Schofield v. Commissioner

JOHN H. SCHOFIELD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Schofield v. Commissioner Docket No. 34036. United States Board of Tax Appeals 19 B.T.A. 234; 1930 BTA LEXIS 2446; March 10, 1930, Promulgated *2446 In the circumstances of this case, held, the petitioner received no taxable income in the calendar year 1923. John H. Schofield pro se. T. M. Mather, Esq., for the respondent. SEAWELL *234 The Commissioner determined a deficiency in income tax in the amount of $1,448.30 for the year 1923. The petitioner alleges the Commissioner erred in adding to petitioner's income for the calendar year 1923 the sum of $26,233.05, as profit on withdrawal from the partnership of Weinroth & Schofield. The case is submitted on the pleadings, testimony of petitioner and George R. Seiffert, and exhibits filed. FINDINGS OF FACT. The petitioner resides in Philadelphia, Pa. The petitioner and one Max Weinroth became copartners under the name of Weinroth & Schofield, in a business of jobbing and selling at wholesale hosiery, underwear, etc., in Philadelphia, on January 1, 1920, and the partnership continued through the years 1920, 1921, and 1922, and until November 2, 1923. At the time of the formation *235 of the partnership, the petitioner contributed to the capital the sum of $50,000 in cash and Weinroth contributed his stock of goods*2447 on hand, bills receivable, etc., all of which were contracted to be of the value of $150,000. During 1920 the petitioner contributed the further sum of $27,000 to the capital of the partnership. The partners were to receive 6 per cent interest on the capital so respectively contributed, and to receive $200 per week each for expenses and salary, and were to divide the profits or share the losses equally. Weinroth and his sister-in-law, a bookkeeper, kept all the books and records of the partnership, the petitioner actually knowing nothing of the manner of keeping the same or what they contained. The petitioner, by oral agreement with his partner, drew only $100 per week for expenses and salary, and supposed Weinroth was drawing only $200 per week until he accidentally learned in 1923 that Weinroth had been and was receiving fraudulently in addition to his $200 per week the $100 which the petitioner had agreed not to draw for himself. This circumstance aroused the suspicions of the petitioner and, taking advantage of the temporary absence of Weinroth and his sister-in-law at the seashore, he employed an accountant and started an investigation and audit of the partnership business. *2448 This audit was not completed before the return of the partner, Weinroth, and his sister-in-law, and when the fact of the audit was known by them, various books of the partnership were removed and obstacles thrown in the way of the accountants engaged in the audit. Sufficient evidence, however, had been obtained to lead the petitioner reasonably to conclude that he was being systematically robbed by his partner and he laid the evidence before an attorney, who filed for him a bill in equity against Weinroth for an accounting and for a dissolution of the partnership. This action resulted in a compromise whereby the petitioner was repaid by Weinroth $50,000 in cash and notes, the amount of his initial investment, and all the assets of the partnership were released to Weinroth and the partnership dissolved. The books of account of the partnership were, in fact, fraudulently kept and they did not at any time during the partnership years properly reflect its true financial condition. Weinroth, beginning in 1920, had continuously during the years of the partnership misappropriated the funds of the partnership to his own use and benefit, frequently using the names of relatives and others*2449 in confusing accounts and showing apparent losses to the partnership which, in fact, did not exist. Many instances of such manipulations were given in evidence by the accountant who examined the books of the partnership. Acting upon information which he received, he testified he was able to follow on the books these transactions. A sale of *236 goods in November, 1920, was made to one Weingast for $13,500. Instead of entering this as a sale on the books of the firm, it was entered as a loan made by Bernhard Segal, a brother-in-law of Weinroth. Segal's loan [?], as appears from the books kept, was ultimately paid off and is reflected as a loss to the partnership. Mere hearsay evidence was offered showing that in fact Weinroth received the money personally, but this is not material and is not considered here. The accountant was likewise enabled to trace a sale of merchandise amounting to $4,113.50 carried in the name of David Kaskey, who was an auctioneer and probably sold the goods for Weinroth & Schofield. A check on the Penn National Bank in payment of this amount was issued to Max Weinroth, endorsed by M. W. Weinroth and paid. At another time, merchandise designated*2450 as lot No. 93 was reported on the books as sold to Kaskey & Co. for $4,000. A check, No. 1266, of Kaskey & Co. issued in payment thereof was located, but was not endorsed or apparently cashed, but returned to Kaskey & Co. accompanied by the check of Weinroth & Schofield, No. 4428 [also located], in favor of J. Steinberg for $1,000, all entered on the books of Weinroth & Schofield so as to indicate a loan to Kaskey & Co. of $5,000. This "loan," as appears by the books of the partnership was paid November 13, 1920, by check for Kaskey & Co., No. 1310 on the Union National Bank. The cash books of Weinroth & Schofield fail to show this payment, but a month later Morris Feldman, a relative of Weinroth, was given credit for the amount and it was entered on the books of the partnership as a loan from Feldman. About the same time another payment of Kaskey & Co. to Weinroth & Schofield by check No. 1314 for $10,000 was entered on the books of Weinroth & Schofield as a loan from Victor Wachs, a brother-in-law of Weinroth, which "loan" was paid off by Weinroth & Schofield December 28, 1920. The books of Weinroth & Schofield showed many sales in addition to the above entered as "loans" *2451 by relatives of Weinroth. On the books also were small items of credit to Weinroth personally for expenses, express and freight, aggregating more than $32,000, for which there were no supporting vouchers. There also appears a payment of interest of more than $4,000 to a sister-in-law of Weinroth, who nowhere appears as a creditor of the partnership. Weinroth owned considerable property in Philadelphia and was at all times fully able to answer any damages to the partnership for misappropriations made by him. Schofield is shown by the evidence never to have received anything from his connection with the firm of Weinroth & Schofield other than the $100 per week for expenses and services, and the return to him of his initial investment of $50,000. The remainder of his *237 invested capital, $27,000, and the interest on the whole $77,000, put into the capital by him during the four years of the existence of the partnership, were totally lost to him. At the hearing respondent contended that the petitioner's investment was $50,000 and that by reason of the misappropriation of the funds of the partnership by one of the partners, there was a loss to the petitioner of his*2452 capital investment amounting to $26,234.05, leaving only $23,766.95 as the amount of his invested capital in 1923; and that in consequence of the settlement of the equity suit that year, there was a gain to petitioner of the amount lost in prior years. The deficiency of $1,448.30 thus determined by the Commissioner for the year 1923 is based on the assumption that the books of the partnership were correctly kept. The evidence is clear that many false entries were made therein and that numerous proper entries were omitted therefrom. No tax returns are in evidence for any of the years during the existence of the partnership. The report of the revenue agent for 1920 and 1921 is filed, but is not evidence of the true status of the business transactions of the partnership. OPINION. SEAWELL: In this case, the petitioner had no counsel to represent him at the hearing and in consequence thereof the record in his behalf is not as full and satisfactory as it might otherwise have been. It is, however, very apparent from the evidence that the petitioner was badly deceived and imposed upon by his partner, Weinroth, now deceased. The evidence is clear and convincing that Weinroth*2453 had control of the firm's books and business; that he misapplied and misappropriated funds and property of the firm and that its books were not correctly kept and that the Commissioner's determination was based on incorrect data, due to the false and fraudulent manner in which the books of the firm of Weinroth & Schofield were manipulated by Weinroth, and his misappropriation of the funds and property of the firm. The evidence of the petitioner himself was not objected to and the motion to strike out the evidence of his witness, Seiffert, was reserved. In so far as the testimony given by the witness Seiffert detailed conversations and communications with other persons, the motion to strike is allowed; but in so far as that testimony dealt with the status of the books of the firm of Weinroth & Schofield and detailed facts ascertained in consequence of information received, the motion is overruled and exception is allowed the respondent. The evidence admitted showing the condition of the partnership books, the false entries therein made and the evident intent of *238 Weinroth to fraudulently withdraw funds of the partnership for his individual use is of such a nature as to*2454 overcome the presumption in favor of the correctness of the determination of the Commissioner and we are of the opinion that the petitioner did not at any time receive any income or profit from his connection with the firm of Weinroth & Schofield. Schofield, who impressed us as an honest and truthful man, so testified. At the hearing the respondent contended that the petitioner's investment in the partnership was $50,000 and that by reason of the misappropriation in 1920 and 1921 of the funds of the partnership by one of the partners there was a loss to the petitioner of his invested capital of $26,233.05 and that the petitioner's reduced capital on November 10, 1923, was accordingly only $23,766.95 and the difference between this amount and the $50,000 received under the settlement of the equity suit is taxable income to the petitioner. The question, therefore, arises: Was this part of the $50,000 received in the equity suit taxable income to the petitioner in the year in which it was received? Did the misapplications and misappropriations of the assets of the firm by Weinroth to his own use and benefit operate to deprive the partnership of the title to or the possession of*2455 the same? Under the law it would seem each of the partners was entitled to possession of the partnership assets and though one partner did take into his individual possession property of the partnership, with intention to embezzle or misapply the same, such property was nevertheless still in the possession of the partnership, as the possession of either was the possession of the partnership. 47 C.J. 783. Restitution of assets improperly removed may be compelled in a court of equity where the offending partner is possessed of means. . The evidence of the solvency of Weinroth was not contradicted, and we are of the opinion that the assets so embezzled by him were still the property of the partnership, and the recovery by, or the return to, the innocent individual member of his interest in such assets would not constitute taxable income to the said partner. The instant case is distinguishable from those decided by the Board in which an employee or officer of a corporation has stolen or embezzled money from it and there is at the time an actual loss, though not discovered until later, for the employee or officer of a corporation*2456 has not that community of possession of the corporate property that a partner has in the partnership assets. ; . In the instant case, the petitioner, having confidence in the honesty of his partner and being ignorant of the true condition of the *239 firm's business and books, because of the fraud practiced on him by his partner, did not discover until the latter part of October, 1923, that his partner was appropriating to his own use the funds of the firm. After such discovery, the petitioner promptly employed an attorney, under whose advice he filed a bill for the dissolution of the partnership and an accounting. As a result of such suit and under advice of counsel, a compromise settlement was effected, whereby the petitioner accepted from Weinroth a return to him in cash and notes of $50,000, the amount of his initial investment, upon the receipt of which he released to Weinroth the entire assets of the firm and thereupon the firm was dissolved. In the light of the evidence, as we view it, no part of the $50,000 received by petitioner was income*2457 or profit. After his unfortunate connection as a partner of Weinroth, petitioner withdrew from the partnership, after losing $27,000 of his capital investment and the interest on his total investment of $77,000, receiving only a return of the $50,000, his initial investment. The Commissioner erred in his determination of petitioner's income-tax liability for 1923. In our opinion, petitioner received no taxable income in 1923. Judgment will be entered for the petitioner.