Byerlein v. Commissioner

Arthur A. Byerlein, Petitioner, v. Commissioner of Internal Revenue, Respondent Byerlein v. Commissioner Docket No. 17999 United States Tax Court 13 T.C. 1085; 1949 U.S. Tax Ct. LEXIS 1; December 30, 1949, Promulgated *1 Decision will be entered under Rule 50. 1. Income received and controlled by petitioner's wife as her share of the proceeds of a business in which petitioner had transferred to her a part of his interest and to which neither she nor petitioner contributed services, held not taxable to him. Clifford R. Allen, Jr., 12 T. C. 227. 2. Deductions for losses on oil leases and for business expenses, including automobile maintenance, entertainment, and accounting and advisory services, held on facts partly allowable. J. Emmett Tunney, Esq., for the petitioner. A. J. Friedman, Esq., for the respondent. Opper, Judge. OPPER *1085 By this proceeding petitioner challenges respondent's determination of deficiencies in income and victory tax*2 of $ 13,093.19 for the year *1086 1943, and in income tax of $ 37,407.09 for the pear 1944. The deficiencies result in part from respondent's action in increasing petitioner's income by amounts his wife received as her share of the profits of a partnership, and respondent's action in disallowing amounts claimed as deductions for losses on abandoned oil leases and as deductions for business expenses, including depreciation on automobile and automobile maintenance, entertainment, and accounting and advisory expenses. Other adjustments are not contested. The parties have filed a stipulation of facts. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner Arthur A. Byerlein filed his Federal income tax returns for the taxable years with the collector of internal revenue for the district of Michigan. Facts relating to family partnership issue: Prior to the year 1934 petitioner was a social acquaintance of Lawrence E. Gregory, who was president, manager, and a stockholder of Detroit Pattern Plate Co., hereinafter called Pattern Plate. On August 29, 1934, petitioner made a loan to Gregory of $ 2,500, and received Gregory's personal note for that amount*3 due in one year and secured by 31 shares of common stock of Pattern Plate. Petitioner later made additional loans to Gregory, the amounts of which were added to the note. In the year 1936 Pattern Plate was threatened with receivership by its creditors, and it employed Albert J. Silber and O. Z. Ide as attorneys to perform legal services in that connection. At Gregory's request petitioner made a further loan in the year 1936 of $ 3,500 to avert the threatened receivership. This loan brought Gregory's debt to about $ 10,000, and his note was renewed in that amount. The total indebtedness was secured by a mortgage on the property of Pattern Plate, and, as an added inducement or bonus for the $ 3,500 loan, petitioner received from Gregory an undisclosed number of shares of Pattern Plate stock. At that time petitioner considered that the company was worth less than $ 10,000, because its building and equipment were in bad condition. In payment for his legal services, including arrangement of the $ 3,500 loan, Ide received 10 shares of Pattern Plate stock, which were subsequently purchased by Silber. At the time of the mortgage in 1936 petitioner began countersigning all checks of Pattern*4 Plate. The usual procedure adopted was that checks drawn on Pattern Plate's account, filled in with names of payees, dates, and amounts, were brought to petitioner once or twice a week *1087 for his signature. For purposes of convenience, since petitioner was not always available, about six blank checks were usually included with those filled in, and petitioner would countersign the blank checks and leave them with Gregory. In July 1942, on advice of Silber, a corporation called Detroit Magnesium & Aluminum Casting Co., hereinafter called the Casting Co., was formed to take over the assets and liabilities of Pattern Plate. One purpose of the formation of the Casting Co. was to avoid payment of state corporate franchise fees for prior years owed by Pattern Plate. In July 1942 the Casting Co. began to operate the business previously conducted by Pattern Plate, and petitioner continued to countersign all checks. In December 1942 petitioner made a gift to his wife, Nora M. Byerlein, of the $ 10,000 Gregory note. At a meeting in December 1942, attended by petitioner, Gregory, Silber, and Guest, accountant for the Casting Co., Silber advised that the company be dissolved and its*5 business conducted as a partnership in order to avoid being subject to excess profits taxes. Accordingly in December 1942 the Casting Co. was dissolved and a partnership of the same name was formed. The members of the partnership were petitioner, Gregory, and Silber. Their interests were in proportion to the stock they had held in the Casting Co., as follows: Gregory 58% Petitioner 35% Silber 7% No written partnership agreement was executed. After formation of the partnership, petitioner's wife surrendered Gregory's note and received in its place a note signed by petitioner, Gregory, and Silber in the amount of $ 10,288, which was paid to her in full on December 15, 1943. On or about February 1, 1943, petitioner made a gift to his wife of a 30 per cent interest in the partnership, and, on advice of Silber, retained for himself a 5 per cent interest in order that he might be one of the partners and thus he and his wife together could outvote Gregory. No written partnership agreement was executed. Petitioner continued to countersign all checks of the partnership. Pattern Plate originally was a pattern shop, but gradually grew into the foundry business and specialized*6 in magnesium castings. Gregory was at all times manager of Pattern Plate, Casting Co., and the business conducted by the partnership. Petitioner, Silber, and petitioner's wife never questioned Gregory's technical production ability, and they left the production phase of the business entirely to him. Neither petitioner nor his wife rendered any services to the partnership. *1088 In October 1944 petitioner employed Samuel H. Glucksman, a certified public accountant, to examine the partnership books. That examination resulted in the discovery that Gregory had overdrawn his salary account. On advice of Glucksman, petitioner wrote Gregory a letter dated December 27, 1944, stating as follows: Following our recent meeting I have been somewhat worried about my possible liability to the Government in connection with the operation of this partnership. I have consulted with my regular tax counsel and am advised by him that several items of disbursement may be subject to question and possible disallowance. Inasmuch as my name appears on all checks issued by this Company, there is also a serious possibility that I may be held personally responsible for such disbursements if they be *7 held improper. For this reason I feel compelled to notify you that I will no longer sign any blank checks presented to me for signature. However, I will be glad to countersign any completed checks which are for payment of ordinary and regular bills of the Company. I am also notifying you that any previous checks signed by me in blank which have not been used, must not be issued for any but regular and ordinary bills in connection with the usual operation of the business, and that you alone will be held personally responsible for the issuance of any such blank checks now in your possession. In a letter dated January 29, 1945, to National Bank of Detroit, petitioner stated: It was satisfactory for you to cash Detroit Magnesium and Aluminum Casting Company's Payroll Check No. 1522, dated January 26, in the amount of $ 1,968.22. In its returns for the taxable years ended November 30, 1943, and November 30, 1944, the partnership reported gross receipts, gross profits, and net income distributable as follows: Gross Gross Year receipts profits [1943] $ 198,874.30 $ 118,049.29 [1944] 314,656.27 205,376.22 Net income Year Gregory Nora Petitioner Silber Byerlein [1943] $ 51,444.27 $ 14,327.94 $ 4,647.06 $ 3,794.98 [1944] 92,318.08 37,405.91 6,234.32 8,728.04 *8 As of November 30, 1944, Gregory purchased the partnership interests of petitioner and his wife for $ 24,710.86, which was received by them as follows: Petitioner's wife, $ 22,160.86; and petitioner, $ 2,550. Petitioner's wife maintained a savings account in her own name in the National Bank of Detroit. On February 1, 1943, the balance in that account was $ 3,463.44. During the year 1943 she made deposits totaling $ 12,800, which included a deposit of $ 7,200 on December 17, 1943, representing money received in payment of the note for $ 10,288. During the same year she made withdrawals from that bank account totaling $ 3,125. During the year 1944 she made deposits totaling *1089 $ 16,800, of which at least $ 15,000 represented receipts of partnership proceeds. During that year she made total withdrawals from the bank account amounting to $ 14,850. During the year 1945 she made deposits totaling $ 26,560.86, of which at least $ 2,500 represented receipts of partnership profits and $ 22,160.86 represented her share of the sale price of the business sold to Gregory. During that year she made total withdrawals from the bank account amounting to $ 1,600. In succeeding years*9 she made no deposits, and only one withdrawal, of $ 125, on September 23, 1948. The balance of the account as of September 23, 1948, the date of the last entry therein, was $ 40,352.26. In separate income tax returns for the years 1943 and 1944, petitioner and his wife reported income from the partnership as follows: [1944] Petitioner's wife $ 14,397.02 $ 37,405.91 Petitioner 4,658.56 6,234.32 In his notice of deficiency, respondent determined: * * * that Nora M. Byerlein was not a bona fide partners [sic] for income tax purposes in the Detroit Magnesium and Aluminum Casting Company, partnership, for the years 1943 and 1944 and, therefore, the income reported by her, less certain adjustments, is included in your income for the respective years. Section 22(a) of the Internal Revenue Code. The parties, acting in good faith and with a business purpose, intended that petitioner's wife join together with petitioner, Gregory, and Silber as a partner in carrying on business. Facts relating to accounting and advisory expense deductions: In addition to Glucksman's services in examining the partnership books, described above, he performed further services for *10 both petitioner and his wife during the taxable years. During the year 1944 petitioner agreed to pay him an annual retainer of $ 2,000 as an economic advisor to investigate prospective investments and to handle tax matters. In accordance with that agreement, petitioner paid Glucksman the annual retainer of $ 2,000 in the year 1944, and an additional $ 1,450 for further services. No written invoice or bill for the services was presented. Of the $ 3,450, $ 400 was for arranging the sale of petitioner's partnership interest to Gregory, $ 500 was a carry-over from a tax matter undertaken in the year 1943, and the remainder was for miscellaneous advisory and tax services not connected with the partnership. At the time of the hearing in this proceeding, petitioner held stock in about twelve corporations. During the year 1944 petitioner's wife paid Glucksman $ 4,000 for services rendered solely to her. No written invoice or bill for the services was presented. Of that amount, $ 500 was for arranging the *1090 sale of her partnership interest to Gregory and $ 3,500 was for other services in connection with her interest in the partnership, including the checking of various figures, *11 getting information, and holding conferences. Glucksman's services were at least partially responsible for the withdrawal of partnership profits by petitioner and his wife in the aggregate amount of about $ 20,000 in the year 1944. In his return for the year 1944 petitioner claimed "Legal & Accounting" expense in the amount of $ 3,502.50, which respondent has disallowed "for lack of substantiation." Petitioner had deductible expenses of $ 3,450 for accounting and advisory services in the year 1944. In her return for the year 1944, petitioner's wife reported net income from the partnership in the amount of $ 33,405.91, being $ 37,405.91 (30 per cent of the partnership's net income), less $ 4,000 claimed as a deduction for "Legal & Accounting" expense. In his notice of deficiency respondent has included in petitioner's taxable income from the partnership the amount of $ 37,955.31, being the $ 37,405.91 received by his wife, with sundry uncontested adjustments to partnership income. Facts relating to automobile and entertainment expense deductions: Petitioner's principal occupation is as an officer and director of Lima-Hamilton Corporation, manufacturer of machinery. He is an*12 engineer by profession, and in the taxable years was in charge of engineering for machinery used in sheet metal work. About one-half of his efforts for Lima-Hamilton consisted of sales promotions. In that connection, petitioner drove his car nearly every day, and occasionally on business trips to factories in Grand Rapids, Pontiac, Flint, and Cleveland. He was not reimbursed for expenses incurred in maintaining the automobile. Also in connection with sales promotions for Lima-Hamilton, petitioner found it necessary to do considerable entertaining. He kept no record of amounts expended for entertainment, but estimated them to be about $ 3,000 per year. In his returns for the years 1943 and 1944 petitioner claimed deductions for depreciation on his car, and for automobile and "business promotion & entertainment" expense, as follows: Expense [1944] Depreciation (used 80% business, cost $ 1,695.19) $ 339.04 $ 339.04 Automobile (gas, oil, repairs, insurance, etc.) 416.00 416.00 Entertainment 2,100.00 2,100.00 In his notice of deficiency respondent disallowed the above deductions "for lack of substantiation, as the items do not qualify as deductions *1091 under*13 Section 23 (a) (1) (A) of the Internal Revenue Code." Petitioner had deductible expenses in the taxable years for entertainment, automobile depreciation, and automobile maintenance, as follows: Expense [1944] Entertainment $ 1,500.00 $ 1,500.00 Automobile depreciation 339.04 339.04 Automobile maintenance 300.00 300.00 Total 2,139.04 2,139.04 Facts relating to loss on oil leases: In the year 1942 petitioner entered into an oral agreement with James G. Tiplady, wherein petitioner agreed to supply money for the acquisition of oil leases and Tiplady agreed to arrange the leases and supervise the drilling of wells. Profits were to be divided equally. Pursuant to this agreement, a block of leases, hereinafter referred to as the first leases, was acquired on lands in Manlius and Heath Townships, Allegan County, Michigan. Tiplady entered into an agreement with Spencer Cook, by the terms of which Cook was to drill a well on the leased land in consideration for leases on part of that land. In accordance with the agreement, Cook drilled a well to an undisclosed depth. That well, completed on March 1, 1943, was a dry hole and was plugged on March 3, 1943. *14 Subsequently, petitioner and Tiplady acquired a lease, hereinafter referred to as the second lease, on land nearer to wells being drilled. However, none of the neighboring wells was productive. In February 1944 petitioner and Tiplady decided to go no further in the oil business, and to terminate their agreement. By that date practically all their leases, including the lease on the land upon which the well was drilled, had been forfeited because of nonpayment of rent. Petitioner paid Tiplady an aggregate of $ 3,520.75 to be expended by him as rent under the leases. In his return for the year 1944 petitioner claimed a deduction for loss on oil lease operations in the amount of $ 3,520.75. Respondent has disallowed the deduction "for lack of substantiation." Petitioner sustained a deductible loss in 1943 on the first leases, and in 1944 on the second lease. OPINION. In its essential elements this proceeding is comparable on the first issue to Clifford R. Allen, Jr., 12 T. C. 227. We can not find here that petitioner rendered any more cognizable services *1092 to the present partnership than were involved in that case, with the result that the partnership*15 income is no more attributable to petitioner's services than to those of his wife. Granting that she performed no services either, and that her partnership capital interest originated with petitioner, there is no more ground for denying the reality of the gift here than there was in the Allen case. While it is true that petitioner here retained a nominal interest in the partnership after the transfer of the preponderance of his interest to his wife, there was not, as in Simmons v. Commissioner (C. C. A., 5th Cir.), 164 Fed. (2d) 220, any continuance of his partnership activities, since these were negligible both before and after the transfer. The partnership earnings belonging to the Byerlein family were the proceeds of property which during the period in controversy there is no reason to doubt belonged to the wife and was subject to her control, and the income of which she received and withdrew without restriction. The record thus shows that the income in issue was not the product of petitioner's services nor, if capital was a significant income-producing factor, of any capital which he owned, controlled, or used. Cf. Commissioner v. Culbertson, 337 U.S. 733.*16 We think respondent erred in attributing to petitioner the income resulting from the wife's interest in the partnership. Clifford R. Allen, Jr., supra. Upon this disposition of the partnership issue, no question remains as to the deduction for accounting services rendered to the wife. Other expenses claimed to have been incurred by petitioner himself we have disposed of in our findings. Respondent's only resistance is based on lack of substantiation. Estimation and allocation have been undertaken as completely as the record permits. Cohan v. Commissioner (C. C. A., 2d Cir.), 39 Fed. (2d) 540. The final issue relating to loss on the abandonment of oil leases must be decided in petitioner's favor. Evidence of his investment and of the worthlessness, forfeiture, and abandonment of the leases is all present. Harvey A. Heller, 1 T. C. 222; acq., 1943 C. B. 11. We have drawn from the record the necessary conclusions as to the year in which the losses occurred and have found the facts accordingly. In this respect we think respondent erred. Decision will be*17 entered under Rule 50.