Schneider v. Kelm

• Decision Date: 10 February 1956
• Docket Number: 4740.,Civ. No. 4739
• Citation: 137 F. Supp. 871
• Parties: Robert S. SCHNEIDER, Plaintiff, v. Elmer F. KELM, (formerly) Collector of Internal Revenue, St. Paul, Minnesota, Defendant. Adolph SCHEIN, Plaintiff, v. Elmer F. KELM, (formerly) Collector of Internal Revenue, St. Paul, Minnesota, Defendant.
• Court: U.S. District Court — District of Minnesota

137 F. Supp. 871

Robert S. SCHNEIDER, Plaintiff, v. Elmer F. KELM, (formerly) Collector of Internal Revenue, St. Paul, Minnesota, Defendant.

Adolph SCHEIN, Plaintiff, v. Elmer F. KELM, (formerly) Collector of Internal Revenue, St. Paul, Minnesota, Defendant.

Civ. Nos. 4739, 4740.

United States District Court D. Minnesota, Fourth Division.

February 10, 1956.

COPYRIGHT MATERIAL OMITTED

Harry L. Altman, Minneapolis, Minn., for plaintiff.

Kurt Melchior, Washington, D. C., for defendant.

DEVITT, District Judge.

This is a "family partnership" case under the internal revenue laws. The plaintiffs, Robert Schneider and Adolph Schein, seek to recover federal income taxes paid by them for the years 1946 and 1947 to the defendant, former Collector of Internal Revenue, pursuant to deficiency assessments made against them by the Commissioner of Internal Revenue.

The question presented on the merits of the case is whether the Commissioner acted correctly in attributing to Schneider and Schein income earned in a dress manufacturing business which they operated, and which was reported to the government as income earned by their respective wives, Bertha Schneider and Jennie Schein.

The two wives held themselves out to the taxing authorities as, and maintain in this law suit that they were, income producing partners. The business involved operated under the name of Boulevard Frocks, and maintained its manufacturing facilities in the City of Minneapolis. Plaintiffs contend that their two wives contributed capital to the business, after having received that capital from plaintiffs as "gifts", and that the two wives also contributed substantially to the partnership operations by acting as advisors and consultants in the design of new dresses and by "shopping" the lines put out by other manufacturers for new ideas.

Partnerships, as such, are not subject to tax but must file an information return. Section 187, Internal Revenue Code (1939), 26 U.S.C.A. § 187.

A cardinal rule of income taxation is that income should be taxed to the person who earns it. Lucas v. Earl, 1930, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731; Helvering v. Horst, 1940, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75; Helvering v. Eubank, 1940, 311 U.S. 122, 61 S.Ct. 149, 85 L.Ed. 81; Commissioner of Internal Revenue v. Court Holding Co., 1945, 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981.

A key decision on the question here involved is Commissioner of Internal Revenue v. Culbertson, 1949, 337 U.S. 733, 69 S.Ct. 1210, 93 L.Ed. 1659, the principles of which have been followed in innumerable decisions, the latest of which in this circuit is Lannan v. Kelm, 1955, 221 F.2d 725. In Culbertson it is stated that 337 U.S. 733, 69 S.Ct. 1213: "* * * he who presently earns the income through his own labor and skill and the utilization of his own capital must be taxed therefor * * *".

The issue is: Did the plaintiffs earn the disputed income or did their wives earn it?

I am satisfied that these two plaintiffs earned the income for the years in question, and that the Commissioner acted properly in assessing the tax against them. While it is true that Bertha Schneider and Jennie Schein signed a partnership agreement with their husbands, and while in matters of form many of the merchanics pertaining to the creation of a purported partnership were suitably undertaken, yet there was no genuine intent that the wives should either render services to the business or that they should contribute capital for the purpose of producing income for the business: nor did they do so.

A tax assessment must be made by the true, rather than by the formal, intent of the parties. The test is whether the income attributed to the taxpayers by the Commissioner was in fact earned by them, by their own labor, or through the productive application of capital which in fact they controlled. Conversely, despite the possibility that a "legally valid" partnership agreement may have been executed between the taxpayers and their "partners", income is to be attributed to the challenged "partners" only according to the true intent of the parties.

In such situations the partnership agreement itself is only an indication of the contribution of the family members to the production of earnings and the Court must regard it with "raised eyebrows", Dyer v. Commissioner, 2 Cir., 1955, 211 F.2d 500, 505, in seeing whether the taxpayers have met the burden upon them to overcome the presumption of a correct assessment.

Looking at the present situation in the light of these standards, the Court has no difficulty in finding that the alleged partnership was a sham for tax avoidance, and that the income of Boulevard Frocks was in fact earned entirely by Robert S. Schneider and Adolph Schein. It is true their wives received formal title by "gift" to one-half of the business' undivided assets. But at all pertinent times the business was in a position to pay off the wives out of United States government bonds or certificates of indebtedness, which were idle funds so far as the needs of the business were concerned. Moreover, the government showed that the earnings placed in the names of Mrs. Schneider and Mrs. Schein did not come in any substantial amount into their own separate domain. Rather, these funds went into joint bank accounts, in part especially established for the purpose, and were used to defray such things as household expenses — thereby relieving the husbands of obligations which had theretofore been theirs.

The plaintiffs and their wives testified to continuous service allegedly rendered by the women in comparative shopping, and in the creation or design of new dresses, but this testimony was met in head-on conflict by the testimony of designers and pattern makers who worked in the business during all of the time here pertinent. Their testimony was unequivocal that Mrs. Schein and Mrs. Schneider made absolutely no contributions in the manner urged, and in fact that neither of them was ever seen in the work rooms of the factory. The testimony of these designers and pattern makers, Mrs. Anderson, Mrs. Mikulak and Mrs. Hokanson, was clear, straightforward and unequivocal. Their relationship...