Sperling v. Commissioner

Ethel Sperling, Petitioner, v. Commissioner of Internal Revenue, Respondent Sperling v. Commissioner Docket No. 37609 United States Tax Court 20 T.C. 1014; 1953 U.S. Tax Ct. LEXIS 65; September 17, 1953, Promulgated *65 Decision will be entered for the respondent. Where three partners paid a fourth partner $ 22,500 for his interest in the firm and the purchase price was $ 6,500 in excess of the fourth partner's capital account as computed by the partners, held, the entire purchase price of $ 22,500, including the $ 6,500 in excess of his capital account, is a capital expenditure and not an ordinary and necessary business expense. Anthony N. Zock, Esq., for the petitioner. Arthur L. Nims, Esq., for the respondent. Hill, Judge. Black, J., dissenting. Tietjens and Withey, JJ., agree with this dissent. HILL *1014 The respondent determined a deficiency of $ 3,101.01 in the income tax of the petitioner for the taxable year 1945. The petitioner conceded a minor issue at the hearing. The issue remaining for our decision is whether the petitioner is entitled to deduct as an ordinary and necessary business expense her pro rata share of an amount paid to a fellow partner in excess of the latter's capital account to procure his withdrawal from the partnership or whether the amount paid was a capital expenditure as determined by the respondent. FINDINGS OF FACT. The petitioner, *66 who resides at Great Neck, New York, filed her income tax return for the calendar year 1945 with the collector of internal revenue for the first district of New York. On August 10, 1943, the petitioner, Samuel A. Bonder, Philip Krieger, and Rubin Lubarsky entered into a partnership known as Abbey Northern Glass Company. The purpose of the partnership was to engage in wholesale and jobbing of glass bottles, jars, and caps. All of the partners in Abbey Northern Glass Company were related to one another. The partnership formed on August 10, 1943, had been preceded by a corporation known as Abbey Northern Glass Corporation, the stock of which was held by the persons named above. Both the partnership and the corporation traced their business history to a wholesale jobbing business founded by Samuel A. Bonder in 1919 for the purpose of selling glass bottles, caps, and closures, known as the Acme Druggist and Hospital Supply Company. The partnership agreement entered into on August 10, 1943, provided in part as follows: 1. Said parties hereby agree to form and hereby do form a partnership for the purpose of conducting in the City of New York, a wholesale jobbing business of hospital *67 glassware, glass containers, plastic containers, and of caps to fit the containers, on the following terms and conditions to the faithful performance of which they mutually engaged and bind themselves. *1015 2. The partnership shall be conducted under the firm name and style of Abbey Northern Glass Company and such partnership shall commence on the date hereof. 3. The said Ethel Sperling agrees that she will contribute to said partnership the sum of eighteen thousand ($ 18,000.) dollars, the said Samuel A. Bonder agrees that he will contribute the sum of three thousand ($ 3,000.) dollars, the said Philip Krieger agrees that he will contribute the sum of seven hundred fifty ($ 750.) dollars, and the said Rubin Lubarsky agrees that he will contribute the sum of seven hundred fifty ($ 750.) dollars, said sums being paid either in cash or in inventory and shall be the capital of said partnership. The parties also agree to make additional contributions to their capital accounts as and when it is agreed by and between them. * * * * 5. Profits which may accrue from the business of said partnership after deducting therefrom all the expenses and outlays attending the conduct and management*68 of said business shall be devided as follows: A) In any year wherein the profits of the co-partnership shall exceed fourteen thousand ($ 14,000.) dollars, the profits shall be divided as follows: Ethel Samuel A. Philip Rubin Sperling Bonder Krieger Lubarsky 1st $ 14,000 (As Salary) $ 3,900 $ 3,900 $ 3,100 $ 3,100 Next 7,000 40% 40% 10% 10% Next 7,000 [10] Next 7,000 [10] All excess [10] B) Should the net profits in any one year only be between ten thousand one hundred ($ 10,100.) dollars and fourteen thousand ($ 14,000.) dollars then in that event, the said Ethel Sperling receives only the excess of ten thousand one hundred ($ 10,100.) dollars as her salary and all the other parties to this agreement receive their salaries as stated above. C) Should the net profit of the partnership in any year be less than ten thousand one hundred ($ 10,100.) dollars, then in that event Ethel Sperling waives her salary and all the other parties to this agreement will be credited with their salaries. The resulting loss after giving effect to the salaries, so credited will be chargeable to all the partners in accordance*69 with the above percentages in the same order as stated in paragraph 5 subdivision A. It is agreed by and between the parties to the agreement that a shorter fiscal period than a year may be used. * * * * 7. Samuel A. Bonder, Philip Krieger and Rubin Lubarsky severally agree that they shall not, either directly or indirectly, alone in [sic] in association with others, engage in, carry on, or be interested in any other business of the same kind to be carried on by said partnership without the written consent of his co-partners. * * * * 9. Any partner may withdraw from said partnership at or after the expiration of one year from the commencement thereof, upon giving six months written notice of his intention to so withdraw addressed to the partnership and delivered to their place of business in New York. Such withdrawal shall not effect a dissolution of the partnership which shall be continued by the survivors. The interest of the withdrawing partner shall be determined as of the date of retirement and no allowance shall be made to him in respect of the firm name or of *1016 the good will of the business. The retiring partners interest shall be liquidated 25% within three*70 (3) months after the date of retirement and the balance in three (3) equal yearly payments. 10. In the event of the death of any of the partners then in that event, the deceased partners interest will be paid to the estate of the deceased partner as hereinbefore provided in the case of the retirement of a partner. Good will and the trade name will also be treated as in the case of a retiring partner. During the period 1940 to 1943 the partnership employed several salesmen in addition to Bonder, whose efforts produced the majority of the partnership's sales. The salesmen were restricted to no particular routes and while they had some steady customers they solicited business from whatever outlets were available. Abbey Northern Glass Company had no exclusive sales contracts but did have an exclusive agency contract with a bottling manufacturer subsequent to 1940. During the period 1940 to 1943 the petitioner and her husband, Harry Sperling, made substantial loans to the business, as the result of which the petitioner and her husband sought an increased voice in the management and policymaking functions of the partnership. This ran counter to the desires of Bonder, who, as the most*71 experienced member of the partnership, had been in charge of its sales and management. The resulting conflict of interests led to many arguments between the partners during the period August 1943 to June 1945 pertaining to matters of business policy or the conduct of the business. Harry Sperling became active in the partnership through the petitioner's interest, and personal differences between Bonder and Harry Sperling caused the latter to threaten to liquidate and dissolve the partnership on several occasions. Harry Sperling was dissuaded from his plans for a forced liquidation of the business by Sidney H. Bender, attorney for the partners, who explained to him the delay, expense, and inconvenience incident to such action. Attorney Bender persuaded the other partners to pay Bonder to leave the business and on May 23, 1945, the partners entered into an agreement which provided as follows: AGREEMENT made the 23rd day of May, 1945, by and between SAMUEL A. BONDER of 5701-15th Avenue, Brooklyn, New York, hereinafter called the "Party of the First Part", and ETHEL SPERLING of 1773 East 12th Street, Brooklyn, New York, PHILIP KRIEGER of 902-45th Street, Brooklyn, New York and RUBIN*72 LUBARSKY of 912-45th Street, Brooklyn, New York, hereinafter called the "Parties of the Second Part". WITNESSETH: WHEREAS, the parties hereto have been operating as partners under the firm name and style of ABBEY NORTHERN GLASS COMPANY at 194 South 8th Street, Brooklyn, New York, under a partnership agreement entered into on *1017 the 10th day of August, 1943, and there having been many and various disputes appertaining to the partnership business between the Party of the First Part and the Parties of the Second Part, and the Parties of the Second Part being desirous of restoring harmony in the business. NOW, THEREFORE, in consideration of the covenants and mutual promises of the parties hereto, it is hereby agreed as follows: 1. The Party of the First Part agrees to retire from the partnership withdrawing his capital in the business which has been ascertained and computed to be $ 16,000.00 and which amount all parties hereto warrant and agree is the correct capital balance as of May 23, 1945. The partnership shall nevertheless continue in existence until June 30, 1945. The Parties of the Second Part agree to pay to the Party of the First Part the sum of $ 6,500.00 to induce*73 the Party of the First Part to retire from the said partnership. This additional compensation is to be paid as follows: $ 5,200.00 by ETHEL SPERLING, $ 650.00 by PHILIP KRIEGER and $ 650.00 by RUBIN LUBARSKY out of the personal funds of each. 2. The sum agreed namely $ 22,500.00 is to be paid $ 5,000.00 on May 23, 1945, one-half the balance due on June 1, 1945, and the remaining half on June 30, 1945. 3. The Party of the First Part shall take the Buick automobile, an asset of the partnership, at an agreed value of $ 375.00. 4. The Party of the First Part shall take one-quarter of all the coasters, stands and rollers of the partnership at no cost. 5. It is expressly understood and agreed by and between the parties hereto that all assets and property not expressly transferred herein to the Party of the First Part shall remain the property of the partnership. 6. The Party of the First Part agrees to execute general releases to the Parties of the Second Part and to HARRY A. SPERLING, HARRY WEINSTEIN, CHESTER KRIEGER and ALICE ROGERS as to all claims he may have against the above-named except as is specifically excepted herein, which releases shall be held in the files of Sidney H. Bender. *74 7. The Parties of the Second Part agree to execute general releases to the Party of the First Part as to all claims they may have against the Party of the First Part except as is specifically excepted herein, and also to secure general releases from HARRY A. SPERLING, HARRY WEINSTEIN, CHESTER KRIEGER and ALICE ROGERS to the Party of the First Part for all claims that they may have against the Party of the First Part, all of these releases being held in the files of Sidney H. Bender. 8. The Party of the First Part hereby sells, assigns and transfers unto the Parties of the Second Part all of his right, title and interest in and to the lease of the premises occupied by the partnership at 194 South 8th Street, Brooklyn, New York, and the Parties of the Second Part agree to hold the Party of the First Part free from any liability thereunder. 9. The Party of the First Part hereby covenants, represents and warrants that the books and records of the partnership set forth all the liabilities of the partnership, and that there are no others. He further agrees that he shall be charged to the extent that he would be liable for the losses of the partnership, as is defined in the partnership *75 agreement of August 10, 1943, in connection with any claims that may be made by any Governmental Bureau or Department, Federal, State or Municipal, in connection with the conduct of the partnership prior to the date hereof. The Parties of the Second Part agree to assume the defense of any suits commenced against the partnership in connection with any such claims by any Governmental Bureau or Department, Federal, State or Municipal, without precluding *1018 the Party of the First Part from obtaining counsel to represent himself at his own expense. In the event that the Party of the First Part does not avail himself of the right of obtaining counsel to represent him, then the cost of defending the actions are to be shared by the Party of the First Part in the same proportion that he would be liable to a judgment obtained in the sit [sic]. 10. The Parties of the Second Part agree to hold the Party of the First Part free and harmless from the payment of any liabilities and obligations of the partnership that appear on the books of the partnership, and also from any obligations of the partnership arising out of any contracts now in existence. 11. Nothing herein contained shall*76 abridge, limit or restrict the right of any party hereto to solicit, sell or otherwise do business with any of the past or present customers of the partnership. IN WITNESS WHEREOF the parties hereto have hereunto set their hands and seals on the day and the year first above mentioned. The amount paid to Samuel A. Bonder in excess of his capital account was arrived at by first estimating the cost of liquidating the business at $ 10,000 and then bargaining Bonder down to the amount finally agreed upon. Philip Krieger and Rubin Lubarsky each paid 10 per cent of the amount paid to induce Bonder's withdrawal, in accordance with their interests in the partnership. The petitioner paid the balance. Bonder felt that he had driven the best possible bargain that he could make in disposing of his interest in the partnership. On July 1, 1945, Chester A. Krieger made a contribution of $ 10,000 to the partnership and was admitted as a new partner. Shortly thereafter the business was again incorporated. Bonder became a competitor of Abbey Northern Glass Company and solicited the same accounts for his own business that he had solicited for the partnership. Frank Sweet had been in the employ of*77 Abbey Northern Glass Company since 1936 or 1938. Next to Bonder, Sweet was the best salesman. Sweet continued to be employed by the partnership until 1947 when he left and entered the employ of Bonder. Abbey Northern Glass Corporation and its successor, Abbey Northern Glass Company, the partnership, had average sales per month from January 1, 1939, to August 31, 1943, of $ 14,807. From September 1943 to June 1947 average monthly sales were $ 32,410, and from July 1947 to December 1951 average monthly sales were $ 12,096. For the period from July 1, 1948, to the end of the 1951 fiscal year the business sustained losses of from $ 5,486.68 to $ 20,105.30 in each year. For the same period the petitioner sustained losses of from $ 11,561.68 to $ 32,435.30. Bonder sold his partnership interest to the remaining partners. The entire consideration received by him as the purchase price, including the $ 6,500 in excess of his capital account and the petitioner's share of that amount, is a capital expenditure. *1019 OPINION. The petitioner contends that she is entitled to deduct the sum of $ 5,200 paid by her to Samuel A. Bonder to induce his withdrawal from the partnership as an ordinary*78 and necessary business expense under the provisions of section 23 (a) (1) (A) of the Code and cites the authority contained in , and , in support of her position. The facts in the two cases on which the petitioner relies differ materially from those presented before us. In the Aitkin and Mosser cases, the remaining partners acquired no increased interests in their respective partnerships by virtue of their payments to the retiring partners. In the Aitkin case, the partnership was dissolved by the withdrawal agreement and the retiring partner took his clients pursuant to an agreement by the remaining partners not to solicit his clients for 1 year. In the Mosser case, the retiring partner received compensation for his withdrawal and in a separate transaction his partnership interest was purchased by others not previously partners. The opinions in both the Aitkin and Mosser cases were premised upon the fact that the remaining partners acquired no assets, tangible or intangible, by the payments made to the retiring partners in*79 excess of their capital accounts and further upon the fact that the benefit of the payments made did not extend beyond the year in which the payments were made. Here the facts are different. The partnership agreement under which the parties had operated provided in paragraph 9 as follows: 9. Any partner may withdraw from said partnership at or after the expiration of one year from the commencement thereof, upon giving six months written notice of his intention to so withdraw addressed to the partnership and delivered to their place of business in New York. Such withdrawal shall not effect a dissolution of the partnership which shall be continued by the survivors. The interest of the withdrawing partner shall be determined as of the date of retirement and no allowance shall be made to him in respect of the firm name or of the good will of the business. The retiring partners interest shall be liquidated 25% within three (3) months after the date of retirement and the balance in three (3) equal yearly payments. Any one of the partners could have withdrawn from the business, taking his capital with him. The remaining partners, it is interesting to note, are given the right under *80 the paragraph set out above to continue the business, a valuable right. Bonder did not withdraw under the provisions set out above. On the contrary, he was bought out. Bonder had no desire to withdraw from the business. Harry Sperling was the moving force in this direction. He had threatened to force a dissolution of the partnership, not Bonder, *1020 who evidently felt his interest in the partnership to be worth more than his capital account indicated. We are convinced that the transaction under consideration was no more than the sale of Bonder's partnership interest to the remaining partners in the business, including the petitioner. It is well established that a partnership interest is a capital asset and that the sale of such an asset results in a capital transaction for tax purposes. , affd. , certiorari denied . Much of the argument and evidence of the petitioner has been directed towards establishing that there existed no good will in the firm name or value in the firm as a going concern. However, we are not convinced that such*81 was the case. Any one of the partners had the right under the partnership agreement to withdraw upon the giving of 6 months' notice. None of them chose to do so. Certainly Bonder did not, for had he done so he would have been entitled to no more than his capital account computed without allowance for such intangibles as the value of the firm name or the value of the good will of the business. In addition, if he had withdrawn, under the partnership agreement the remaining partners had the right to continue the business under the firm name with the benefit of any good will attaching thereto. That this right had value is borne out by the fact that the petitioner and the other two remaining partners paid a premium of $ 6,500 to secure Bonder's interest in the partnership. Bonder sold his interest in the partnership to the remaining partners for the price of $ 22,500 and, as he testified, made the best possible bargain that he could make in disposing of his interest in the partnership. Therefore, we hold that the entire sum of $ 22,500 paid to Bonder for his partnership interest, including the $ 6,500 in excess of his capital account and the petitioner's share of that amount, to *82 be a capital expenditure. Decision will be entered for the respondent. BLACK Black, J., dissenting: I respectfully dissent from the majority opinion. Paragraph 1 of the agreement which was entered into by the parties on May 23, 1945, explains that the $ 22,500 was paid to Bonder for his retirement from the partnership. Paragraph 1 of the agreement reads as follows: 1. The Party of the First Part agrees to retire from the partnership withdrawing his capital in the business which has been ascertained and computed to be $ 16,000.00 and which amount all parties hereto warrant and agree is the *1021 correct capital balance as of May 23, 1945. The partnership shall nevertheless continue in existence until June 30, 1945. The Parties of the Second Part agree to pay to the Party of the First Part the sum of $ 6,500.00 to induce the Party of the First Part to retire from the said partnership. This additional compensation is to be paid as follows: $ 5,200.00 by ETHEL SPERLING, $ 650.00 by PHILIP KRIEGER and $ 650.00 by RUBIN LUBARSKY out of the personal funds of each. Of course, the $ 16,000 which was paid to Bonder under the foregoing provisions of the agreement was not deductible. *83 It was clearly a payment for capital assets and must necessarily be capitalized. Petitioner does not contend otherwise. But the $ 6,500 payment which was made to Bonder, it seems to me, falls into a different category. The agreement states: "The Parties of the Second Part agree to pay to the Party of the First Part the sum of $ 6,500.00 to induce the Party of the First Part to retire from the said partnership." Under the doctrine of , this $ 6,500 payment was not a capital expenditure but was deductible as a business expense. The Aitkin case contains the following finding of fact: Dippy's capital investment at the time of organization of Dippy and Aitkin was $ 200. Dippy had $ 1,515.97 to his credit on the books of the partnership on September 1, 1920. One-third of the undivided profits of the partnership from January 1, 1920, to September 1, 1920, amounted to $ 14,154.56. These three amounts were paid to Dippy. In addition to them, he was paid $ 5,000 by Aitkin and Kynett. This additional payment was not made for any assets, tangible or intangible, but was the amount demanded by Dippy before he would*84 consent to an immediate dissolution of the partnership and was paid by the petitioners to protect themselves against the injury which they anticipated would result from a continuance of the partnership. Upon these facts, the Board held that the $ 5,000 which was paid Dippy to get him out of the firm and which was not paid him as a part of the price for his capital interest in the partnership was deductible as a business expense by the two partners who paid it, namely, Aitkin and Kynett. In so holding, we said: The payment which these petitioners made to protect themselves against the future actions of Dippy was directly connected with and proximately resulted from their business. No capital asset was acquired. The situation is not unlike that presented to the Supreme Court in ; ; 6 Am. Fed. Tax. Rep. 7358, where expenses of defending an action for an accounting, instituted by a former partner, were allowed as a deduction from income as ordinary and necessary business expenses. We are of the opinion that the Commissioner erred in refusing*85 to allow the deductions claimed. In the instant case petitioner paid her proportionate part of the $ 6,500 which was paid to Bonder to induce him to retire from the firm. It seems to me that the amount which the petitioner thus paid is deductible as a business expense under the doctrine of the Aitkin*1022 case, supra. The majority opinion undertakes to distinguish the facts in the instant case from those which were present in the Aitkin case. However, I am unable to see where there is any substantial distinction in the facts of the two cases. I, therefore, dissent.