Kuney v. Frank

• Decision Date: 16 November 1962
• Docket Number: No. 17507-17509.,17507-17509.
• Citation: 308 F.2d 719
• Parties: Max KUNEY, Jr., and Constance K. Kuney, His Wife; Max J. Kuney, Sr., Olive R. Kuney, Appellants, v. William E. FRANK, District Director of Internal Revenue, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

308 F.2d 719 (1962)

Max KUNEY, Jr., and Constance K. Kuney, His Wife; Max J. Kuney, Sr., Olive R. Kuney, Appellants, v. William E. FRANK, District Director of Internal Revenue, Appellee.

Nos. 17507-17509.

United States Court of Appeals Ninth Circuit.

October 11, 1962.

Rehearing Denied November 16, 1962.

Clodfelter & Bowden, and Allen A. Bowden, Seattle, Wash., for appellants.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, I. Henry Kutz, and Donald P. Horwitz, Attys., Dept. of Justice, Washington, D. C., Brockman Adams, U. S. Atty., Seattle, Wash., for appellee.

Before HAMLIN, MERRILL and DUNIWAY, Circuit Judges.

DUNIWAY, Circuit Judge.

In these three cases we are again in the never-never land of family partnerships and the income tax. Each case is an action to recover taxes claimed to have been illegally collected, following denial of claims for refund. The cases were consolidated for trial and are also consolidated on appeal. A jury returned a verdict in favor of the appellant taxpayers. Thereafter, pursuant to Rules 50(b) and 59, F.R.Civ.P., 28 U.S.C.A., a motion was made by appellee, District Director of Internal Revenue, for a judgment notwithstanding the verdict and, in the alternative, for a new trial. The court granted and entered judgment notwithstanding the verdict, and denied the motion for a new trial. All plaintiffs appeal.

The sole question is whether there was substantial evidence to sustain the verdict. The trial court held that there was not, and we agree.

The jury was instructed to return a special verdict, and did so, in the following form:

"On a consideration of all facts and circumstances shown by the evidence and under the law given you by the Court, do you find the status of Kuney Sr. and Kuney Jr. in their trustee capacity (separate and apart from their personal capacity) as partners in the Kuney family partnership genuine, bona fide and valid for income tax purposes?

"Answer yes or no.

"Yes."

In granting judgment n. o. v., the Court said:

"Conceding that in the record there is some evidence not inherently incredible which might support a fact finding favorable to plaintiffs on one or more of the factors referred to, factors entering into the ultimate decision as to the bona fides of the arrangement it appears clear to me that a finding favorable to plaintiffs on the vital element pertaining to retention and exercise of control, referred to in two or three of the factors, is positively negatived by the evidence, and there is no evidence whatever to support the finding favorable to plaintiffs as to those elements."

It is upon this ground that we are affirming.

We are often astonished at the apparent naiveté of taxpayers, and, sometimes, of their counsel. The courts have said, almost ad nauseam, and in various ways, that the income tax relates to realities, so that "By the simple expedient of drawing up papers, single tax earnings cannot be divided into two tax units and surtaxes cannot be thus avoided." (Commissioner v. Tower, 1946, 327 U.S. 280, 291, 66 S.Ct. 532, 538, 90 L.Ed. 670). This is but another way of stating the principle, announced in Helvering v. Horst, 1940, 311 U.S. 112, 119, 61 S.Ct. 144, 148, 85 L.Ed. 75, that "The dominant purpose of the revenue laws is the taxation of income to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid." The principle has been repeatedly applied and one of its corollaries is that actual retention of the control of income and assets that produce it results in taxation of that income to him who retains the control.

Yet taxpayers persist in creating paper concepts, "for tax purposes," and then going about their business as if the concepts did not exist. Sometimes, as in this case, both they and their counsel seem to have the notion that the tax laws govern their economic relationships and dealings, rather than merely attaching tax consequences to what they themselves actually do, so that economic realities are supposedly created, many years after the fact, by the government's auditors, and can be juggled retroactively by the taxpayers, to fit whatever tax concept saves them the most tax.

In the case of family partnerships, there are two factors that encourage such Alice in Wonderland performances on the part of taxpayers. One is the family relationship itself, which so readily lends itself to paper arrangements having little or no relationship to reality. (See Helvering v. Clifford, 1940, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788; Commissioner v. Tower, supra; Lusthaus v. Commissioner, 1946, 327 U.S. 293, 66 S.Ct. 539, 90 L.Ed. 679; Commissioner v. Culbertson, 1949, 337 U.S. 733, 69 S.Ct. 1210, 93 L. Ed. 1659).

The other is sections 191 and 3797(a) (2) of the Internal Revenue Code of 1939, as added and amended, respectively, in 1951 (Rev.Act 1951, § 340, 65 Stat. 452, 511), now embodied in section 704(e) of the Internal Revenue Code (26 U.S.C. § 704(e)). It has been said that these sections "legitimatized family partnerships" (Stanback v. Commissioner, 4 Cir. 1959, 271 F.2d 514, 518). It was in reliance upon these sections that the family partnership here involved was created. But we have held that the sections do not legitimatize all family partnerships. (Spiesman v. Commissioner, 9 Cir. 1958, 260 F.2d 940). They simply apply the rule that income arising from capital is attributable to the owner of that capital. (Blair v. Commissioner, 1937, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465). Thus section 191 (now § 704(e) (2)) provides: "In the case of any partnership created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor's capital." This is buttressed by section 3797(a) (2), (now § 704(e) (1)), which says "A person shall be recognized as a partner for income tax purposes if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person." These provisions recognize the principle that earnings are taxed to him who earns them, and the principle that income from capital, however acquired, is attributable to its owner. They eliminate, as a factor to be considered in determining the bona fides of a family partnership, the fact that the new partner acquired his interest by gift, and that he may be an inactive partner.

As we pointed out in Spiesman, supra, the report of the House Ways and Means Committee (H.Rep.No. 586, 82nd Cong., 1st Sess., p. 33, 1951-2 Cum.Bull. 357, 381) makes it clear that these sections do not legitimatize all family partnerships. After stating the foregoing principles, the report states:

"The amendment leaves the Commissioner and the courts free to inquire in any case whether the donee or purchaser actually owns the interest in the partnership which the transferor purports to have given or sold him. Cases will arise where the gift or sale is a mere sham. Other cases will arise where the transferor retains so many of the incidents of ownership that he will continue to be recognized as a substantial owner of the interest which he purports to have given away, as was held by the Supreme Court in an analogous trust situation involved in the case of Helvering v. Clifford, (309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788). The same standards apply in determining the bona fides of alleged family partnerships as in determining the bona fides of other transactions between family members. Transactions between persons in a close family group, whether or not involving partnership interests, afford much opportunity for deception and should be subject to close scrutiny. All the facts and circumstances at the time of the purported gift and during the periods preceding and following it may be taken into consideration in determining the bona fides or lack of bona fides of a purported gift or sale."

See, also, Reg. 118 (1939 Code), § 39.191-1(b), 26 C.F.R. (1953) § 39.191-1 (b) and (1954 Code), 26 C.F.R. § 1.704.1(c).

Here, although it is conceded that the gifts of partnership interests were valid under state law, and that capital was a material income-producing factor, the trial judge concluded that the arrangement was, as a matter of law, invalid for tax purposes, because the evidence shows, without contradiction, that the appellants retained control of the income and of the donated interests.

The evidence, all of it coming from the mouths of appellants and their Certified Public Accountant, discloses the following uncontradicted facts: The tax years involved are 1952, 1953, and 1954. Prior to 1952, Max J. Kuney and his son, Max J. Kuney, Jr., were engaged in the heavy construction business, as partners, in Spokane and Seattle. They operated under a written agreement of partnership. After the passage of section 191 and the amendment of section 3797(a) (2) of the Internal Revenue Code of 1939, and on February 11, 1952, Kuney Senior executed a Trust Agreement, in which Kuney Junior is made trustee for the benefit of the minor son of...