Klein v. Comm'r of Internal Revenue

• Decision Date: 17 February 1956
• Docket Number: Dockets Nos. 43026,46287,46314.,43464
• Citation: 25 T.C. 1045
• Parties: FREDERICK S. KLEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTESTATE OF ROSS NADEAU, DECEASED, JOHN F. McNAMEE, R. ARTHUR NADEAU ANDNATIONAL STATE BANK OF NEW JERSEY, CO-EXECUTORS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

25 T.C. 1045

FREDERICK S. KLEIN, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENTESTATE OF ROSS NADEAU, DECEASED, JOHN F. McNAMEE, R. ARTHUR NADEAU ANDNATIONAL STATE BANK OF NEW JERSEY, CO-EXECUTORS, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Dockets Nos. 43026

43464

46287

46314.

Tax Court of the United States.

Filed February 17, 1956.

1. Under a partnership agreement, one partner was first to receive 5 per cent of the partnership gross sales, and the remaining partnership net income or net loss was then to be divided between the partners in a 25-75 per cent ratio. During certain years, the first partner was not credited with his percentage of sales; but after threatened litigation, the same was allowed to him in a later year. Held, that the distributive shares of the partners in the undisputed ordinary net income or ordinary net loss of the partnership should be determined in accordance with the partnership agreement; and that the distributive share of each partner must be included in his gross income for the year in which the taxable year of the partnership ended, without regard to the time of actual distribution or receipt.

2. Held, where, by agreement of the partners, one partner was required to pay certain partnership expenses out of his own funds, without reimbursement, he is entitled to deduct the same from his individual gross income; and the amounts so deductible for certain travel and entertainment expenses are determined. Andrew B. Crummy, Esq., for petitioner in Docket Nos. 43026 and 46314.

Edward Baumgarten, Esq., and David Zuckerman, Esq., for petitioners in Docket Nos. 43464 and 46287.

Scott A. Dahlquist, Esq., for the respondent.

Respondent has determined deficiencies in income tax in these proceedings as follows:

+---------------------------------------------+
                ¦Docket No.¦Petitioner        ¦Year¦Amount    ¦
                +----------+------------------+----+----------¦
                ¦43026     ¦Frederick S. Klein¦1946¦$31,149.50¦
                +----------+------------------+----+----------¦
                ¦43464     ¦Ross Nadeau 1     ¦1946¦19,142.84 ¦
                +----------+------------------+----+----------¦
                ¦46287     ¦Ross Nadeau 1     ¦1947¦6,343.59  ¦
                +----------+------------------+----+----------¦
                ¦46314     ¦Frederick S. Klein¦1947¦7,748.62  ¦
                +---------------------------------------------+
                

FN1 Ross Nadeau died on July 24, 1953, after his petition to this Court had been filed, and prior to the trial. Accordingly, the Estate of Ross Nadeau, deceased, John F. McNamee, R. Arthur Nadeau, and National State Bank of New Jersey, Co-executors, have been substituted as petitioners in Docket Nos. 43464 and 46287, and the captions of these proceedings have been changed to reflect the substitution.

The proceedings were consolidated for hearing. Two of the issues raised in Klein's petition for 1947, one increasing income from dividends and interest, and the other increasing net long-term capital gain, were conceded by petitioner at the hearing.

The issues for decision are: (1) What were the distributive shares of Klein and Nadeau in the undisputed net income or loss of Glider Blade Company, a partnership, for its fiscal years ended February 28, 1946 and 1947, and its final fiscal period ended August 31, 1947? (2) What deductions, if any, should be allowed to Klein for certain travel and entertainment expenses?

FINDINGS OF FACT.

Petitioner Frederick S. Klein (hereinafter called Klein) filed his individual income tax returns for each of the years involved with the collector of internal revenue for the fifth district of New Jersey, at Newark. Decedent Nadeau (hereinafter called Nadeau) filed his individual income tax returns for the taxable years involved with the same collector.

On April 19, 1943, but effective as of March 15, 1943, Klein and Nadeau executed articles of co-partnership, whereby they became the members Glider), to carry on the business of purchasing, selling, and manufacturing razor blades. Net profits or losses were, pursuant to the articles, to be divided on the basis of 25 per cent to Klein and 75 per cent to Nadeau. Later in the same year, but also effective as of March 15, 1943, an oral agreement was entered into between Klein and Nadeau, amending the articles of co-partnership in the following regard: In computing the distributive shares of the net income or loss of Glider, an amount (sometimes designated by the parties as a ‘commission’) equal to 5 per cent of Glider's gross sales was first to be credited to Klein; and the net profits or losses remaining after such credit were then to be divided between Klein and Nadeau in the above-mentioned 25-75 per cent ratio.

Glider's books were kept and its partnership information returns were filed in accordance with the accrual method of accounting and on the basis of fiscal years ending on the last day of February. The amounts of Glider's sales and net income (or loss) for the taxable periods here involved, which are undisputed, were as follows: Fiscal year or period ended— Sales— Net income (or loss)

+----------------------------------------------------------------+
                ¦Fiscal year or period ended  ¦Sales      ¦Net income (or loss)  ¦
                +-----------------------------+-----------+----------------------¦
                ¦Feb. 28, 1946                ¦$963,482.03¦$184,861.35           ¦
                +-----------------------------+-----------+----------------------¦
                ¦Feb. 28, 1947                ¦234,594.57 ¦27,759.99             ¦
                +-----------------------------+-----------+----------------------¦
                ¦Aug. 31, 1947                ¦16,229.85  ¦(6,051.41)            ¦
                +----------------------------------------------------------------+
                

For the fiscal years ended February 29, 1944, and February 28, 1945, the years prior to those involved in the instant proceedings, the distributive shares of the partners were computed in accordance with the articles of co-partnership as amended (hereinafter called the amended partnership agreement). However, the partners' distributive shares for the fiscal years ended February 28,1946 and 1947, were entered on the books in the 25-75 per cent ratio, without crediting Klein with the above-mentioned 5 per cent of sales; and the original partnership information returns for said years reflected this same division. These returns were prepared by accountants from Glider's books and from information supplied by the partner who signed the return. Klein signed the return for the fiscal year 1946 and Nadeau signed that for the fiscal year 1947.

At the end of the 1946 fiscal year, Klein's withdrawals from the partnership exceeded the amount credited to him on the partnership books by the amount of $12,760.44. For the 1947 fiscal year, the amount of his excess withdrawals per books was $13,473.76, bringing his total excess withdrawals per books to $26,234.20.

In July 1947 Klein retained counsel, and caused a bill of complaint to be prepared for filing in the Chancery Court of New Jersey, in which Nadeau and others were named as defendants. Klein's position in the complaint and supporting affidavit, as so prepared, was in substance that he and Nadeau had agreed in the amended partnership agreement that the would receive ‘5% of sales of the partnership for each year in addition to the 25% of the profits'; that for 1946, he should have been credited with 5 per cent ‘commissions' on sales in the amount of $48,174.10, and with profits of $34,171.81, or a total of $82,345.91; that for 1947, he should have been credited with 5 per cent commissions on sales in the amount of $11,729.72, and with profits of $3,632.57, or a total of $15,362.29; that he had, under protest, signed the 1946 partnership return which did not reflect the 5 per cent of sales, for the reasons that it had been prepared during his absence, and was already overdue, and that Nadeau had assured him ‘the matter of the 5% commission on sales due (him, i.e., Klein) would be adjusted * * * later on’; that his withdrawals from the partnership were ‘against the commissions and profits due to him’ so that his account actually was not overdrawn; and that the audits and tax returns were not correct and true. The prayer of the complaint, so far as is here material, was that Nadeau be ordered to make an accounting and payment to Klein of all money due him; that the partnership be dissolved; and that Nadeau and the partnership be enjoined from instituting any suit against Klein for any moneys claimed to be due from him by reason of the partnership operations.

The complaint was never filed, but a settlement between the partners was effected on September 2, 1947, under which Glider was dissolved, and Nadeau agreed to pay Klein $18,000 in full settlement of all claims ‘for compensation or otherwise’ that Klein might have against the partnership. This amount was to be paid in two installments of $9,000 each, on December 1, 1947, and March 1, 1948. Nadeau gave Klein two nonnegotiable, non-interest-bearing promissory notes for $9,000 each; and he deposited with escrowees certain stocks and bonds of the value of $20,000 to secure payment. Nadeau paid and Klein received $9,000 in December 1947, and a like amount on March 1, 1948. The settlement also included general releases by each partner to the other; and a sale, for a separately stated consideration, of all partnership net assets to Nadeau.

At some time after September 2, 1947, Nadeau informed the accountants who had been handling the partnership books, of the settlement. On the basis of such information, the capital account of Klein, as then shown on the partnership books, was adjusted so as to credit him with the 5 per cent of sales for each of the fiscal years ended February 28, 1946 and 1947, plus 25 per cent of the remaining net income. As regards Nadeau, his capital account was adjusted so as to credit him with only 75 per cent of Glider's net income remaining after the allowance to Klein for the 5 per cent sales. Entries also were made in the partnership books for the taxable...