Zack v. Commissioner

Morris W. Zack and Sarah Zack, Petitioners, v. Commissioner of Internal Revenue, Respondent Zack v. Commissioner Docket No. 52987 United States Tax Court 25 T.C. 676; 1955 U.S. Tax Ct. LEXIS 4; December 30, 1955, Filed *4 Decision will be entered under Rule 50. 1. Joint Venture -- Division of Profits. -- Petitioner's sons and son-in-law each owned a bona fide 20 per cent interest in an undivided one-third interest in hoists which were sold, and petitioner's inclusion in his reported income of 40 per cent of the gross receipts represented by such undivided one-third interest in the hoists was proper. 2. Capital Assets -- Property Held Primarily for Sale to Customers in the Ordinary Course of Taxpayer's Trade or Business. -- The sales of the hoists were sales to customers in the ordinary course of petitioner's trade or business. Morris Garvett, Esq., and Charles L. Levin, Esq., for the petitioner. Peter K. Nevitt, Esq., for the respondent. Murdock, Judge. Withey, J., dissenting. MURDOCK *676 The Commissioner determined a deficiency of $ 26,036.68 in the income tax of the petitioners for 1950. The issues for decision are (1) whether the petitioners are taxable on one-third or only two-fifteenths of the income realized in 1950 from the sale of certain bomb hoists, and (2) whether that income was taxable as ordinary income from the conduct of a trade or business or as capital*5 gain. *677 FINDINGS OF FACT. The petitioners, husband and wife, filed a joint Federal income tax return for 1950 with the collector of internal revenue for the district of Michigan. Morris W. Zack is sometimes hereinafter referred to as Zack. Sam Breakstone of Cleveland, Ohio, and H. J. Johnson Company entered into an agreement on March 20, 1948, by which the latter agreed to sell to Breakstone 1,565 electric bomb hoists at $ 15 each, f. o. b. Columbus, Ohio. The bomb hoists had been manufactured for use by the Armed Forces and after the conclusion of World War II had been declared to be surplus. Breakstone made a downpayment of $ 1,000 at the time of entering into the agreement and was required to make additional payments of $ 1,000 each at intervals extending over a period to end about July 1948. Breakstone was to receive shipments of additional hoists as he met later payments. Breakstone had paid $ 5,000 on the contract by April 30, 1948. Breakstone had been conducting a store in Cleveland in which he sold mostly ball bearings and roller bearings and some other mechanical items. He displayed some of the bomb hoists in his store but never had any calls for the sale of*6 any of them. He also had printed and distributed brochures illustrating and describing the hoists and bearing his name as "Factory Distributor," and his address and telephone number. Breakstone began to have financial difficulties shortly after he entered into the agreement of March 20, 1948, and was unable to complete the payments for the bomb hoists. He offered on April 12, 1948, to sell an interest in the hoists to J. H. Tyroler of Cleveland, Ohio, who was connected with Tyroler Metals, Inc. Tyroler called his friend Zack, who was president of M. W. Zack Metal Company in Detroit, and told him of Breakstone's purchase of the hoists, of his inability to complete the payments therefor and that Tyroler Metals, Inc., was not interested in purchasing the hoists but he would be willing to advance one-half of the money required to complete the payments if Zack would advance the other half so that each of the three, Breakstone, Tyroler, and Zack, would be the owner of a one-third interest in the hoists. Zack replied that the M. W. Zack Metal Company would not take any interest in the hoists, but he, his two sons, and his son-in-law would take a one-third interest on the terms proposed*7 by Tyroler. The two sons and the son-in-law agreed orally with Zack that each would take 20 per cent of a one-third interest and would pay 20 per cent of the amount required to be paid with respect to a one-third interest and Zack would take the remaining 40 per cent. *678 Breakstone and Tyroler came to Zack's office in Detroit on April 13, 1948. Zack informed Breakstone and Tyroler that his sons and son-in-law would participate with him in a one-third interest and Breakstone, Tyroler, and Zack signed an instrument reading in part as follows: This transaction is as a result of a purchase made by Mr. Sam Breakstone of 648 Huron Road, Cleveland 15, Ohio, from the H. J. Johnson Co., 38 E. Spring Street, Columbus 15, Ohio, for approximately one thousand five hundred sixty-five (1565) * * * electric hoists, * * * at the price of $ 15.00 each, F. O. B. cars or trucks, Columbus, Ohio. In consideration of Mr. Breakstone's purchase, he is to advance $ 3500.00, or not less than $ 2000.00 for this purchase. The balance is to be paid by Mr. J. H. Tyroler, 5305 Sweeney Avenue, Cleveland 4, Ohio, and Mr. M. W. Zack, 2130 Howard Street, Detroit 16, Michigan. It is agreed between Mr. Breakstone, *8 Mr. Tyroler, and Mr. Zack, that all profits and losses are to be equally divided. It is also agreed that whoever has the opportunity to make the sale of the above-mentioned material, should contact the other two parties of this agreement and notify them of the proposition for the sale. It is also agreed that in the event the electric hoists have to be converted from D. C. to A. C., the cost for same will be paid by Mr. Tyroler and Mr. Zack. In case of a partial sale, it is agreed that the monies derived from said sale will apply against the advance made by Mr. Tyroler and Mr. Zack. In the event that the hoists have to be moved from Columbus, Ohio, to Cleveland, Ohio, or Detroit, Michigan, said hoists should be sent to Cleveland in the name of Mr. Tyroler, and to Detroit in the name of Mr. Zack. Zack then gave Tyroler a check for $ 15,000 to be applied on the purchase price of the hoists. No part of this amount was furnished by Zack's sons or his son-in-law although each offered to pay his share. Each authorized Zack to approve of sales of the hoists without prior consultation with them and agreed that they would pay Zack on demand for the cost of their participations in a one-third*9 interest in the hoists. Zack never made any demand upon them for payment. Zack thereafter approved sales of the hoists as occasions arose. However, he consulted with one of his sons on one occasion prior to approving the sale then involved. Johnson Company on April 30, 1948, entered into an agreement with Breakstone, Tyroler, and Zack which was supplementary to the agreement of March 20, 1948. Johnson Company, under the new agreement, accepted $ 16,000 in addition to the $ 5,000 theretofore paid as payment in full for the hoists. The total number of hoists delivered to Breakstone, Tyroler, and Zack under the agreement was 1,499, resulting in a cost of approximately $ 14 per hoist. Breakstone continued his efforts, as before, to sell the hoists. He displayed the bomb hoists in his store, and contacted prospective customers through letters and calls in person. He continued to distribute *679 the brochures and otherwise attempted to sell the hoists until practically all of them had been sold. Breakstone purchased the hoists for resale and Tyroler and Zack acquired interests in the hoists with a view to the immediate resale of the hoists. Zack never solicited any one to purchase*10 the hoists but informed salesmen of the M. W. Zack Metal Company in New York City about the hoists and requested them to telephone him if they ran into any purchasers for them. They were furnished with sales literature by Breakstone. Four hoists were sold as samples to Gimbel Bros. at $ 65 each on June 18, 1948, and one was shipped to each of its stores in New York City, Philadelphia, Pittsburgh, and Milwaukee. $ 257.40 was received from the sale of the hoists. Gimbel Bros. made no further purchases of the hoists. The other sales of the hoists were made as follows: Number Total selling Date of sale Purchaser sold price Feb. 15, 1950 Taylor Machine Co., Cleveland, Ohio [4] $ 234 Sept. 8, 1950 McGrath and Company, St. Paul, [200] 20,000 Minn. Sept. 11, 1950 Parkersburg Junk Co., Parkersburg, 1,275 127,500 W. Va. Total 1,479 $ 147,734 The remaining 16 hoists were abandoned during 1950. Breakstone procured Gimbel Bros., Taylor Machine Co., and Parkersburg Junk Co. as purchasers of the hoists sold to them and furnished the name of McGrath and Company to Tyroler as a prospective purchaser of hoists. The sale was made through Tyroler. Breakstone sold *11 his one-third interest in the hoists to Tyroler on September 11, 1950, and also his interest in the contract with Parkersburg Junk Co. for the sale of hoists to it. Zack owned about 67 per cent of the stock of M. W. Zack Metal Company and was its president. His sons, Eugene M. and Samuel N. Zack, owned about 11 per cent and 9 per cent, respectively, of the corporation's stock and were vice president and treasurer, respectively. The remainder of the stock was owned by Zack's wife and grandchildren. Zack's son-in-law, Carl Schram, was assistant secretary and assistant treasurer of the corporation. Zack's two sons and his son-in-law each received $ 8,000 from Tyroler on October 17, 1950, with the explanation that the amount "is your profit on the hoists deal." Zack was reimbursed for the advance made by him for the cost of the hoists so that he, his two sons, and his son-in-law equally shared the cost of the Zack interest in the hoists. The petitioners reported for 1950 a long-term capital gain of $ 7,797.48 on the sale of bomb hoists while their sons and son-in-law reported long-term capital gains of $ 4,000 each. *680 The Commissioner, in determining the deficiency, held that*12 the transaction involving the bomb hoists was a joint venture between Breakstone, Tyroler, and Zack; the two sons and the son-in-law were not members of the joint venture; and one-third of the earnings of the venture was taxable to Zack as ordinary income from the conduct of a trade or business. The two sons and the son-in-law of Zack each acquired a 20 per cent interest in a one-third interest in the 1,499 bomb hoists involved herein and continued to be the owners of such interests until the sale or abandonment of the hoists. Zack and his associates held the bomb hoists for sale to customers in the ordinary course of their trade or business. All facts stipulated are incorporated herein by this reference. OPINION. The Commissioner takes the position that the arrangement between Zack, his two sons, and his son-in-law, whereby they were to share in the one-third interest in the bomb hoists here involved on a 40-20-20-20 percentage basis, was a sham and, accordingly, he has taxed one-third of the profits from the sale of the hoists to the petitioners as ordinary income from a trade or business. Zack's sons and his son-in-law each acquired a 20 per cent interest in the bomb hoists in*13 1948 and continued to hold such interests until the sale or abandonment of the hoists. The agreement between Zack, his sons, and his son-in-law, as might be expected, lacked most of the formalization that such an agreement would have between parties who were not so closely related by family and business activity. But the evidence shows that they agreed to share the undertaking and they carried out that agreement, as the receipt of the cash distribution of their respective shares verifies. The Commissioner erred by including the sons' and son-in-law's shares of the profit from the sales of the bomb hoists in the income of the petitioners. The Commissioner's further position is that the income derived from the sale of the bomb hoists constituted ordinary income, instead of long-term capital gains as reported by the petitioners. His position is that transactions involving the bomb hoists resulted in the sales of other than capital assets within the provisions of section 117 (a) (1), Internal Revenue Code of 1939, because they were property held by Zack and his associates primarily for sale to customers in the ordinary course of their trade or business. The purchase and sale of the*14 hoists was not a part of any other business regularly carried on by Zack, but it has long been recognized that a taxpayer may be engaged in several businesses. The question is whether Zack and his associates were selling the bomb hoists in the *681 ordinary course of a business carried on by them. The only purpose in buying the bomb hoists was to resell them at a higher price. There was no "investment" such as might be made in other types of property, but on the contrary there was a general public offering and sales in such a manner that the exclusion of the statute cannot be denied. Anything which Zack or his associates did in promoting the sales of the bomb hoists must also be attributed to each of the others. Breakstone displayed the hoists, printed and distributed a quantity of brochures illustrating and describing the hoists, wrote letters to and personally contacted potential customers, and continued this until practically all the hoists were sold. Likewise, Zack had his salesmen, who had been furnished with the brochures, looking for customers, and Tyroler was active in working with Breakstone and negotiating sales. The activities amounted to the carrying on of a*15 business of selling the bomb hoists and the sales were to customers in the ordinary course of that business. The sales were not of capital assets. Cf. Nathan D. Goldberg, 22 T. C. 533; Louis Greenspon, 23 T. C. 138; and Philber Equipment Corporation, 25 T. C. 88. Decision will be entered under Rule 50. WITHEY Withey, J., dissenting: I must dissent from the majority opinion in this case for the reason that under the facts found there is not the continuity of sales necessary for the conduct of a business within the meaning of section 117 (a) (1) of the Internal Revenue Code of 1939. In support of its decision, the majority has cited Nathan D. Goldberg, 22 T. C. 533; Louis Greenspon, 23 T. C. 138; and Philber Equipment Corporation, 25 T. C. 88. These cases as a matter of fact by corollary are authority for the opposite conclusion. In Nathan D. Goldberg, supra, ninety separate sales transactions of houses were consummated in 1946. In the area where the sales *16 were made there was a heavy demand for houses; there was a ready market. In Louis Greenspon, supra, 138 sales transactions involving metal piping were carried on during the 2 years at issue. Sales were made to customers who were the ultimate users of such pipe and who comprised the customer list of a corporation with whom petitioner had been identified. In Philber Equipment Corporation, supra, petitioner, through a used car dealer, during the fiscal year there involved sold 40 motor vehicles. The existence of customers constituting a ready market for used cars should be judicially noticed. In the case at bar, but four sales transactions took place between June 18, 1948, and September 11, 1950. There was no market for the bomb hoists involved. They were designed and useful only for the specialized *682 purpose of hoisting bombs into the bomb bays of military aircraft. Petitioner individually made no sales of the hoists, secured no customers for them, employed no sales force, maintained no inventory of the hoists, nor any independent business office in connection with their sale. In fact, a more passive attitude*17 toward sales than that exhibited by petitioners cannot readily be called to mind. See Thomas E. Wood, 16 T. C. 213; George R. Kemon, 16 T. C. 1026; Stern Brothers & Co., 16 T. C. 295.