Kent v. Commissioner of Internal Revenue

• Decision Date: 27 September 1948
• Docket Number: No. 10617.,10617.
• Citation: 170 F.2d 131
• Parties: KENT v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

170 F.2d 131 (1948)

KENT v. COMMISSIONER OF INTERNAL REVENUE.

No. 10617.

United States Court of Appeals Sixth Circuit.

September 27, 1948.

Lewis R. Donelson, III, of Memphis, Tenn. (Lewis R. Donelson, III and Allan

Davis, both of Memphis, Tenn., on the brief), for appellant.

Louise Foster, of Washington, D. C. (Theron L. Caudle, Charles Oliphant, Sewall Key, Rollin H. Transue, A. F. Prescott and Louise Foster, all of Washington, D. C., on the brief), for appellee.

Before SIMONS, McALLISTER, and MILLER, Circuit Judges.

McALLISTER, Circuit Judge.

Petitioner sought redetermination of deficiencies in income taxes, which were asserted by the Commissioner for 1940 and 1941. The result of respondent's action was to tax petitioner on certain income arising out of three different partnerships: (1) Southern Air Services; (2) the Pine Bluff School of Aviation; and (3) Helena Aero Tech School. Petitioner claims that his wife was the owner of the interests in the partnerships which were taxed to him. An additional issue in the case is whether petitioner is taxable on a gain resulting from a corporate liquidation.

This controversy arises out of the following circumstances: William R. Kent, at the time of the events leading up to this suit, was a successful businessman in many fields of endeavor. He was also a pioneer enthusiast of aviation. He started flying as early as 1916, when he first bought an old Navy plane which he flew along the shores of Lake Michigan near his summer home. He subsequently qualified for and obtained a pilot's license in 1927. In 1934, he organized Southern Air Services, Inc., which operated charter flying service and a training school for flying. The venture was set up as a corporation, principally to avoid personal liability for damages resulting from airplane crashes. Another purpose of adopting the corporate form was to avoid confusion with, and keep the concern separate from petitioner's other business interests. The new enterprise was a subordinate activity for petitioner. For some years, it was operated at a loss, and it was not until three years after its organization that it showed a net operating profit, and six years, before its accumulated deficit was wiped out. Commencing in 1937, petitioner, the owner of all the stock, was paid a salary of $150 per month, as president. The business was always conducted by a salaried manager. In 1940, the manager was J. F. Lanier, who was paid a salary of $400 per month. He had been employed since 1936. All during this time, petitioner was engaged in his other business enterprises, of which the principal seems to have been the Anderson-Tully Company, a lumber concern, to which petitioner devoted a considerable part of his time; and this company was his chief means of support in 1940 and 1941. In the latter year, he drew from it a salary of $32,000.

During the fall of 1940, petitioner was approached by the United States Army, with a view to establishing a primary training flying school for Army pilots. The government contracting agent indicated that past experiences made the Army reluctant to deal with a corporation, and urged petitioner to establish an independent business, of a partnership character, in order to enter into the proposed government contract. The Army objected, in some measure, to doing business with Southern Air Services, Inc., because of its corporate form. It was stated that it had been found that it was cumbersome and delaying to deal with corporations. Furthermore, the Army had come to the conclusion that contractors operating Army schools in conjunction with civilian flying schools were faced with problems of divided allegiance, which did not work to the best interests of the Army. The new venture, then, was to be, at the Army's request, entirely separate from the civilian training school operated by Southern Air Services, Inc.

In order to bring about such a complete separation of interest in the two schools — the civilian flying school, already in operation, and the Army training school to be organized — petitioner, following the plan and request of the Army, gave up all his interest in the civilian school, and organized a new partnership to create and operate a new Army training school. He did it in this wise: On October 31, 1940, being the owner of all the stock in the corporation, Southern Air Services, Inc., he transferred the total of the common and preferred stock to Lanier, the general manager, and to his wife, Louise C. Kent. He sold to Lanier 7½ shares of preferred stock and one share of common; he made a gift to his wife of 67½ shares of preferred, and 9 shares of common. On the same day, a special meeting of the stockholders was called for the purpose of dissolving the corporation and surrendering its charter, which was done by resolution. At the meeting, petitioner acted as president, Lanier, as vice president, and Bertrand W. Cohn, the attorney for the corporation, as secretary. These three were also the directors of the company. Later, on the same day, a partnership agreement was executed by Mrs. Kent and Lanier, in which they agreed to carry on as partners, under the style of Southern Air Services, the business formerly conducted by Southern Air Services, Inc.

On the dissolution of the corporation, its assets were distributed to the stockholders of record, Mrs. Kent and Lanier. Mrs. Kent reported this distribution as a long-term capital gain, on her income tax return for 1940, and paid the tax thereon. The assets received by Mrs. Kent and Lanier from the distribution were contributed to the new company formed by them as partners. The gift of stock to his wife whereby petitioner severed all relationship with the civilian flying school, was unconditional, irrevocable, and in conformity with the laws of the State of Tennessee regarding stock transfers. Furthermore, petitioner filed a federal gift tax return for the year 1940, showing a gift of the shares of stock to his wife at a valuation of $28,501.48, the same valuation per share which was placed upon the stock sold to Lanier. The Civil Aeronautics Administration was also informed by letter dated November 1, 1940, of the change in ownership from the corporation to the partnership composed of Mrs. Kent and Lanier.

It should here be emphasized that the giving of the stock by petitioner to his wife is the crux of this case. Upon it, depends the validity of petitioner's contentions with respect to all three partnerships, Southern Air Services, Pine Bluff School of Aviation, and Helena Aero Tech. If, in this case, petitioner prevails on the issue of the gift of stock, he prevails on the issue affecting all the partnerships, and if he fails on the issue of the gift, he fails in his contentions on all the partnerships.

It is the claim of the government that Mrs. Kent never became a partner of Lanier, but that it was only an alleged partnership in which petitioner substituted his wife for himself in the business, in order to escape liability for tax on a portion of the income received from the civilian flying school.

Subsequent to the Southern Air Services transaction on October 31, 1940, petitioner proceeded with his plans for setting up an Army flying school, and on December 11, 1940, he went to Akron, Ohio, to sign a contract with the United States Army for the operation of such a school. The Army contract, which petitioner saw for the first time on that day, required, among other things that the contracting party be the holder of a Civil Aeronautics Administration certificate for the operation of an advanced flying school. Petitioner had contemplated when he arrived in Akron that this Army school would be operated by a corporation in which the stock would be held by himself and Cohn, his attorney and lifelong friend, and members of the Cohn family. Petitioner had, of course, considered the idea of forming a partnership to operate the proposed school, in accordance with the suggestion of the Army, but because he could not see how the interested parties were going to procure the necessary capital through a partnership arrangement, and because they felt they could do so by means of a corporation, they had abandoned the partnership idea and resolved to carry out their plan through a corporation. But when, upon their arrival in Akron, they read the provisions in the Army contract requiring that in order to contract with the Army, they be possessed of a Civil Aeronautics Administration certificate, for the operation of an advanced flying school, they suddenly realized that they could not operate as a corporation, for neither the proposed corporation nor any of its stockholders or directors had such a certificate, and neither they nor the corporation could have secured one from the Civil Aeronautics Administration. The only way they could avail themselves of such a document was to tie Southern Air Services, or its partners, in some way into the transaction, as that partnership was the owner of such a certificate. So, in spite of the fact that it was a complete reversal of the plan to have the civilian school and the Army school entirely separate as far as elements of ownership went, in accordance with the suggestions and wishes of the Army officers who had carried on the negotiations, it was then decided to bring Mrs. Kent and Lanier into the project in order that the corporation could be the beneficiary of the Civil Aeronautics certificate, which was owned by Mrs. Kent and Lanier as partners in the civilian school. This was determined on, even at the risk of having all the arrangements with the Army go to pieces because of not following its instructions as first given. They were in such a situation that they had to take that chance. It was the only thing they could do.

The new venture, accordingly, was organized as a partnership under the name of Pine Bluff School of Aviation, with petitioner Kent, Cohn, and Mrs. Kent, as partners. Lanier was included in...