Kemon v. Comm'r of Internal Revenue
| Decision Date | 14 May 1951 |
| Docket Number | 20268,20266,20271.,20269,20267,20270,Docket Nos. 20265 |
| Citation | 16 T.C. 1026 |
| Parties | GEORGE R. KEMON, ET AL.,1 Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
The partnership of which petitioners were members was a trader as to securities held by it for more than 6 months. Such securities were not held primarily for sale to customers in the ordinary course of trade or business. The gain on their sale or exchange is taxable at capital gains rates pursuant to section 117(b) of the Internal Revenue Code. Fred L. Rosenbloom, Esq., and Thomas P. Glassmoyer, Esq., for the petitioners.
William H. Best, Jr., Esq., for the respondent.
Respondent has determined deficiencies in petitioners' income tax as follows:
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¦Dkt. No.¦Petitioner ¦1943 ¦1944 ¦
+--------+-------------------------------+---------+---------¦
¦20265 ¦George R. Kemon ¦$2,478.45¦$3,139.01¦
+--------+-------------------------------+---------+---------¦
¦20266 ¦William Lilley, Jr. ¦9,987.57 ¦15,349.83¦
+--------+-------------------------------+---------+---------¦
¦20267 ¦Est. of Howard J. Comber, dec'd¦901.46 ¦None ¦
+--------+-------------------------------+---------+---------¦
¦20268 ¦Henry C. Welsh, Jr. ¦3,661.46 ¦4,890.78 ¦
+--------+-------------------------------+---------+---------¦
¦20269 ¦Anna K. Herrman ¦None ¦259.00 ¦
+--------+-------------------------------+---------+---------¦
¦20270 ¦Thomas David Call ¦None ¦430.12 ¦
+--------+-------------------------------+---------+---------¦
¦20271 ¦Alfred D. Wells ¦None ¦124.01 ¦
+------------------------------------------------------------+
The deficiencies arise from respondent's determination that securities sold during the years in question by Lilley & Co., a partnership, of which the petitioners were members, were not capital assets and the gain upon their sale is taxable as ordinary income instead of as capital gain, as contended by petitioners.
Income tax returns were filed with the collection of internal revenue for the first district of New Jersey in Camden, New Jersey, by petitioner George R. Kemon for the years 1942 through 1944, and with the collector of internal revenue for the first district of Pennsylvania in Philadelphia, Pennsylvania, by Howard J. Comber, deceased, for the years 1942 and 1943, and by the remaining petitioners the years 1942 through 1944.
During the years 1942 through 1944, petitioners Kemon, Lilley, Jr., Welsh, Jr., and Comber, now deceased, were partners in the firm of Lilley & Co., a partnership with its principal office in Philadelphia and with a branch in New York City. Petitioners Herrman, Call, and Wells were also partners in the firm during the year 1944. Lilley & Co. is the successor of Lilley, Blizzard & Co., a firm organized in Philadelphia in 1922.
During the taxable years in question, the principal activity of Lilley & Co. was the buying and selling of unlisted securities for its own account. During these years the firm also did a small amount of brokerage business. During each of the years 1942, 1943, and 1944, Lilley & Co. completed approximately 7,000 or 8,000 transactions per annum.
During the years in question, Lilley & Co. realized net gain from sales or exchanges of securities which had been purchased for its own account as follows:
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¦ ¦Securities held¦Securities held¦ ¦
+----+---------------+---------------+-----------¦
¦Year¦for more than ¦for six months ¦Total gains¦
+----+---------------+---------------+-----------¦
¦ ¦six months ¦or less ¦ ¦
+----+---------------+---------------+-----------¦
¦1942¦$42,300.86 ¦$79,340.93 ¦$121,641.79¦
+----+---------------+---------------+-----------¦
¦1943¦34,622.26 ¦121,541.65 ¦156,163.91 ¦
+----+---------------+---------------+-----------¦
¦1944¦58,289.64 ¦134,281.71 ¦192,571.35 ¦
+------------------------------------------------+
Gross commissions from transactions in which the firm acted as brokers during the year totaled:
+---------------+
¦1942¦$7,775.89 ¦
+----+----------¦
¦1943¦13,229.56 ¦
+----+----------¦
¦1944¦14,742.27 ¦
+---------------+
During the years 1942, 1943, and 1944, Lilley & Co. realized additional income from the following sources:
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¦Source of Income ¦1942 ¦1943 ¦1944 ¦
+-----------------------------------------------+---------+---------+---------¦
¦Interest on corporation bonds ¦$3,399.20¦$4,370.29¦$9,289.29¦
+-----------------------------------------------+---------+---------+---------¦
¦Interest on tax-free covenant bonds upon which ¦5,718.76 ¦2,245.10 ¦737.00 ¦
¦a Federal tax paid at source ¦ ¦ ¦ ¦
+-----------------------------------------------+---------+---------+---------¦
¦Dividends ¦2,666.15 ¦4,926.81 ¦5,331.49 ¦
+-----------------------------------------------------------------------------+
In its partnership return for the year 1942, Lilley & Co. reported no capital gains or losses. The total income reported consisted of ‘Bond Trading Profit,‘ ‘Stock Trading Profit,‘ ‘Commissions,‘ interest, dividends, and fees. In its partnership return for the year 1943, Lilley & Co. reported gains from the sale or exchange of capital assets.
Lilley & Co.'s activity in buying and selling securities for its own account has always been confined largely to low-priced, unmarketable securities of real estate corporations. Most of the bonds purchased were in default and most of the stocks were paying no dividends. In many cases the issuing corporation was in the hands of a creditors' committee or was involved in reorganization or receivership proceedings. Most of the securities were speculative, unrated by leading statistical services, and lacked such qualities as safety, income, and marketability.
Lilley & Co.'s activity in buying and selling securities for its own account was conducted almost exclusively by telephone, telegraph, and teletype. Some of the securities were brought from bondholders of corporations involved in reorganization or receivership proceedings and some were sold to professional real estate operators or syndicates. Most of them, however, were brought from and sold to registered broker- dealers or security houses.
The purposes for which the firm purchased securities were usually one of the following three: First, securities were purchased for immediate or simultaneous resale at a profit. This occurred when a broker-dealer offered the firm securities at a price below that for which the firm had an offer to buy from another broker-dealer. Second, securities, usually bonds, were purchased for the anticipated profit to be realized upon the liquidation of the issuing corporation. Such transactions occurred where the firm obtained information with respect to a defaulted security indicating that the actual value of the security was in excess of the prevailing market price and that a liquidation of the corporation appeared probable. Third, the firm accumulated securities of a corporation, usually one having real estate as its principal assets, in financial difficulties, in order to obtain a holding sufficiently large to enable the firm to force a reorganization of the corporation and ultimately gain control thereof. Sometimes, instead of reorganizing the firm the partnership would sell the holdings it had accumulated to a real estate syndicate or a professional dealer in real estate.
In cases where Lilley & Co. determined to accumulate a certain security either for purposes of holdings until the liquidation of the company or for the purpose of gaining control of the corporation, it normally would not sell any of the securities being accumulated even if an offer that would result in a profit was received. However, even after having embarked upon a course of accumulation, Lilley & Co. would sometimes sell the particular securities if events proved that its original analysis of their potential value was incorrect or if an opportunity to invest in a more attractive security presented itself. Lilley & Co. also occasionally sold some of the securities which it was accumulating in order to create a market. This occurred when Lilley & Co., upon inquiry from a broker, not identified as a buyer or a seller, was forced to state both bid and offering prices in order to disguise its real interest.
Lilley & Co. as a general rule always bought securities in small lots. With the exception of sales of securities which had been purchased with a view to immediate resale at a profit, the securities which the company bought and sold for its own account were always sold in a large lot, frequently in one transaction.
Of the sales of securities purchased by Lilley & Co. for its own account and held for 6 months or less, 44.93 per cent of the sales in 1943 and 41.65 per cent of the sales in 1944 were made on the same day on which the securities were purchased. Of such sales, 61.63 per cent in 1943 and 65.98 per cent in 1944 were made within the first 7 days after the securities were purchased.
In 1942 and 1943, Lilley & Co. disposed of the following securities to the partners of the firm pro rata at market price:
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¦ ¦1942 ¦
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¦ ¦ ¦
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