Tweedy v. Commissioner

LAWRENCE L. TWEEDY AND GRACE V. TWEEDY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Tweedy v. Commissioner Docket Nos. 106646, 107217. United States Board of Tax Appeals 47 B.T.A. 341; 1942 BTA LEXIS 702; July 16, 1942, Promulgated *702 1. Petitioner is a United States citizen and was a bona fide nonresident of the United States for more than six months of each of the taxable years. During the taxable years he was a general partner and manager of the London office of a domestic brokerage firm, with respect to which capital was a material income-producing factor. Petitioner at no time contributed capital to the firm, but received a percentage of its profits plus a sum designated "salary." Held, that petitioner's earned income from sources without the United States, excludable from gross income under section 116(a) of the Revenue Acts of 1936 and 1938, is limited to 20 percent of his share of the partnership's net profits, which included the amounts designated "salary." 2. Capital losses deductible in joint return held limited to $2,000. Marvin L. Levy,46 B.T.A. 1145. Martin D. Jacobs, Esq., for the petitioners. Richard C. Flesch, Esq., for the respondent. ARUNDELL *342 The Commissioner derermined deficiencies in the income tax of petitioners for the years 1937 and 1938 in the sums of $223.64 and $790.42, respectively. Petitioners claim an overpayment*703 for 1937 in the sum of $405.51. The primary issue is whether or not amounts received by one of the petitioners in the taxable years, while residing in London, England, constitute income from sources outside the United States within the meaning of section 116(a) of the Revenue Acts of 1936 and 1938. The other issue is whether or not a husband and wife filing a joint return may take a deduction for capital losses in the amount of $4,000. The proceedings were consolidated for hearing and opinion. The facts were stipulated and only those facts necessary for discussion of the issues presented will be set forth herein. FINDINGS OF FACT. Petitioners are husband and wife and lived together during the years involved in these proceedings. They are American citizens, residing in London, England, and during the years 1937 and 1938 were bona fide nonresidents of the United States for more than six months of each year. Their returns for the taxable years were filed with the Collector of Internal Revenue for the second district of New York. On September 16, 1932, petitioner Lawrence L. Tweedy, hereinafter referred to as Tweedy, was employed by the New York Stock Exchange firm of*704 Baker, Weeks & Harden, sometimes hereinafter referred to as the "firm", as manager of the firm's London office at a salary of $1,000 a month. On June 30, 1936, Tweedy was taken into the firm as a general partner. At that time he made no contribution to the capital of the firm, and he has not contributed capital at any time subsequent thereto. Pursuant to the partnership agreement each of the general partners received annually a sum designated as "salary." These salaries were regarded as expenses of the firm and were to be paid whether or not there were any earnings. The so-called profits were to be determined after first deducting the salaries as a part of the firm's expenses. At the time the partnership was first entered into Tweedy's interest in the "distribution of profits" was 2 percent. On December 31, 1936, this percentage was increased to 5 percent and remained at this figure until January 1, 1938, when this percentage was further increased to 6 percent, at which figure it remained during the year 1938. During the year 1936 Tweedy received a salary of $15,220.46 as compensation for his services as an employee of the firm. During the year 1937 Tweedy received*705 from the firm, of which he was a partner, the sum of $21,012.09, of which $15,220.46 was designated as "salary" and the balance of $5,791.63, determined by Tweedy's "percentage" as set forth above, as "distribution of profits." *343 On or about June 15, 1938, petitioners caused to be filed an income tax return in which they reported the sum of $16,809.67, or 80 percent of the sums received by Tweedy from the firm during the year 1937, as gross income and paid a tax amounting to $404.01. On or about March 4, 1941, petitioners filed a claim for refund of the tax paid as aforesaid and no part of that sum has been repaid to petitioners or to any person on or for their behalf. No assignment has been made of this claim or of any part thereof. On March 1, 1938, the firm reduced all salaries paid by it 10 percent, including the payments to Tweedy which were designated in the partnership agreement as "salary." During the calendar year 1938 Tweedy received from the firm the sum of $20,095.89, of which $14,082.62 was designated as "salary" and the balance of $6,013.27 as "distribution of profits." The petitioners did not report any part of the moneys received by Tweedy from*706 the firm during the calendar year 1938 as taxable income in their income tax return for that year. During the taxable year 1937 Tweedy sustained a net capital loss of $2,838.05 and his wife, petitioner Grace V. Tweedy, sustained a net capital loss of $13,140.37. In their joint income tax return filed for the year 1937 petitioners claimed a deduction for capital losses in the sum of $4,000. The Commissioner disallowed $2,000 of this deduction. OPINION. ARUNDELL: The major question presented is whether or not respondent was correct in treating only 20 percent of the amounts received by Tweedy from the partnership as earned income from sources without the United States. Petitioners contend that all the amounts in question constitute compensation for personal services rendered outside this country and as such are excluded from gross income by virtue of the provisions of section 116(a) of the Revenue Acts of 1936 1 and 1938. 2 Respondent argues that the only amounts excluded from gross income under that section are those which constitute earned income and that in order to determine what is earned income we are required *344 by section 116 to look to section 25(a) 3*707 of the respective acts, which defines earned income in general. He maintains that, since capital is admittedly a material income-producing factor in the business of the firm of which Tweedy is a member, the latter's earned income cannot exceed 20 percent of his share of the firm's net profits. *708 Respondent would appear to be correct if Tweedy's trade or business is that of the firm of which he is a partner and from which the income in question was received. The only peg on which petitioners hang their argument, that capital was not a material income-producing factor in Tweedy's business, is the fact that Tweedy did not personally make a capital contribution to the partnership of which he was a member. But this would draw the line where the statute does not. When tweedy ceased to be an employee of the firm and became one of its general partners he obtained a proprietary interest in the business, and this stake so acquired brings him within the statutory limitation on earned income. This view, we think, conforms with the whole pattern of the section. As we are dealing here with the income of a member of a partnership, section 4 of the Revenue Acts of 1936 4 and 1938 5 would seem to require that we examine section 185 of those two statutes. Section 185 6 provides that the earned income of partners shall be determined in accordance with the rules and regulations prescribed by the Commissioner with the approval of the Secretary of the Treasury. Article 185-1 of the*709 Commissioner's Regulations 94 and 101, which was promulgated *345 to give effect to section 185, supra, provides that, where a partnership is engaged in a trade or business in which capital is a material income-producing factor and a partner renders personal services in connection therewith, that partner's earned income, for purposes of the earned income credit granted by section 25(a), may not exceed 20 percent of his share of the net profits of the partnership. This regulation makes no distrinction between a partner who has contributed capital and one who has not contributed capital. The sole test is whether capital is a material income-producing factor of the partnership. These are "legislative" regulations and must be accorded great weight so long as they are not arbitrary. . *710 Petitioners urge, in the alternative, that so much of Tweedy's income as was designated "salary" should, in any event, be treated as earned income. Prior to his admission to the partnership Tweedy received a salary which was clearly compensation for services and was earned income. Although he continued to perform substantially the same duties after he became a member of the partnership as before, his relationship to the firm became an entirely different matter. Even if his drawing account was termed "salary" or "compensation", the amounts withdrawn were in reality either profits or anticipated profits. See . As a partner he may not pay a salary to himself. . Nor do we think it important that Tweedy's "salary" was payable regardless of whether the firm had net profits. The partnership agreement provides that each general partner shall contribute his share of the firm's losses. Thus, although the "salaries" are payable whether or not there are earnings, the absence of earnings would cause the partnership to operate at a loss and as a consequence Tweedy would have to make good his share*711 of such losses. What he received in each of the taxable years was his share of the firm's net profits, however those profits were designated. It follows that Tweedy's earned income may not exceed 20 percent of the total amount received by him in each year from the partnership. Respondent is sustained on this issue. The final question before us is whether or not petitioners, who filed a joint return for the taxable year 1937, may deduct a total of $4,000 for capital losses where each of petitioners sustained a net capital loss in excess of $2,000. We have recently held that a husband and wife filing a joint return are limited to only one $2,000 capital loss deduction. . Our opinion there controls the disposition of this issue and respondent's action is accordingly sustained. Decision will be entered for the respondent. Footnotes 1. SEC. 116. EXCLUSIONS FROM GROSS INCOME. In addition to the items specified in section 22(b), the following items shall not be included in gross income and shall be exempt from taxation under this title: (a) EARNED INCOME FROM SOURCES WITHOUT UNITED STATES. - In the case of an individual citizen of the United States, a bona fide nonresident of the United States for more than six months during the taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) if such amounts would constitute earned income as defined in section 25(a) if received from sources within the United States; but such individual shall not be allowed as a deduction from his gross income any deductions properly allocable to or chargeable against amounts excluded from gross income under this subsection. ↩ 2. Section 116(a) of the Revenue Act of 1938 is identical to that in the 1936 Act. ↩ 3. SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME. (a) CREDITS FOR NORMAL TAX ONLY. - There shall be allowed for the purpose of the normal tax, bur not for the surtax, the following credits against the net income: * * * (4) EARNED INCOME DEFINITIONS. - For the purposes of this section - (A) "Earned income" means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include any amount not included in gross income, nor that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income. * * * ↩ 4. SEC. 4. SPECIAL CLASSES OF TAXPAYERS. The application of the General Provisions and of Supplements A to D, inclusive, to each of the following special classes of taxpayers, shall be subject to the exceptions and additional provisions found in the Supplement applicable to such class, as follows: * * * (b) MEMBERS OF PARTNERSHIPS, - SUPPLEMENT F. * * * ↩ 5. Section 4 of the Revenue Act of 1938 is identical to that in the 1936 Act. ↩ 6. SEC. 185. EARNED INCOME. In the case of the members of a partnership the proper part of each share of the net income which consists of earned income shall be determined under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary and shall be separately shown in the return of the partnership. ↩