Morrison v. Comm'r of Internal Revenue, Docket No. 14162.

• Citation: 11 T.C. 696
• Decision Date: 26 October 1948
• Docket Number: Docket No. 14162.
• Parties: JOSEPH J. MORRISON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

11 T.C. 696

JOSEPH J. MORRISON, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 14162.

Tax Court of the United States.

Promulgated October 26, 1948.

1. Petitioner's wife and two sons made no contributions of capital originating with them to the business, did not aid in its management and control and did not otherwise perform vital additional services. Held, income of business taxable in full to petitioner, notwithstanding purported family partnership arrangement. Commissioner v. Tower, 327 U.S. 280, and Lusthaus v. Commissioner, 327 U.S. 293, followed.

2. Respondent mailed a notice of deficiency to petitioner within three years from time he filed his return for taxable year. Subsequent to termination of three-year period internal revenue agent in charge mailed letter to partnership reallocating substantially all of its income to petitioner. Held, deficiency was determined within the time prescribed by statute, internal revenue agent's letter not being a notice of deficiency. H. F. Farrington, C.P.A., for the petitioner.

J. Frost Walker, Esq., for the respondent.

The Commissioner determined a deficiency of $28,000.12 in income and victory taxes for the calendar year 1943. The year 1942 is also involved because of the Current Tax Payment Act. The issues are (1) whether all the net income of a partnership is taxable to petitioner, and (2) whether the deficiency was determined within the time prescribed by statute.

FINDINGS OF FACT.

The petitioner, Joseph J. Morrison, is an individual and resides at Watertown, New York. He filed his income tax return for the calendar year 1943 with the collector of internal revenue for the twenty-first district of New York, at Syracuse, New York.

Petitioner entered the furniture business at the age of seventeen as a partner with his uncle, W. H. Van Buren. A year later petitioner bought out his uncle and thereafter, until January 2, 1940, continued the business as a sole proprietorship. In 1922, subsequent to his entering the furniture business, petitioner married Margareatte B. Morrison. Their living quarters were above the store and Mrs. Morrison assisted in the business, waiting on customers and doing the bookkeeping, putting in most of the working hours daily from 1922 until 1924, when their first child was born. From 1924 through 1938 Mrs. Morrison assisted intermittently in the business. For all the years through 1939 petitioner reported in his income tax returns the income from the business known as ‘Morrisons Furniture Store‘ as taxable to him individually.

In 1939 Mrs. Morrison was credited, for the first time, with a salary in the amount of $6,000, although her activities during that year did not differ markedly from those of previous years. This money was not drawn by her during the year, but was credited to her in a lump sum in December 1939. Also, in December 1939, petitioner made a gift of $4,000 to Mrs. Morrison which was credited to her capital account in the subsequent family partnership. The profits of Morrisons Furniture Store in 1939 were the largest in its history, the net income for that year being $29,864.13, as compared with the previous year's total of $9,048.65. On January 2, 1940, articles of copartnership were drawn up and signed by petitioner and his wife, the partnership keeping the name of ‘Morrisons Furniture Store.‘ The total capital of the partnership at the time of its formation was $154,000. Of this, each partner had a half interest of $77,000, and each partner was to share equally in the profits and losses of the partnership. Of Mrs. Morrison's $77,000, $10,000 consisted of her $6,000 salary for 1939 and the $4,000 gift from petitioner, both received a few days before the formation of the partnership. The remainder of her capital contribution, $67,000, consisted of a gift from petitioner, made simultaneously with the formation of the partnership, on which he paid a gift tax. After the formation of the partnership Mrs. Morrison continued intermittently to perform various duties in connection with the furniture store, such as buying materials and stock work. The articles of copartnership provided that petitioner was to give his full time to the business. As to his wife, there was this provision:

It is further mutually agreed that said Margareatte B. Morrison, Party of the Second Part, shall not be required to give all of her time to the affairs and interests of said co-partnership but that she will devote at least a part of her working time to the affairs and interests of said co-partnership business, and when the demands of the business shall warrant the said Party of the Second Part hereby agrees that she will give her entire working time to said business and to its interests.

During 1940 and 1941 profits continued to increase, the net income for 1940 being $59,768.87, and for the first seven months of 1941, $52,405.98. On August 1, 1941, a four-member partnership was formed, consisting of petitioner, his wife, and their two sons, John and Patrick. At that time the two sons were respectively seventeen and sixteen years of age and were attending high school. Petitioner was then thirty-nine. Simultaneously with the formation of the partnership petitioner and Mrs. Morrison each gave each son a one-eighth interest in the partnership, so that each of the four parties had a one-fourth interest. Under the articles of copartnership each of the four partners was to share equally in the profits and losses of the partnership. Petitioner and Mrs. Morrison paid gift taxes on these gifts. The sons had worked in the store during vacations and after school hours since they were twelve, and the older son had received afternoons off from high school in conjunction with a selling course he was taking in order to work in the store. Prior to the formation of the partnership the sons had been paid at the rate of 25 cents an hour for their services in the store. Under the four-member partnership agreement the sons were to ‘perform services for the co-partnership of which they are capable at such times as they are free from requirements of their education. ‘ As in the two-member partnership agreement there were provisions that petitioner give his full time to the business, but that his wife not be required to give all her time. After the formation of the partnership the duties of the sons remained substantially the same as they had been theretofore, except that they were relieved of some of their heavier duties in the store, such as uncrating furniture. Neither son was given the privilege of writing checks for the partnership. Simultaneously with the four-member partnership agreement petitioner and Mrs. Morrison signed an emancipation agreement whereby they waived any rights to the earnings of their sons, both minors. In 1943 petitioner filled out his classification for draft purposes and stated that he had no dependents. He was accordingly classified 1-AH.

The older son, John, finished high school in June 1943 and entered the Navy July 10, 1943. The younger son, Patrick, finished high school in January 1944 and entered the Navy March 3, 1944. The four-member partnership was dissolved August 1, 1944, and was incorporated as of that date. In this corporation petitioner was president and treasurer; his wife, vice president and secretary; John, assistant secretary; and Patrick, assistant treasurer. Petitioner's salary was $15,000, his wife's $7,000, and each son's $900. Each member of the family received a quarter of the stock at the time of the formation of the corporation. Later there were other transactions in the stock, so that at the time of trial the sons owned the controlling interest in the business. The older son was discharged from the Navy November 17, 1945, and the younger son on May 21, 1946. After leaving the service both sons entered the business and devoted their full time to it.

In 1942 the four-member partnership formed a realty corporation for the purpose of taking title to the building in which the store was located. In this corporation petitioner received 66 shares of stock, his wife 64 shares, and his sons each 60 shares.

During the fiscal year ended July 1943, while the four-member partnership was still in existence, petitioner withdrew from the partnership account a total of $23,671.89. Mrs. Morrison withdrew during the same period $15,132.39. John withdrew $10,846.57 and Patrick withdrew $10,749.14. The excessive drawings on the part of the petitioner were for the purpose of settling his father's estate and paying income taxes. Some time after the drawings, notes were given by petitioner to the other three partners covering the amounts. Those notes were paid with interest in full in January 1947.

The Commissioner mailed notice of deficiency to petitioner March 14, 1947. The partnership net income was reallocated for the fiscal years ended July 31, 1942 and 1943, so that Mrs. Morrison was held to have received $1,600 for each year— $600 as compensation for services and $1,000 as return of 10 per cent on a capital investment of $10,000— and the remainder of partnership net income was treated as taxable to petitioner alone. A letter from the internal revenue agent in charge, addressed to the partnership and detailing the reallocation, was mailed March 21, 1947.

OPINION.

HARLAN, Judge:

The first and primary issue in this case is whether the income from the partnership known as Morrisons Furniture Store for the calendar years 1942 and 1943 is taxable equally to all four members of the partnership, petitioner, his wife, and their two sons. The case is in many respects similar to Commissioner v. Tower, 327 U.S. 280, and Lusthaus v. Commissioner, 327 U.S. 293, decided by the Supreme Court in favor of the position here held by respondent.

In the Tower case the taxpayer transferred shares of stock of the corporation he controlled to his wife on the condition that she place the corporate assets represented by...