therefore, that the mere facts that appellant performed services abroad and received income from the partnership do not entitle him to regard the distribution entirely as earned income from sources outside the United States.

Section 185 of the Internal Revenue Code of 1939 provided until 1943 that the earned income of partners was to be determined by reference to the partnership's earned income. Although this section was repealed, in connection with the repeal of the domestic earned income credit,² we think the rule it established is the natural way to interpret the foreign earned income exclusion in the partnership context.

What remains for decision is the second argument, that his exclusion should not be limited to the partnership's proportion of foreign earned income, but should comprise his entire partnership distribution. In other words, taxpayer asks us to reject the "conduit" approach to the taxation of partnership distributions, under which each partner's share of the net income is composed of a proportionate part of the various items on the partnership return, in favor of the "entity" approach, under which the distribution from the partnership is taken onto the return and treated as if taxpayer had earned it from individual employment. Since the entire amount of partnership income from abroad was earned income, and since taxpayer is entitled to an earned income exclusion, he claims that his entire distribution would thus be tax exempt.

The 1954 Code's partnership provisions are much more elaborate than the corresponding sections under the prior statute which we construe here. The only items of partnership income and loss which the 1939 Code specifically required a partner to take into account separately on his individual return were his shares of short and long term capital gains and...