Stiefel v. Commissioner

Reuben Stiefel, Petitioner, v. Commissioner of Internal Revenue, Respondent Stiefel v. Commissioner Docket No. 11713 United States Tax Court 9 T.C. 576; 1947 U.S. Tax Ct. LEXIS 79; October 3, 1947, Promulgated *79 Decision will be entered for petitioner. Petitioner and his wife acquired all of the capital stock of a corporation which owned and operated a mercantile business. Stock certificates were written, but not executed, which indicated that if they had been executed as written petitioner owned 99 per cent and his wife 1 per cent of the stock. The stock was purchased with funds contributed in substantial amounts by each of the spouses under an agreement between them that each should own one-half thereof. The spouses each rendered full time and valuable services in the operation of the corporation's business. The corporation was later dissolved and capital gain resulted. The mercantile business was thereafter continued under an oral partnership agreement between the spouses, which recognized a one-half ownership in each of the assets and business of the dissolved corporation and provided that the business should be operated by them as partners on an equal partnership basis. Each of the spouses devoted full time service to the operation of the business under the partnership arrangement. Held, that petitioner and his wife each owned one-half of the capital stock of the corporation*80 and that each owned one-half of the distributed assets of the dissolved corporation; held, further, that the capital gain realized on dissolution of the corporation and the income of the partnership are taxable one-half each to petitioner and his wife. Robert Ash, Esq., and Carl F. Bauersfeld, Esq., for the petitioner. Bernard D. Hathcock, Esq., for the respondent. Hill, Judge. HILL *576 Respondent determined deficiencies in petitioner's income tax for the years 1943 and 1944 in the respective amounts of $ 2,541.39 and $ 9,461.67. The adjustments made by respondent involved increasing petitioner's income on account of certain capital gains and partnership income. The question involves the determination of the extent of the petitioner's interest in a corporation and a succeeding partnership. The returns were filed with the collector of internal revenue for the district of Florida. FINDINGS OF FACT. Petitioner resides with his wife Adah in Orlando, Florida. They are in the shoe business. Prior to March 31, 1943, the business was conducted as a corporation, known as Goldsmith's, Inc., hereinafter referred to as the company. On March 31, 1943, the company*81 was liquidated and the business thereafter was conducted in the form of a partnership, known as Goldsmith's, hereinafter referred to as the partnership. Petitioner and Adah each reported for 1943 one-half of the capital gain resulting from the liquidation of the company. Respondent determined that 99 per cent of the gain should have been reported by petitioner and 1 per cent by Adah. *577 Petitioner entered into a written agreement dated July 17, 1937, with Sadie C. Goldsmith. By its terms Sadie sold petitioner 100 shares of the common capital stock of the company. These shares constituted all the authorized issued and outstanding stock of the company. The purchase price paid was $ 10,500. The money required for the purchase was raised in this manner. Petitioner borrowed $ 12,500 on an insurance policy on his life of which Adah was beneficiary. Adah borrowed $ 5,000 from her mother, and she also borrowed $ 2,000 from a brother-in-law, S. B. Schwartz. Adah also borrowed $ 1,000 from another brother-in-law, A. A. Ungar. This aggregate amount of borrowed money, i. e., $ 20,500, was deposited into the joint account of petitioner and Adah. The purchase price of $ 10,500 *82 was paid from this account. As an operating fund, $ 3,500 was put into the business and the remaining $ 6,500 was held for emergency purposes. The stock book of the company, under the date of July 17, 1937, indicates that 89 shares were issued to petitioner, 1 share to Adah, and 10 shares to Ungar. None of the certificates bears a corporate seal and only Ungar's is signed by petitioner as president of the company. Ungar was secretary and Adah was vice president. Ungar was repaid the $ 1,000 he loaned Adah and he surrendered his stock certificate and resigned as secretary prior to the company's liquidation. Thereafter, petitioner nominally held 99 shares. Ungar was an automobile dealer in Miami and a director of a bank there. He had a good business reputation and valuable business contacts. For these reasons he was originally included, at least formally, as a stockholder and an officer. When the company was acquired from Sadie it was understood and agreed between petitioner and Adah that they were going into business together on a 50-50 basis. Adah had always urged that they go into business for themselves. Petitioner had been in the shoe business for many years and was experienced*83 in all its phases. Adah had had store experience and was familiar in general with retail store operations. After the acquisition of the company petitioner and Adah both spent full time at the store, conducting its operations. Adah was in charge of the office and the bookkeeping. Petitioner supervised the store and did the buying. They always consulted together concerning policy. Petitioner respected Adah's business judgment and found her help and advice invaluable. Adah's bookkeeping involved keeping a record of merchandise purchased and sold by size, color, and price. She signed checks for pay rolls and merchandise. Her desk was in a position overlooking the floor and she could thus keep an eye on the salesmen and help out selling in rush times. When petitioner was away on buying trips, Adah was in charge and ran *578 the store. During 1942 and 1943 petitioner went on 8 or 10 buying trips a year for approximately 10 days at a time. After the company was liquidated in March 1943 a partnership was formed. The business was conducted essentially in the same manner as it had been before. No written partnership agreement was executed, but it was understood and agreed *84 between petitioner and Adah that they were conducting the business together as partners on a 50-50 basis. Notification of the partnership was given the bank, Dun & Bradstreet, and general creditors. The money borrowed to acquire the company from Sadie has all been repaid except the $ 5,000 borrowed from Adah's mother. Petitioner reported one-half of the capital gain realized on the liquidation of the company and one-half of the partnership income. Respondent has increased petitioner's income for 1943 on the grounds that petitioner owned 99 per cent of the company and owns a 99 per cent interest in the partnership. OPINION. The question is the extent of petitioner's interest in the company and the succeeding partnership for income tax purposes. The extent of his interest determines the amount of capital gain on liquidation of the company and the amount of income from the partnership on which he is taxable. Respondent contends that petitioner had a 99 per cent interest in the company and has a similar interest in the partnership. Petitioner contends that he owned one-half of the corporation and owns a one-half interest in the partnership. We agree with petitioner. Respondent's*85 position is based essentially on the fact that the stock book and certificates of stock of the company indicate that at the time of liquidation petitioner owned 99 per cent of the shares. Respondent further relies in part on the fact that petitioner furnished more capital than did Adah and the actual amounts contributed by each to the common fund used to purchase and operate the business can not be traced. We are satisfied from the record that petitioner and Adah in acquiring the company and operating it intended to do so on a 50-50 basis. It is true that petitioner borrowed $ 12,500 and Adah borrowed $ 8,000. The total amount, i. e., $ 20,500, was deposited in their joint account. From this account $ 10,500 was paid Sadie for the company's stock. A further amount of $ 3,500 was put into the business to operate and $ 6,500 was set aside for an emergency. It is true that it is impossible to trace the contributions of petitioner and Adah after they were deposited to the joint account. However, we see no reason from these circumstances to conclude of necessity that petitioner and Adah did *579 not intend to each acquire a one-half interest in the enterprise. Nor do we find*86 anything in these circumstances to prevent us from giving effect to their intention. The fact that the stock book indicates that petitioner was issued 89 shares, Ungar 10 shares, and Adah 1 share is not, in our opinion, controlling. Ungar's appearance as a stockholder was for business purposes and was later discontinued. As between petitioner and Adah, their understanding and agreement as to 50-50 ownership and participation is controlling, and not the stock book entries. The certificates, at least with respect to petitioner and Adah, do not appear to have been issued in any event. They were not signed by the president, nor do they bear a corporate seal. Even if they had been issued, we think, in view of the clear and undisputed intentions of petitioner and Adah, that petitioner would have to be deemed to have held the stock in trust for Adah with respect to her one-half interest. Respondent, in our opinion, is relying on book entries and ignoring the intent of the parties. We have found that the parties intended to acquire equal interests in the company, and we can see no reason for not recognizing or giving effect to their intention. They both contributed substantial capital*87 to the common fund and both gave full time services. Under these circumstances, we can find no element of lack of bona fides, and, therefore, we have concluded and hold that petitioner and Adah did in fact each acquire a one-half interest in the company. The above conclusion and holding in effect determine the partnership issue in petitioner's favor. Respondent does not contend that the partnership was invalid, but contends that for tax purposes we must reallocate the partners' respective interests. Respondent, in effect, argues that, although petitioner and Adah were valid partners, their respective partnership interests for tax purposes must be considered as 99 per cent and 1 per cent, respectively. These percentages, of course, stem from respondent's position with respect to the ownership of the company's stock which we have already discussed. Since we have held that petitioner and Adah owned equal interests in the company, it follows that their capital contributions to the succeeding partnership were equal. They both contributed vital services to the partnership. Under these circumstances, we are thoroughly satisfied that the partnership was bona fide and we find no*88 necessity or justification for rearranging or modifying the terms of the partnership agreement or altering the partnership interests for tax purposes. In this respect the instant case differs from Claire L. Canfield, 7 T.C. 944, where we found that the partnership agreement lacked the necessary reality to determine by its terms the taxability of the income earned. We hold that respondent's determination was erroneous. Decision will be entered for petitioner.