Lilly v. Comm'r of Internal Revenue, Docket Nos. 18881
| Decision Date | 06 June 1950 |
| Docket Number | Docket Nos. 18881,18882. |
| Citation | 14 T.C. 1066 |
| Parties | HELEN W. LILLY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. The amount paid to the manager of a local branch of the business here involved in addition to his salary was a bonus constituting reasonable compensation for services he actually rendered, and was deductible by such business as an expense of doing business in the year in which paid.
2. A legal, bona fide partnership existed between the two petitioners, husband and wife, in the taxable years in the operation of the City Optical Co. and the Richmond Optical Co., and the income derived therefrom is taxable to the two individuals in the proportion provided in the partnership contract.
3. The business operated during the taxable years by petitioner Helen W. Lilly under the name of the Duke Optical Co. was a sole proprietorship belonging to that petitioner, and the income therefrom was taxable to her.
4. The partnership owned and operated by the petitioners during the taxable years and the sole proprietorship operated as the Duke Optical Co. by petitioner Helen W. Lilly are not entitled to deduct as ordinary and necessary expenses ‘kick-backs‘ or amounts credited and paid to doctors and constituting a percentage of the amount charged by such partnership and sole proprietorship to their customers who were patients of such doctors.
5. The deficiencies of petitioner Thomas B. Lilly for the taxable years involved are not due to negligence or intentional disregard of rules and regulations within the purview of section 293(a) of the Internal Revenue Code. Richard E. Thigpen, Esq., Arthur M. Jenkins, Esq., Claude C. Pierce, Jr., Esq., and Charles S. Lowrimore, C.P.A., for the petitioners.
James C. Maddox, Esq., for the respondent.
These consolidated cases involve income tax liability. Respondent has determined deficiencies for calendar years and in amounts as follows:
+----------------------------------------+
¦ ¦Docket No. 18881,¦Docket No. 18882,¦
+----+-----------------+-----------------¦
¦Year¦Thomas B. Lilly ¦Helen W. Lilly ¦
+----+-----------------+-----------------¦
¦1943¦$80,001.45 ¦$26,685.29 ¦
+----+-----------------+-----------------¦
¦1944¦60,491.47 ¦23,167.14 ¦
+----------------------------------------+
A 5 per cent penalty was proposed against Thomas B. Lilly for each of the years involved in the respective amounts of $6,577.70 and $3,024.57. In the proceeding of that petitioner there is also present the question of his income for 1942, by reason of the Current Tax Payment Act of 1943. Certain subordinate issues raised by the petition under Docket No. 18881 have been abandoned by petitioner, leaving for decision the following questions:
(a) Whether an amount paid to the manager of a local branch of the business here involved was compensation for services actually rendered.
(b) Whether the entire net income of the business operated under the names of City Optical Co. and Richmond Optical Co. is taxable in the years here involved (1943 and 1944) to petitioner Thomas B. Lilly.
(c) Whether the entire net income of the business operated under the name of the Duke Optical Co. was taxable to Thomas B. Lilly.
(d) Whether the optical business carried on as a partnership by the petitioners and the sole proprietorship operated by the Duke Optical Co. are entitled to deductions as ordinary and necessary expenses of amounts credited and paid to doctors and constituting a percentage of the amount charged by such partnership and sole proprietorship for the manufacture of glasses for patients of such doctors.
(e) Whether, if deficiencies are due from petitioner Thomas B. Lilly for the taxable years 1943 and 1944, they are due for negligence or intentional disregard of rules and regulations within the purview of section 293(a) of the Internal Revenue Code.
The petitioners are husband and wife, having been married October 2, 1937. They reside at Wilmington, North Carolina, and their returns for the taxable years were filed with the collector of internal revenue for the district of North Carolina.
Petitioner Thomas B. Lilly has been engaged in the optical business since 1920. In 1922 he organized a sole proprietorship known as the City Optical Co., at Wilmington, North Carolina. Branches of this business were later, and prior to 1940, opened and operated at Fayetteville, North Carolina; Greensboro, North Carolina; and Richmond, Virginia, under the name of Richmond Optical Co.
Petitioner Helen W. Lilly was born and educated in Virginia, and received a B.S. degree from the Farmville State Teachers College, following which she taught in Virginia and North Carolina for several years and then worked for about 18 months as an assistant buyer of sportswear in a department store in Richmond, Virginia. In 1933 she began teaching the seventh grade in the William Hooper School at Wilmington, North Carolina. She had been for many years ‘eye conscious‘ by reason of the fact that she suffered from eye trouble, as had several of the members of her family. Also in her work as a teacher she had many pupils whose studies were seriously handicapped by reason of defective eyesight. Many of these children were underprivileged and, in her work, she obtained eye examinations and treatments for them.
Helen W. Lilly ceased teaching school after her marriage in 1937, but continued her interest in eye clinics, traveled with a representative of the North Carolina Commission for the Blind, and participated in eye clinics. Upon her marriage to Thomas B. Lilly, she accompanied him upon inspection trips he made to branches of his business, interviewing the managers of these branches and the oculists in the territory served, and familiarized herself with and helped substantially in the operation of the business and the decision of its various problems. Finally, in 1938 or 1939, she approached her husband with the proposition that she be permitted to acquire an interest in the business of the City Optical Co. and that it be operated as a partnership. These discussions resulted, on December 31, 1942, in petitioner Helen W. Lilly giving to her husband her promissory note in the sum of $37,333.75, bearing interest at 3 per cent, and his written conveyance to her of a 49 per cent interest in the City Optical Co. and the Richmond Optical Co., the combined book value of which at that time was $76,191.32. When this transaction occurred, petitioner Helen W. Lilly had some estate of her own, acquired before marriage from her employment, or by intermittent gifts from her husband. From the time of her first employment as a teacher until her marriage to Thomas B. Lilly she had saved a portion of her earnings each month, and these she had invested in life insurance and Government bonds. These savings were in a comparatively substantial amount.
Immediately following this, on the same date, a written partnership agreement was executed by the two petitioners, under which Thomas B. Lilly was to receive 51 per cent of the net earnings, and Helen W. Lilly was to receive 49 per cent of the net earnings. Each one of the two was given equal rights of management and control of the business, including the right to draw checks upon its accounts in the several banks with which it did business. The two petitioners thereupon conveyed to the partnership the assets and business theretofore known as the City Optical Co. and the Richmond Optical Co. The banks with which the deposits of the business were maintained were notified of the formation of the partnership and the right of each petitioner to withdraw funds. The business was formally registered as a partnership by and between the two petitioners by certificate duly filed with the clerk of the Supreme Court of New Hanover County, North Carolina, at Wilmington, North Carolina. The books of the former business were recast as of January 1, 1943. Capital accounts were opened in the names of the petitioners, Thomas B. Lilly being credited with 51 per cent and Helen W. Lilly with 49 per cent.
Petitioners had no children. Following the execution of the partnership agreement, Helen W. Lilly devoted her time and activities to substantially assisting in the operation of the business, participating with her husband in the discussion of and decision of all matters of policy pertaining thereto. She visited the various branch stores of the business from time to time, conferring with the local managers with regard to local problems of operation, investigating and settling matters of complaints with respect to service, and contacting various doctors in the local territories for the purpose of maintaining friendly relations and building up good will. She actually participated equally with her husband in the management and operation of the business. She drew checks upon the company's various bank accounts in payment of its bills and for the withdrawal of funds which were used by her for her own personal interests or investments and which were charged against her drawing account upon the books of the company. She signed notes and executed agreements binding the partnership. Her withdrawals for 1943, 1944, and 1945 were as follows:
+----------------------------------------+
¦ ¦1943 ¦1944 ¦1945 ¦
+------------+------+---------+----------¦
¦ ¦ ¦ ¦ ¦
+------------+------+---------+----------¦
¦Wilmington ¦$7,790¦$9,034.34¦$25,267.51¦
+------------+------+---------+----------¦
¦Fayetteville¦ ¦652.26 ¦ ¦
+------------+------+---------+----------¦
¦Richmond ¦ ¦1,996.12 ¦367.50 ¦
+------------+------+---------+----------¦
¦Greensboro ¦ ¦ ¦1,942.08 ¦
+------------+------+---------+----------¦
¦Total ¦7,790 ¦11,682.72¦27,577.09 ¦
+----------------------------------------+
On August 9, 1945, petitioner Helen W. Lilly...
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