Pauli v. Commissioner

KARL PAULI, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Pauli v. Commissioner Docket No. 13927. United States Board of Tax Appeals 11 B.T.A. 784; 1928 BTA LEXIS 3728; April 23, 1928, Promulgated *3728 The sum of $6,000 paid to the petitioner in 1919 and 1920, by the partnership of which he was a member, and entered in the firm books as salary, was a distribution of anticipated profits and not compensation for services performed for the partnership as determined by the respondent. Edward D. Gough, Esq., for the petitioner. Frank S. Easby-Smith, Esq., for the respondent. ARUNDELL *784 This proceeding involves the determination of deficiencies in income taxes for the years 1919, 1920 and 1921 in the respective amounts of $1,099.63, $213.77 and $129.93. The petitioner claims that the respondent erred in (1) treating payments of $6,000 made to him in 1919 and 1920 by the partnership of which he was a member as salary for services rendered the firm; (2) disallowing as a deduction of the partnership for the year 1919 the sum of $1,522 claimed as a bad debt, and (3) reducing from $5,150.16 to $1,478.15 the loss incurred by the partnership in 1920 in the operation of a branch of its business under the name of United Metal Leaf & Bronze Powder Co. No error is alleged for the year 1921. FINDINGS OF FACT. During the years 1919 and 1920 petitioner*3729 was an active member of the partnership trading under the firm name of H. D. Catty Co. and engaged in the business of importing merchandise and selling it in the United States. The profits of the partnership were divided on the basis of 37.5 per cent to the petitioner and 62.5 per cent to H. D. Catty, the other member of the firm. For the calendar years 1919 and 1920 the books of the partnership showed net profits of $25,192.69 and $31,705.07, respectively, after deducting as a business expense the sum of $6,000 paid to each partner and charged to "Salaries-Partners." The $6,000 paid to each member of the firm was in fact the amount each partner was entitled and expected to draw on their distributive share of the net profits. The journal of the partnership contains the following entry, dated December 31, 1919: P & L $25,192.69 To A/C Payable K. Pauli $7,947.26 H. D. Catty 17,245.43 *785 In 1918, H. D. Catty Co. purchased a quantity of goods from a firm located in Japan at a cost of $3,044. After paying for the goods and discovering that they were defective, the firm endeavored to persuade the seller to accept a return of the merchandise, *3730 failing in which, the partnership charged and billed the full purchase price of the goods, plus the duty, to the Japanese firm. In 1919, $1,522 of the amount of the account was charged off as a bad debt and was claimed as a deduction in the partnership return. The respondent refused to allow it for that year, but did allow it as a deduction from gross income of the partnership for the year 1921. During the period from July 1, 1920, to December 31, 1921, H.D. Catty Co. operated a branch of its business under the name of United Metal Leaf & Bronze Powder Co. The operations of the latter for 1920 were incorporated in the partnership return for that year. On an audit of the partnership returns for the years 1920 and 1921 the respondent determined the loss sustained in conducting the branch business from July 1, 1920, to December 31, 1921, the date on which its books were closed, to be $4,434.45, of which one-third, or $1,478.15, was assigned as a loss of the partnership for the year 1920. OPINION. ARUNDELL: The petitioner contends that the $6,000 paid to him in 1919 and 1920 by the partnership, and entered in its books in an account termed "Salaries-Partners," was not in fact*3731 compensation for services rendered the firm, but was the maximum amount each member was permitted to, and did, draw as profits of the partnership in advance of the determination of actual earnings. The respondent, in auditing the returns of the petitioner and the books of the partnership, treated the amount as salary to the former and an expense of the latter, with the result that he determined the income of the petitioner from the firm to be $6,000, plus 37.5 per cent of the net earnings of partnership, computed with the $6,000 already paid to each partner deducted as a business expense. It is well settled in New York that a partner is not entitled to compensation for services rendered the partnership in the absence of an agreement to that effect. Section 40(6) of Book 38, McKinney's Consolidated Laws of New York (Laws 1919, ch. 408); ; . See also . In the latter case we said: An agreement between partners to pay salaries from profits is nothing more than the determination of a basis for dividing such profits. A partner devoting his time and energies*3732 to the business of the firm is in fact working for himself *786 and can not be considered as an employee of the firm in the sense that he is in the service of another. The uncontradicted testimony of the petitioner is that the payments were not considered by the parties as salary, but were regarded as drawings against profits. This testimony is corroborated by the manner in which the partnership computed the distributive shares of each member at the close of 1919. It computed the amount still due each partner on the basis of profits of $37,192.69 ($25,192.69, representing profits as shown by the books, plus $12,000 already paid but deducted as an expense in reaching the former figure), less $6,000, the amount already paid each member. Even though the payments were entered in the partnership books as salary the facts clearly show that they were advance payments of firm profits. In determining the income of the petitioner from the partnership, the payments of $6,000 made in 1919 and 1920 should be treated as profits of the partnership. The evidence presented by the petitioner on the item of $1,522 charged off in 1919 as a bad debt is insufficient to warrant a holding*3733 that it was ascertained to be worthless in that year. The respondent's action respecting the loss sustained by the partnership in the branch of its business conducted under the name of United Metal Leaf & Bronze Powder Co. is affirmed in the absence of proof that the loss was different from that determined by the respondent. Judgment will be entered on 10 days' notice, under Rule 50.