Silling v. Commissioner

C. E. Silling, Sr., and Marian R. Silling, Petitioners, v. Commissioner of Internal Revenue, Respondent Silling v. Commissioner Docket No. 53539 United States Tax Court 27 T.C. 701; 1957 U.S. Tax Ct. LEXIS 279; January 23, 1957, Filed *279 Decision will be entered under Rule 50. Petitioner purchased his partner's interest in their partnership and thereafter continued the operation of the business as a sole proprietorship. The purchase price was determined upon the basis of the estimated profits to be derived from the performance of certain contracts on which the firm was then engaged. Held, although these contracts had a zero basis in the hands of the partnership, petitioner is entitled to allocate the purchase price of his partner's interest to such contracts and to amortize the basis thereby established in computing the profits realized on their performance by him as a sole proprietor. J. B. Fisher, Esq., for the petitioners. Gene W. Reardon, Esq., for the respondent. Rice, Judge. RICE *702 SUPPLEMENTAL FINDINGS OF FACT AND OPINION. This proceeding involves a deficiency in income tax determined against C. E. Silling, Sr. (hereinafter referred to as petitioner), and Marian R. Silling, for the taxable year 1951 in the amount of $ 16,099.33. Petitioners claim an overpayment of tax for that year. The issue raised by the pleadings was whether the sum of $ 24,000, which was paid to L. G. Tucker*280 (hereinafter referred to as Tucker) by the firm "Tucker & Silling" in 1951, constituted Tucker's distributable share of partnership profits, or whether Tucker had sold his interest in the partnership to Silling as of March 10, 1951, and whether said $ 24,000 constituted the first of three installment payments aggregating $ 40,000 to be made by petitioner for Tucker's partnership interest. In a Memorandum Opinion filed on October 31, 1955, in a consolidated proceeding involving petitioners and L. G. Tucker, et al., we held as follows: We, therefore, hold that Tucker sold his interest in the partnership to Silling as of March 10, 1951, arriving at a value for such interest on the basis of the principal assets of the partnership at that time, namely, the anticipated earnings from contracts then being performed by the partnership. Although the purchase price may have been largely determined on the basis of such anticipated earnings, this does not constitute an assignment of income so long as the services had not yet been performed and these estimated amounts were not yet earned. See Hill v. Commissioner, 38 F. 2d 165 (C. A. 1, 1930), certiorari denied*281 281 U.S. 761 (1930); Estate of Bavier C. Miller, 38 B. T. A. 487 (1938). The $ 24,000 received by Tucker in 1951 was partial consideration for the purchase of his partnership interest. Such amount must be treated by petitioner Silling as the purchase price of a capital asset and cannot be deducted by him from his distributive share of the earnings of the firm during 1951. Subsequent to the filing of our Memorandum Opinion, petitioners timely moved that we consider an alternative argument which had not been raised by the original pleadings. Said motion was granted, amended pleadings filed, and additional hearings were held. We must now decide whether the $ 24,000 which petitioner paid to Tucker in 1951 for his partnership interest resulted in the acquisition by petitioner of certain "wasting assets" for which he is entitled to amortization. SUPPLEMENTAL FINDINGS OF FACT. In 1938, petitioner and Tucker formed a partnership for the practice of architecture under the name "Tucker & Silling." Their partnership agreement provided that, in the event of the death or the voluntary withdrawal of one of the partners from the partnership, *282 the interest of such partner in the partnership should become the property of the remaining partner; however, the estate of the deceased partner, or the retiring partner, was to be entitled to one-half of the *703 net earnings of the partnership earned and uncollected at the time of death or withdrawal. It was further provided that if Tucker and Silling mutually agreed to dissolve the partnership, then all the net assets were to be divided equally between them. On October 1, 1945, petitioner, Tucker, and one C. L. Bowyer entered into an agreement which provided, in pertinent part, as follows: Witnesseth: That whereas all of the parties hereunto have been associated either as partners or as employees of Tucker & Silling, Architects, which is engaged in the general business of Architects, in said City of Charleston; and Whereas, L. G. Tucker and C. E. Silling have executed a partnership agreement dated the 28th day of December 1938 for the conduct of the business of Tucker & Silling, Architects, which agreement is not waived in any manner by the herein agreement of the undersigned, except as to the distribution of earnings and assumption of business liabilities thereunder, all*283 as more fully set forth hereinafter; and Whereas, it is the desire of all of the parties hereto to continue the said business for the joint and mutual benefit of all of the parties hereto in the manner hereinafter set out; Now, Therefore, The parties hereto do mutually agree among themselves and with each other as follows: (1) The management and direction of the business of Tucker & Silling, Architects, shall be controlled by the parties of the first part hereunder [L. G. Tucker and C. E. Silling], they being the partners of the said Tucker & Silling, Architects. (2) In all future operations or the dissolvement of the partnership of Tucker & Silling, Architects, all moneys earned by it, after all costs and expenses of every kind have been paid, shall be distributed as follows, and in the order indicated: (a) the first $ 11,700.00, or any part thereof, shall be divided equally between L. G. Tucker, C. E. Silling, and C. L. Bowyer. (b) any moneys in excess of the distribution outlined under paragraph 2 (a) above shall be distributed in the following proportions: L. G. Tucker 40 per cent, C. E. Silling 40 per cent, C. L. Bowyer 20 per cent. All liabilities of the said Tucker & *284 Silling, Architects, incurred hereunder, shall be assumed from year to year by the undersigned in direct proportion to the distribution of moneys outlined in the herein paragraph 2. * * * * (5) This agreement is not intended in any respect as an agreement of partnership, either general or limited, among the parties hereto, or any of them, but shall be construed only as an agreement for payment for services mutually rendered. On March 10, 1951, petitioner purchased Tucker's interest in the partnership for $ 40,000, and, as part of the purchase agreement, retained the right to use the name "Tucker & Silling" for the firm until the completion of its existing architectural contracts. Tucker received $ 24,000 of the purchase price of his interest in 1951, $ 12,000 in 1952, and the remaining $ 4,000 in 1953. At the time of the sale, the partnership's tangible assets consisted of a few drafting boards and typewriters, *704 and it had no salable goodwill. Its principal assets consisted of some 16 contracts requiring architectural services to be performed by the firm in connection with the construction of certain college buildings, hospitals, office buildings, and an airport. The *285 purchase price of Tucker's interest was determined upon the basis of the estimated profits to be derived from the performance of these contracts. The firm was engaged on these contracts, as well as others subsequently acquired, during the period March 10, 1951, to February 27, 1953. After the purchase of Tucker's interest in the partnership on March 10, 1951, the business of the firm was continued by petitioner under the name "C. E. Silling & Associates," except that with respect to certain of the contracts obtained prior to March 10, 1951, the name "Tucker & Silling" was used. After March 10, 1951, C. L. Bowyer continued to receive a percentage of the firm's profits but he did not share in its losses and was not considered a partner. The firm filed United States partnership returns of income for the calendar years 1951 and 1952 and the period January 1, 1953, to March 1, 1953. These returns were prepared by the firm's certified public accountant. In each such return, C. E. Silling, L. G. Tucker, and C. L. Bowyer were named as the partners and as having received distributive shares of partnership income. The three installment payments, aggregating $ 40,000, which were made to *286 Tucker as the purchase price of his partnership interest were reported on these returns as constituting his distributive share of partnership income. As the result of the performance of the various contracts which were considered in arriving at the purchase price of $ 40,000 to be paid to Tucker for his interest in the partnership, the firm received the following aggregate fees during the periods indicated below: Mar. 9, 1951, to Dec. 31, 1951 $ 133,310.06 Jan. 1, 1952, to Dec. 31, 1952 194,123.48 Jan. 1, 1953, to Feb. 26, 1953 189,969.80 After Feb. 26, 1953 41,906.11 OPINION. On March 10, 1951, petitioner and his partner, Tucker, agreed that they should terminate their association in the partnership "Tucker & Silling" and that Tucker should be paid the amount of $ 40,000, in three installment payments, for his partnership interest. This amount was determined on the basis of Tucker's estimated share of the profits to be derived from certain architectural contracts then being performed by the firm. On the returns filed by petitioner and the business for 1951, Tucker was treated as a continuing partner in the firm throughout that taxable year, and the $ 24,000 paid to Tucker*287 by the business was reported as Tucker's distributive share of partnership *705 profits. In our prior Memorandum Opinion in this proceeding, we held that petitioner had purchased Tucker's interest in their partnership, on March 10, 1951, for $ 40,000 and that the $ 24,000 of the firm's income which its return for 1951 attributed to Tucker was, in fact, reportable by petitioner. Petitioner then filed an amended petition which raises the issue now before us, namely, whether the purchase of Tucker's interest in the partnership resulted in petitioner's acquisition of certain "wasting assets" which he is entitled to amortize, in part, in 1951. Petitioner bases his claim upon the theory that the purchase of Tucker's interest in the partnership as of March 10, 1951, gave him a stepped-up basis for certain of his architectural contracts and that such basis is amortizable over the life of the contracts. The general rule is that a partnership interest is a capital asset and its purchase price is not recoverable from gross income. Autenreith v. Commissioner, 115 F. 2d 856 (C. A. 3, 1940), affirming 41 B. T. A. 319 (1940);*288 Edwards v. Commissioner, 102 F. 2d 757 (C. A. 10, 1939), affirming B. T. A. Memorandum Opinion dated April 26, 1938; Watson v. Commissioner, 82 F. 2d 345 (C. A. 7, 1936), affirming B. T. A. Memorandum Opinion dated March 30, 1935; Hill v. Commissioner, 38 F. 2d 165 (C. A. 1, 1930), affirming 14 B. T. A. 572 (1928), certiorari denied 281 U.S. 761 (1930). It is regarded as having an indefinite life and the recovery of its basis must await its ultimate disposition. See Henry W. Healy, 18 B. T. A. 27 (1929). But where one of two partners purchases his retiring partner's interest and thereafter continues the operation of the business, the existence of the partnership terminates and it is thereby converted into a sole proprietorship. Nathan Blum, 5 T. C. 702 (1945). Rev. Rul. 55-68, 1955-1 C. B. 372. The remaining partner, who becomes a sole proprietor, must be regarded as having received all the assets of the partnership upon*289 its termination and his basis for such assets is the basis of his original partnership interest, section 113 (a) (13) of the 1939 Code, 1 plus the amount paid for the retiring partner's interest. This basis must be allocated proportionately among the various assets of the business. Consequently, even though these contracts may have had a zero basis in the hands of the partnership, petitioner is entitled to a stepped-up basis in computing the gain realized upon their completion by him as a sole proprietor. See Murray Thompson, 21 T. C. 448 (1954), affd. 222 F. 2d 893 (C. A. 3, 1955). There is no evidence in the record as to any *706 basis which petitioner may have had as to his interest in the partnership and petitioner has not asked that we allocate any such basis to the contracts. As for the $ 40,000 purchase price paid Tucker for his interest, it seems clear that petitioner is entitled to amortize the basis thus acquired for the contracts in computing the profits realized on their performance. See Peter P. Risko, 26 T. C. 485 (1956); Eleanor S. Howell, 24 T. C. 342 (1955);*290 Raymond S. Wilkins, 7 T. C. 519 (1946), affd. 161 F. 2d 830 (C. A. 1, 1947). Respondent cites and relies upon Balis v. United States, 134 Ct. Cl. 848, 139 F. Supp. 930 (1956). That case is distinguishable, however, for the taxpayer therein paid a stipulated amount to his former partners for the right to take some of the firm's accounts with him upon leaving the firm. This was termed a capital expenditure and amortization denied since these accounts would presumably*291 produce income to the taxpayer over an indefinite period of time. In the instant case, the value of the contracts was exhausted once they had been performed. Respondent also argues that in addition to petitioner and Tucker, a certain C. L. Bowyer was a partner in the firm "Tucker & Silling" and that petitioner's purchase of Tucker's interest did not result in a termination of the partnership for tax purposes and a stepped-up basis for its principal assets, its various architectural contracts, citing Anderson v. United States, 131 F. Supp. 501 (S. D., Cal., 1955), affd. 232 F. 2d 794 (C. A. 9, 1956). However, that case is distinguishable because there the partnership continued, while here it is clear that the partnership was terminated by the purchase of the retiring partner's interest and the business was thereafter conducted as a sole proprietorship. It is true that C. L. Bowyer received a percentage of the firm's profits, both prior and subsequent to March 10, 1951, but the testimony of both petitioner and Tucker, as well as the contractual agreement entered into with Bowyer on October 1, 1945, clearly show that Bowyer*292 was at no time considered a partner in the business. Bowyer had no authority in the management of the business, and it is noteworthy that after March 10, 1951, he was to share in its profits but not in its losses. Obviously, this was a method of determining the compensation of a key employee and the partnership returns filed by the firm are not determinative of the issue. Although the accountant who prepared these returns may have been mathematically correct in reporting the amounts disbursed to petitioner, Tucker, and Bowyer, clearly he erred in denoting each of such payments as distributive shares of partnership income. Thus, we have already held that the amounts paid to Tucker constituted petitioner's income which he used to make the installment payments due on the purchase price of Tucker's interest in the partnership. Upon the basis of the undisputed testimony of Tucker and petitioner, who were adverse parties in this *707 proceeding, and the written contract executed with C. L. Bowyer, we hold that Bowyer was not a partner in the firm during the year here in issue. Commissioner v. Culbertson, 337 U.S. 733 (1949); Isadore Louis Rosenberg, 15 T. C. 1 (1950).*293 Decision will be entered under Rule 50. Footnotes 1. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. (a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that -- * * * * (13) Partnership. -- * * * If the property was distributed in kind by a partnership to any partner, the basis of such property in the hands of the partner shall be such part of the basis in his hands of his partnership interest as is properly allocable to such property.↩