Tunnell v. United States

• Decision Date: 08 October 1958
• Docket Number: No. 12541.,12541.
• Citation: 259 F.2d 916
• Parties: James M. TUNNELL, Jr., and Mildred S. Tunnell, Appellants, v. UNITED STATES of America.
• Court: U.S. Court of Appeals — Third Circuit

259 F.2d 916 (1958)

James M. TUNNELL, Jr., and Mildred S. Tunnell, Appellants, v. UNITED STATES of America.

No. 12541.

United States Court of Appeals Third Circuit.

Argued May 15, 1958.

Decided October 8, 1958.

James M. Tunnell, Jr., Wilmington, Del., for appellants.

Louise Foster, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, Louise Foster, Attys., Dept. of Justice, Washington, D. C., Leonard G. Hagner, U. S. Atty., Wilmington, Del., on the brief), for appellee.

Before MARIS, KALODNER and STALEY, Circuit Judges.

KALODNER, Circuit Judge.

The plaintiffs, husband and wife, commenced this action to recover alleged overpayment of their income taxes for the calendar year 1951, when they filed a joint return. Although the district court entered judgment in their favor, 148 F. Supp. 689, the plaintiffs deem the amount inadequate and therefore prosecute this appeal.

The single issue presented is whether the entire proceeds from the sale by husband-plaintiff (hereinafter called the taxpayer) of his interest in a partnership of lawyers is subject to capital gains treatment, or a portion thereof, attributable to earned but uncollected fees, must be taxed as ordinary income.

The facts are as follows:

In 1951, taxpayer owned a fifty percent partnership interest in a law partnership. On June 7, 1951, he withdrew from the partnership. On November 2, 1951, taxpayer and his partners entered into an "Agreement of Dissolution of Partnership" which recited, among other things, that they desired to put in writing the settlement of the partnership rights and obligations. In this document, taxpayer transferred and assigned to the remaining partners all his right, title or interest in the law firm, its good will, furniture, fixtures, bank account, book accounts, and claims for any services which had been rendered prior to June 7, 1951, but which had not progressed far enough to justify billing; in consideration taxpayer was to receive from the remaining partners the sum of $27,500, of which $18,116.07 was acknowledged to have been paid to taxpayer on June 6, 1951, and the balance, $9,383.93, was to be paid following execution of the written agreement.

At the time taxpayer withdrew from the firm, the partnership books showed accounts receivable, charged on the books but uncollected, in the amount of $21,833.51.

Both the taxpayer and the partnership were on the "cash receipts and disbursements", rather than the "accrual", accounting basis. The taxpayer and his wife included in their joint return the proceeds of the sale of taxpayer's partnership interest, treating $24,192.87.¹ thereof as ordinary income. Subsequently taxpayer concluded that the entire amount of the proceeds of the sale was gain derived from the sale of a capital asset held for more than six months, and he filed a petition for refund. This petition was denied.

Proceeding to the district court, the taxpayer contended that a partnership interest, under Section 117 of the Internal Revenue Code of 1939, 26 U.S.C. § 117, is a capital asset; that a sale of a partnership interest is not divisible into segments for tax purposes; that there was no net income realized from the receivables and he owned no distributive share on the date of the sale. Accordingly, taxpayer concluded that Section 182 of the Internal Revenue Code of 1939² is inapplicable, and that he is entitled to capital gain treatment on the entire proceeds of the sale.

The United States did not dispute that a partnership interest is a capital asset.³ But it did contend that to the extent the sale of taxpayer's partnership interest reflected his interest in accounts receivable, computed at 50% of $21,833.51, or $10,916.76, it was a distributive share of partnership earnings and taxable as ordinary income. Consistent with this theory, the government conceded that the difference between that sum and the total price, or $13,276.11, is subject to capital gain treatment, and that the taxpayer should have a refund to that extent.

The district court treated the contentions of the parties at length, and discussed the pertinent authorities. It rejected the distinction between "cash" and "accrual" accounting bases as a reliable guide: compare Swiren v. Commissioner, 7 Cir., 1950, 183 F.2d 656, certiorari denied 340 U.S. 912, 71 S.Ct. 293, 95 L.Ed. 659; Meyer v. United States, 7 Cir., 1954, 213 F.2d 278, and United States v. Snow, 9 Cir., 1955, 223 F.2d 103, 107, footnote 1, certiorari denied 350 U.S. 831, 76 S.Ct. 64, 100 L.Ed. 741. It concluded that while the sale of a partnership is treated as the sale of a capital asset, the sale of a right to receive ordinary income is not. Accordingly, it held that the proceeds of the sale of taxpayer's partnership interest, to the extent that it was attributable to the presence of accounts receivable at the time of the sale, was taxable as ordinary income.⁴

We agree with these conclusions of the district court.

In Commissioner of Internal Revenue v. P. G. Lake, Inc., 1958, 356 U.S. 260, beginning at page 265, 78 S.Ct. 691, at page 694, 2 L.Ed.2d 743, the Supreme Court said:

"The purpose of § 117 was `to relieve the taxpayer from * * * excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions.\' See Burnet v. Harmel, 287 U.S. 103, 106, 53 S.Ct. 74, 75, 77 L.Ed. 199. And this exception has always been narrowly construed so as to protect the revenue against artful devices. See Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 52, 76 S.Ct. 20, 24, 100 L.Ed. 29.

"We do not see here any conversion of a capital investment. The lump sum consideration seems essentially a substitute for what would otherwise be received at a future time as ordinary income. The payout of these particular assigned oil payment rights could be ascertained with considerable accuracy. * * * cash was received which was equal to the amount of the income to accrue during the term of the assignment, the assignee being compensated by interest on his advance. The substance of what was assigned was the right to receive future income. The substance of what was received was the present value of income which the recipient would otherwise obtain in the future. In short, consideration was paid for the right to receive future income, not for an increase in the value of the income-producing property.

"These arrangements seem to us transparent devices. Their forms do not control. Their essence is determined not by subtleties of draftsmanship but by their total effect. See Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788; Harrison v. Schaffner, 312 U.S. 579, 61 S.Ct. 759, 85 L.Ed. 1055. We have held that if one, entitled to receive at a future date interest on a bond or compensation for services, makes a grant of it by anticipatory assignment, he realizes taxable income as if he had collected the interest or received the salary and then paid it over. That is the teaching of Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, and Harrison v. Schaffner, supra; and it is applicable here. As we stated in Helvering v. Horst, supra, 311 U.S. 117, 61 S.Ct. 147, `The taxpayer has equally enjoyed the fruits of his labor or

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