Phelps v. Commissioner

B. M. PHELPS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. D. L. ARMISTEAD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Phelps v. Commissioner Docket Nos. 14749, 14750, 21952, 21953, 28226, 28227. United States Board of Tax Appeals 13 B.T.A. 1248; 1928 BTA LEXIS 3080; October 26, 1928, Promulgated *3080 The petitioners, carrying on a partnership business under the name of Phelps & Armistead in 1919, entered into an oral agreement with their wives that they should be equal partners with themselves and that each should thereafter receive one quarter of the profits of the business. Held, that the petitioners are not liable to income tax in respect of the shares of the profits belonging to their wives. Theodore B. Benson, Esq., and C. F. Cocke, Esq., for the petitioners. John D. Foley, Esq., for the respondent. SMITH *1248 The Commissioner has determined deficiencies against the petitioners as follows: B. M. Phelps D. L. Armistead Year Docket No. Deficiency Docket No. Deficiency [1920] 14749 $1,849.35 14750 $1,856.28 [1921] 2,297.89 2,305.06 [1922] 21953 2,327.47 21952 2,398.38 [1923] 28226 1,596.82 28227 1,763.51 These proceedings have been consolidated for the purpose of hearing and decision. The only question in issue is whether the wives of the partners were members of the partnership of Phelps & Armistead from July 1, 1919, to June 30, 1923. FINDINGS OF FACT. The petitioners*3081 are residents of Roanoke, Va. In 1912 they organized a partnership to carry on business under the name of Phelps & Armistead and engaged in a retail furniture business. They were equal partners in the business up to about the middle of 1919. The partnership agreement was oral and never reduced to writing. At or about July 1, 1919, the partners decided to take in their wives as equal partners with themselves. There was a meeting of the partners and their wives held at their store about the middle of 1919, when the agreement was made. The understanding reached between the individuals was that the wives should be taken into the partnership and share equally with their husbands in the business and that they *1249 should each receive one quarter of the profits and each stand one quarter of the losses of the business. This agreement was not reduced to writing, but entries were made upon the partnership's books of account as of July 1, 1919, by which one-half of the capital account of each of the petitioners was transferred to his wife and from that time on the profits of the business were divided into four parts and one part credited to each of the partners. The books of account*3082 clearly reflect these transactions. At sundry times a part of the profits of the partnership was paid over to the partners and a check for each partner's profits was paid to him or her. The wives of the partners deposited the profits distributed, one to her individual account and the other in a joint bank account with her husband. The moneys thus accumulated by their wives were invested, either according to their own wishes or by their husbands for them. The wives of the partners in 1919 made no capital contribution to the partnership and throughout the taxable years rendered no services to and received no salaries from the partnership. The Commissioner has refused to recognize a partnership existing between the petitioners and their wives for the taxable years involved and has added to the incomes reported by the petitioners the shares of partnership profits paid over or credited to the petitioners' wives. The petitioners made their income-tax returns upon the basis of the calendar year. The partnership made its returns upon the basis of the fiscal year ended June 30. OPINION. SMITH: Section 218(a) of the Revenue Acts of 1918 and 1921 reads in part as follows: *3083 That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. * * * Section 224 of the Revenue Acts of 1918 and 1921 provides: That every partnership shall make a return for each taxable year, stating specifically the items of its gross income and the deductions allowed by this title, and shall include in the return the names and addresses of the individuals who would be entitled to share in the net income if distributed and the amount of the distributive share of each individual. The return shall be sworn to by any one of the partners. Section 5134 of the Code of Virginia, 1919, which was in force during the taxable years, reads in part as follows: * * * A married woman may contract and be contracted with, sue and be sued, in the same manner and with the same consequences as if she were unmarried, whether the right or liability asserted by her or against her shall have accrued heretofore or hereafter. * * * The *1250 evidence of record shows that at some time during 1919 petitioners took up with the collector of their district the question as to whether it would be proper for them to take in their wives*3084 as members of their firm and make returns upon the basis that their wives were members of the partnership. The official or employee in the collector's office advised them that he saw no objection to such proceeding. Thereafter, in 1919, petitioners and their wives had a meeting at their store and it was agreed among them that the wives should be equal partners with themselves in the business. The respondent denied the existence of a partnership between the petitioners and their wives, apparently upon the ground that there were no written articles of copartnership; that the wives contributed no capital or services to the partnership; and that the scheme was only for the purpose of reducing surtax. We think that the evidence actually shows an agreement of partnership between the petitioners and their wives on or about July 1, 1919, whereby the wives of the petitioners were taken into the business as equal partners with the petitioners. On that date a new partnership was formed composed of four individuals, each having a one-fourth interest therein. The claim of the respondent that the wives contributed no capital to the partnership does not disprove the fact that a partnership*3085 agreement was entered into. Persons are often made members of a partnership without themselves contributing anything to the partnership originally. The members of a partnership may set over to a person to be taken in as a partner a percentage of their own interests in the partnership. This is what was done in this case. Each of the petitioners gave to his wife one-half of his capital in the business. From that time on each of the petitioners had capital invested in the business. It is immaterial that they furnished no services to the partnership and received no salaries from the partnership. If the petitioners furnishing the services were willing that the other members of the partnership furnish no services yet share equally with them in the profits of the business, there is no provision of law to prevent them from doing so. Although proof that persons claiming to be members of a partnership furnished no capital and contributed no services to the partnership might tend to prove that no partnership agreement was entered into, proof of such facts becomes immaterial when all members of the partnership agree that a partnership contract was entered into. Nor do we think that*3086 it is material that the apparent object of the reorganization of the partnership in 1919 was for the purpose of reducing surtaxes payable by the petitioners. Clearly taxpayers have the right to change their form of organization and their methods of doing business in any way they may see fit so long as they keep within the law. *1251 In , it was stated: * * * The right to change the status of an organization, or to dissolve an organization in any legal manner, is not made ineffectual because the motive impelling the change is to reduce or avoid taxation in the future. The right so to do is an incidental right, inseparably connected with an individual's right to own and control his property. * * * It is not unnatural that any thoughtful business man takes such steps. It is altogether different from tax dodging, the hiding of taxable property, or the doing of some unlawful or illegal thing in order to avoid taxation. * * * We are satisfied that a valid partnership existed between the petitioners and their wives for the taxable years involved in these proceedings. Judgment will be entered under Rule 50.