Lusthaus v. Commissioner of Internal Revenue

• Decision Date: 25 February 1946
• Docket Number: No. 263,263
• Parties: LUSTHAUS v. COMMISSIONER OF INTERNAL REVENUE
• Court: U.S. Supreme Court

327 U.S. 293

66 S.Ct. 539

90 L.Ed. 679

LUSTHAUS

v COMMISSIONER OF INTERNAL REVENUE.

No. 263.

Argued Jan. 10, 11, 1946.

Decided Feb. 25, 1946.

Messrs.Paul E. Hutchinson and William Wallace Booth, both of Pittsburgh, Pa., for petitioner.

Mr. Arnold Raum, of Washington, D.C., for respondent.

[Argument of Counsel from page 294 intentionally omitted] Mr. Justice BLACK delivered the opinion of the Court.

The question in this case is the same as in Commissioner v. Tower, 327 U.S. 280, 66 S.Ct. 532. Here, too, the Commissioner made a deficiency assessment against the husband, petitioner, for purported partnership earnings reported in his wife's return for 1940 and not reported by the petitioner. The Commissioner's action was based on a determination, made after an investigation, that for income tax purposes no partnership existed between the petitioner and his wife. The following are the controlling facts: Petitioner has operated a furniture business since 1918 and since 1933 he has conducted a retail furniture business at two stores located in Uniontown, Pennsylvania. His wife helped out at the stores whenever she was needed without receiving compensation. In 1939 the petitioner found himself confronted with the prospect of large profits and correspondingly large income taxes. This caused him concern and he called in his accountant and attorney. Together they worked out a plan for the supposed husband-wife partnership here involved. The wife had little to do with the whole transaction, and testified when asked about the details that 'on the advice of counsel I did what he told me to do'. In accordance with the plan the petitioner executed a bill of sale to his wife by which he purported to sell her an undivided half interest in the business for $105,253.81. At the same time the wife executed a pa tnership agreement under which she undertook to share profits and losses with her husband. The wife paid for her undivided half interest in the following way. Petitioner borrowed $25,000 from a bank and gave his wife a check for $50,000 drawn against the amount borrowed and further funds which he had withdrawn from the business and deposited with the bank for that purpose. The wife then gave petitioner her check for $50,255.81 and the petitioner repaid the $25,000 to the bank. Petitioner's wife also gave him eleven notes in the amount of $5,000 each of which according to an understanding were to be paid from the profits to be ascribed to the wife under the partnership agreement.¹ Petitioner reported in a 1940 gift tax return that he had made a gift of $50,000 to his wife. Pennsylvania issued petitioner and his wife a certificate authorizing them to carry on the business as a partnership. When the partnership was formed petitioner's wife owned her home, valued at twenty-five to thirty thousand dollars and securities worth up to twenty-five thousand dollars.

After the partnership was formed the wife continued to help out in the stores whenever she was needed just as she had always done. But petitioner retained full control of the management of the business. His wife was not permitted to draw checks on the business bank account. During the taxable year here involved the husband filed social security tax returns as owner of the business. Neither partner could sell or assign the interest ascribed by the partnership agreement without the other's written consent. Though, at the close of each year the profits of the business were credited on the books to petitioner and his wife equally, no withdrawals were to be made under the partnership agreement unless both partners agreed. The husband drew no salary. During 1940, which is the tax year here involved, the business net profits were in excess of $80,000, from which the respondent withdrew about $4,500 and his wife withdrew only $59.61. The following year the withdrew approximately $16,000 and $19,900 respectively, the wife's withdrawal being used largely to pay back some of the $5,000 notes given as part of her alleged contribution to the partnership capital. On this evidence the Tax Court found that the wife acquired no separate interest in the partnership by turning back to her husband the $50,000 which he had given her conditioned upon her turning it back to him; and that the partnership arrangements were merely superficial, and did not result in changing the husband's economic interest in the business. It concluded that while the partnership was 'clothed in the outer garment of legal respectability' its existence could not be recognized for income tax purposes. 3 T.C. 540. The Circuit Court of Appeals affirmed. 149 F.2d 232. The petitioner challenges the Tax Court's finding that the wife was not a genuine partner on the ground that the evidence did not support it. We hold that it did.

For the reasons set out in our opinion in Commissioner v. Tower, 327 U.S. 280, 66 S.Ct. 532 the decision of the Circuit Court of Appeals is affirmed.

Affirmed.

Mr. Justice JACKSON, took no part in the consideration or decision of this case.

Mr. Justice REED, dissenting.

As the Court considers, and as we do, th question in this case is the same as that in Commissioner v. Tower, decided today, and as the Court relies to support its conclusion upon the reasons set out in the Tower opinion, we shall state the grounds for our dissent in this case rather than the Tower case. We choose this certiorari for our explanation because the issue stands out more boldly in the light of the facts before and findings of the Tax Court.

A. L. Lusthaus, as an individual proprietor, had operated a furniture business in Uniontown, Pennsylvania for a number of years. In 1939 a realization of existing and prospective federal income tax burdens caused him to cast about for a legal means of lessening the tax. Such method of tax avoidance has not heretofore been considered illegal and apropos of this rule, this Court says today in the Tower opinion, 'We do not reject that principle.' See Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 267, 79 L.Ed. 596, 97 A.L.R. 1355, and cases cited; Bullen v. State of Wisconsin, 240 U.S. 625, 630, 631, 36 S.Ct. 473, 474, 475, 60 L.Ed. 830.

The statement in the Court's opinion adequately covers the facts. But it should not be inferred from the Court's statement that the notes given were 'according to an understanding * * * to be paid from the profits to be ascribed to the wife under the partnership agreement,' that payment of the notes was so limited. The notes were unconditional promises to pay. The payment of them from profits was only a hope.

It is essential, too, we think, to note that in these partnership cases the tax doctrine of Lucas v. Earl, 281 U.S. 111, 115, 50 S.Ct. 241, 74 L.Ed. 731, as to the attribution of income fruit to a different tree from that on which it grew is inapplicable. Here, so far as the income is attributable to the property given, the gift cannot be taken as a gift of income before it was earned or payable, as in Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731; Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, 131 A.L.R. 655; Helvering v. Eubank, 311 U.S. 122, 61 S.Ct. 149, 85 L.Ed. 81; where the income was held taxable to the donor. It was a gift of property which thereafter produced income which was taxable to the donee, as in Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465; cf. Helvering v. Horst, supra, 311 U.S. at page 119, 61 S.Ct. at page 148, 85 L.Ed. 75, 131 A.L.R. 655.

From first to last, the record shows a controversy as to whether the business is a valid partnerhip under the tax laws. The issue never has been whether Mr. Lusthaus failed to return his personal earnings for taxation. There was an effort on the part of the Commissioner to tax him upon a part or all of the partnership earnings as personal compensation which he had earned individually but as- signed to the partnership for collection or which he had earned individually but caused to be paid to a fictitious partnership. While the Tax Court pointed out that the income resulted in part from petitioner's managerial ability, it also recognized that the capital contributed to the earnings. 3 T.C. at page 543. The Tax Court thought that the wife acquired 'no separate interest of her own by turning back to petitioner the $50,000' which had been given her conditionally and for that specific purpose. Why it thought the wife did not become an owner in the partnership business, the Tax Court does not explain. The Court's opinion does not turn upon any issue which is connected with the value of Mr. Lusthaus' services and we mention it only for the purpose of focusing attention upon what seems to us the Court's error. If the case was in the posture of a tax claim against Mr. Lusthaus based upon his failure to account for income actually earned by him but paid to his wife, an entirely different issue would be presented.

Since the questions of taxability in this case turn on the wife's bona fide ownership of a share in the partnership, we cannot say that federal law is controlling. Even if it were, we are pointed to no federal law of partnership which precludes the wife's becoming a partner with her husband and making her contribution to capital from money or property given to her by her husband, as well as from any other source.¹ The Court's opinion does not hold that income of fusband and wife must be taxed as one. Congress has refused to do this although urged to do so.² It does not hold that a wife may not be a partner of her husband under some circumstances. It is said she may be 'If she either invests capital originating with her or substantially contributes to the control and management of the business, or otherwise performs vital additional services, or does all of these things * * * 26 U.S.C. §§ 181, 182, 26 U.S.C.A.Int.Rev.Code, §§ 181, 182.' Tower opinion, 327 U.S. 290, 66 S.Ct. at page 537. But as we read the Court's opinion,...