Reece v. Comm'r

Franklin A. Reece, Petitioner, v. Commissioner of Internal Revenue, Respondent. Franklin A. Reece and M. Teresa Reece, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent Reece v. Comm'r Dockets Nos. 50107, 50123 United States Tax Court 24 T.C. 187; 1955 U.S. Tax Ct. LEXIS 189; 105 U.S.P.Q. (BNA) 385; May 12, 1955, Filed *189 Decisions will be entered under Rule 50. Assignment to Wife -- Tax Consequences. -- Taxpayer created an invention which was patented and sold to B. The contract of sale stipulated payments therefor were to be made by B quarterly each year during the life of the patent, based on the number of units sold. Several years later, by way of gift upon which the taxpayer paid a Federal gift tax, he made an absolute assignment of the contract of sale to his wife which was accepted by B and thereafter all payments made thereunder were paid to the wife. Held, the assignment to the wife transferred property and property rights of which she became the owner, and hence the payments made to her were not taxable to the taxpayer. Melville F. Weston, Esq., for the petitioners. Jack H. Calechman, Esq., for the respondent. Johnson, Judge. JOHNSON *385 *188 The Commissioner determined deficiencies in income tax as follows: Docket No. Petitioner Deficiency Year 50107 Franklin A. Reece $ 9,839.00 [1947] 50123 Franklin A. Reece and M. Teresa Reece 981.45 [1950] Both parties in their briefs now agree that the single issue for decision is: Was the amount of $ 13,259.55*190 paid to M. Teresa Reece by Universal Winding Company in 1947 taxable to petitioner, Franklin A. Reece, as determined by the Commissioner? A second issue was eliminated in respondent's brief, viz: Respondent now concedes that amounts paid to M. Teresa Reece by Universal Winding Company in 1947 and 1950 were gain from the sale of a capital asset. The amount deductible for medical expenses in 1947, and also adjustments in the deficiency notices not contested will be computed under Rule 50. FINDINGS OF FACT. Some of the facts were stipulated and the stipulation of facts, together with*386 the five exhibits therein referred to and attached thereto are incorporated herein and made a part hereof by this reference. Petitioners Franklin A. Reece and M. Teresa Reece are husband and wife, residing at 7 Pine Road, Chestnut Hill, Massachusetts. Franklin A. Reece will hereinafter be referred to as the petitioner, and M. Teresa Reece will be referred to as Teresa. Petitioner filed an individual income tax return for the year 1947. Petitioner and Teresa filed a joint income tax return for the year 1950. Both returns were filed with the collector of internal revenue for the district of Massachusetts. *191 Petitioner is president of The Reece Corporation of Boston, Massachusetts. He has been such, with respect to said corporation and its predecessor corporation, since 1930. He entered the employ of the predecessor corporation in 1913 and was continuously employed by it, his services during the years prior to 1926 being principally in connection with its development and research activities. The above corporations have been principally engaged in the business of manufacturing, selling, and leasing industrial sewing machines. In 1928, petitioner devised a helical traverse double grooved roll to be used in winding machines, upon which device 2 years later (March 4, 1930) Patent No. 1,749,355 was issued by the United States Patent Office. In 1928 Universal Winding Company completed the first model from a drawing submitted by petitioner. Universal Winding Company never had any occasion to make a revision in petitioner's original drawing. Petitioner was never an employee of Universal Winding Company. On February 5, 1929, Universal Winding Company, hereinafter called Universal, wrote petitioner relative to purchasing the invention *189 and the manner and amounts of payments to be*192 made therefor, from which letter we quote: You are to assign direct to this company application for patents covering your invention in this and such foreign countries as may be necessary to give us full development and introduction of the mechanism here and abroad and cover any improvements which you may make at any future time. In consideration of this we are to pay you royalty for each and every winding spindle that we sell covered by your invention. The royalty we pay you is to be figured on a descending scale, payable quarterly, and payments maintained on all sales made during the life of the patents both domestic and foreign. The descending scale is to be figured on a basis of yearly sales, as follows: We will pay you each year one dollar ($ 1.00) per spindle until such time during the year we have sold ten thousand (10,000) spindles, the royalty shall then drop to seventy-five cents (75 cents) per spindle and this rate shall be maintained until we have sold ten thousand (10,000) more spindles, the royalty shall then drop to fifty cents (50 cents) per spindle and this rate shall be maintained for the balance of the sales of that year. It is understood that to cover the time*193 and expenses incurred by you to this date with reference to the invention we are to pay to you twenty-five hundred dollars ($ 2500) and for this we enclose our check payable to your order. We understand that when controlling patents are issued to us covering your invention in the form as applied for we will pay you as advance the sum of seventy-five hundred dollars ($ 7500), this to apply on account of royalties. On February 13, 1929, petitioner accepted the proposal embodied in the foregoing letter, and on February 20, 1929, he executed an assignment to Universal Winding Company of the invention and any patent or patent application thereon. Pursuant thereto a patent application dated February 25, 1929, was filed by Universal Winding Company in the name of petitioner as "assignor" upon which application patent No. 1,749,355 was issued to Universal Winding Company. On December 26, 1935, petitioner made an assignment to Teresa of all his interest under his contract with Universal by written instrument, which was accepted by Universal and is as follows: Know All Men by These Presents: That I, Franklin A. Reece, of Chestnut Hill, Massachusetts, in consideration of love and affection, *194 hereby assign and transfer to my wife, Marie Teresa Reece, her executors, administrators and assigns, my royalty contract with the Universal Winding Company as set forth in its letter to me dated February 5, 1929, covering my invention, together with all my right, title and interest in and to payments now due or hereafter to become payable to me by said Company thereunder; the said contract to be held by my said wife for her own use and behoof as fully and entirely as the*387 same would have been held by me had this assignment not been made. Executed this 26 day of December, 1935. /s/ Franklin A. Reece (S) In the presence of: /s/ J. W. Nichols Universal Winding Company hereby consents and agrees to the above assignment and acknowledges receipt of notice thereof, this day of December, 1935. Universal Winding Company By /s/ Robert A. Leeson, President *190 The assignment from petitioner to Teresa was a gift and petitioner on March 6, 1936, filed a Federal gift tax return with respect thereto and paid a Federal gift tax thereon. From the gift tax return so filed we quote: Approximate Description of property value at constituting gift Date of gift date of gift Assignment from husband, Franklin A. Reece, of royalty contract with Universal Winding Company covering payment for patent. (Copy of contract and of assignment annexed to donor's return.) Average royalty payments for years 1931 to 1935 inclusive $ 6600. Patent issued March 4, 1930 Dec. 26, 1935 $ 57,819.10 *195 By virtue of the foregoing assignment Universal thereafter paid all royalties to Teresa. In 1947 they paid her $ 13,259.55 and in 1950, $ 3,439.55. None of the 1947 payments was included by petitioner in his 1947 return, while in 1950 petitioner and Teresa each included $ 1,719.77 thereof in their joint return. The payments to Teresa were made for her sole use and benefit and were not subject to any control by petitioner. In the year 1947 petitioner paid medical expenses in the amount of $ 3,123.87. The Commissioner's deficiency notice for the 1947 return states: It is further determined that the gift to your wife of anticipated royalties from the assignment of the patents was ineffective for income tax purposes. Therefore, the total royalties as received are included in your taxable income. OPINION. The rule of law governing the issue here is aptly stated, supported by numerous authorities there cited, in William Ernest Seatree, 25 B. T. A. 396, affd. 72 F. 2d 67, as follows: It is well settled that an assignment of income does not relieve the assignor of the tax thereon, but that if property or property rights are assigned*196 the income subsequently arising therefrom is not taxable to the assignor, for the reason that the property no longer belongs to him and therefore the income from such property belongs, not to him, but to the new owner. Subsequent decisions of this and other courts have likewise so held, some of which are cited in petitioner's brief, among them being John F. Canning, 29 B. T. A. 99; Julius E. Lilienfeld, 35 B. T. A. 391; Carl G. Dreymann, 11 T. C. 153; and Nelson v. Ferguson, 56 F. 2d 121. Respondent on brief argues that petitioner's -- assignment to his wife amounted to nothing more than a direction to pay royalties to her, an anticipatory assignment of his future income. The income having been earned by Mr. Reece, it is taxable to him. With this conclusion we cannot agree. The assignment in question was more than a direction to pay royalties or an anticipatory *191 assignment of future income. The assignment was an absolute conveyance of property and property rights and carried with it the ownership of the property conveyed. The payments in question*197 were not for personal services performed by petitioner. He was never in the employ of Universal. As was said in Carl G. Dreymann, supra, the payments here were more than mere "royalty" payments, "they were part of the periodic payments which constituted the purchase price of the invention." See also Kimble Glass Co., 9 T. C. 183, which holds that the sale of a patent was a sale of personal property; Commissioner v. Celanese Corporation, 140 F. 2d 339, affirming Tax Court Memorandum Opinion entered January 27, 1943. The payments here were proceeds derived from the sale of the patent which was income-producing property. It logically*388 follows that the assignment of the contract for the sale of the patent and the purchase price to be paid therefor was a transfer of property rights, and payments made thereunder belong to the donee and not to the donor and are not taxable to the latter. The validity of the assignment was not questioned. Petitioner treated the assignment as a gift of property and paid a gift tax thereon at a valuation of $ 57,819.10. Respondent's concession that the amounts*198 paid Teresa by Universal were gains from the sale of a capital asset rather than ordinary income tends to contradict respondent's contention that property was not transferred, but "merely an assignment of future income." We hold that the payments in question were not taxable to petitioner. Decisions will be entered under Rule 50.