This proceeding involves a deficiency in income tax of $10,114.14 for the calendar year ending December 31, 1944.
The principal issue is whether petitioner's wife, Edna B. Morris, in the year 1944 was a partner in a brokerage firm of which her husband was one of the senior members and, in the alternative, whether petitioner's wife was a creditor of the firm during the period in question.
FINDINGS OF FACT.
Petitioner John A. Morris resides in New York City, and he filed his 1944 Federal income tax return with the collector of internal revenue for the second district of New York.
Petitioner and his wife, Edna B. Morris, were married on May 27, 1942.
In 1929 petitioner became a general partner in the brokerage firm of Gude, Winmill Co. and has continued to be a general partner to date. The firm is a member of the New York Stock Exchange and operates under the laws of the State of New York.
On the dates tabulated below, the petitioner transferred the following shares of Oklahoma Natural Gas capital stock to his wife, such securities having a basis in the hands of petitioner of $24,101.43 and a fair market value as follows: Fair market Date of transfer Shares and class of stock value at date of transfer Dec. 24, 1943 ...... 50 shares $3 preferred ......... $2,650.00 Feb. 15, 1944 ...... 50 shares $3 preferred ......... 2,743.75 Apr. 5, 1944 ....... 400 shares $3 preferred ........ 22,050.00 Apr. 6, 1944 ....... 1,000 shares common ............ 22,312.50 --------- Total .......................................... 49,756.25 Between April 12 and April 18, 1944, the above described securities were sold by petitioner's wife for the sum of $49,519.93, yielding a taxable profit of $25,418.50, which she reported in her 1944 Federal income tax return. This transaction was executed by petitioner at the direction of his wife.
On or about April 20, 1944, petitioner gave to his wife the sum of $30,000. This gift was accomplished by the transfer from petitioner's "Special Account" with the firm to an account opened in the name of petitioner's wife on the books of the firm. At this time petitioner withdrew $58,000 from his capital account with the firm, reducing his capital contribution from $308,000 to $250,000, and Robert C. Winmill, the other dominant partner in the firm, reduced his capital account by $15,000 coincident with giving Viola T. Winmill a share of the profits.
Petitioner first conceived the idea of making the gifts in question in the autumn of 1943. In making the gifts, petitioner told his wife that she was to have absolute control of the securities and money, as he wanted to interest her in their management because she would undoubtedly inherit a substantial estate from him. The securities and cash in the approximate total of $80,000 which were the subject of the gift constituted about 5 or 6 per cent of the net worth of petitioner at the time of the gift.
No gift tax return was required to be filed by the petitioner for the calendar year 1943, as the securities given were of a value less than $3,000. The remaining gifts to his wife were reported in a Federal gift tax return for the calendar year 1944 and a tax of $7,199.81 was paid.
At or about the time of petitioner's gifts to his wife, changes in the membership of the brokerage firm were under discussion and one partner was expected to withdraw and another to be admitted. Petitioner advised the firm his wife might be interested in a limited partnership, under which she would invest $80,000. Thereafter, petitioner discussed the matter with his wife and she decided to become a limited partner in the brokerage firm. Under the terms of the partnership agreement, petitioner's wife was to invest $80,000, on which she was to receive 6 per cent interest, and in addition she was to receive 2 per cent of any profits earned over and above all expenses and charges. The partnership agreement was entered into on April 21, 1944. It was recorded in the office of the Clerk of the County of New York and it was passed upon and approved by the New York Stock Exchange, as required by the latter's rules and regulations. The partnership agreement ran to April 30, 1945.
The partnership contract disclosed the several interests of the partners to be as follows: Type of Cash capital Name partner capital contribution Robert C. Winmill ....................... General $215,000 Frederick F. Alexandre .................. " John A. Morris .......................... " 250,000 Paul L. Hughes .......................... " James G. Tremaine ....................... " 30,000 Coleman B. McGovern ..................... " Charles R. Gay .......................... " Joseph F. Wixted ........................ " Robert H. Radsch ........................ " 25,000 George E. Watson, Jr. ................... " Viola T. Winmill ........................ Limited 100,000 Edna B. Morris .......................... " 80,000 Reserve, to be used in accordance with directions of certain general partners. Interest Division on cash of profits contribution after interest Robert C. Winmill ....................... 6% 20% Frederick F. Alexandre .................. 10% John A. Morris .......................... 6% 11 1/2% Paul L. Hughes .......................... 10% James G. Tremaine ....................... 6% 5% Coleman B. McGovern ..................... 5% Charles R. Gay .......................... 7 1/2% Joseph F. Wixted ........................ 7 1/2% but not less than $9,600 per year Robert H. Radsch ........................ 6% 7 1/2% George E. Watson, Jr. ................... 5% Viola T. Winmill ........................ 6% 3% Edna B. Morris .......................... 6% 2% Reserve, to be used in accordance ....... 6% with directions of certain general partners.
Under the terms of the partnership agreement in effect just prior to the time Mrs. Morris became a member of the partnership firm, petitioner's participation in the profits after interest was 10 per cent, and Robert C. Winmill's participation was 20 per cent. After Mrs. Morris joined the firm, petitioner's participation in the profits was increased to 11 1/2 per cent and Robert C. Winmill's participation remained the same, at 20 per cent.
The 6 per cent interest upon capital contributions paid to partners for the two periods of 1944 in accordance with the effective partnership agreements was as follows: Jan. 1 to May 1 to Total for Partners Apr. 30, 1944 Dec. 31, 1944 year John A. Morris ..... $6,026.66 $9,992.67 $16,019.33 Edna B. Morris ..... 133.34 3,200.00 3,333.34 R. H. Radsch ....... 1,000.00 1,000.00 J. G. Tremaine ..... 600.00 1,200.00 1,800.00 R. C. Winmill ...... 4,300.00 8,600.00 12,900.00 V. T. Winmill ...... 2,000.00 4,000.00 6,000.00 --------- --------- ---------- Total ........ 13,060.00 27,992.67 41,052.67 There was credited on the books of the brokerage firm at the end of each month the 6 per cent interest on the capital invested by Mrs. Morris and the 2 per cent covering her share in the profits. The 6 per cent interest was mailed to her in monthly checks, usually in the amount of $400 each, and during the year 1944 there was paid to Mrs. Morris $2,800. The 2 per cent earnings were left in the business and were used from time to time to pay her taxes and to purchase securities in her name and for her account. From May 1, 1944, to December 31, 1948, her security portfolio had been increased by $25,000.
Petitioner and his wife kept separate bank accounts and had no joint bank accounts. Neither had a power of attorney in respect to any of the cash, securities, or other property of the other, nor did Mrs. Morris ever return any part of the above gifts to petitioner, and the accounts of petitioner and his wife were kept separately on the books of the partnership.
The money received by Mrs. Morris was deposited in her personal bank account and was expended as she saw fit. From this income she purchased personal luxuries, made gifts to friends, and contributed to charities in which she was interested. During all the period subsequent to the gifts, petitioner continued to pay the rent, wages of three family servants, all household expenses for food, etc., a child's clothing and expenses and the clothing for his wife.
Mrs. Morris continued to be a limited partner to the present time. There are no duties or services to be performed by the limited partners in the management or operation of the firm. Mrs. Morris did not render any services nor did she ever participate in the management of the firm. Any services she may have rendered were of a casual and incidental nature.
From 1930 until the time of the hearing in this proceeding, the firm has had only five limited partners. Two of those five were men who had formerly been in the brokerage business, and the remaining three are the wives of general partners of the firm. Mrs. Radsch became a limited partner some time in 1948.
Viola T. Winmill, who was a limited partner prior to 1944, did not begin to participate in the partnership's earnings until May 1, 1944, which was the effective date of the admission of Edna Morris as a limited partner. Until May 1, 1944, Viola T. Winmill, as a limited partner, only received interest at 6 per cent on her capital contribution. Thereafter, she participated in the partnership's earnings.
Contributions by limited or special partners are a common method of financing stock brokerage houses in New York. By actual count, about 40 per cent of the houses on the New York Stock Exchange have limited partners.
Under the terms of paragraph eight of the partnership agreement, the limited partners were entitled to the return of the capital contributions. The pertinent section reads as follows:
Eighth. Return of Limited Partners' Contributions. The contribution of each limited partner to the capital of the partnership, without deduction whatsoever for any losses or liabilities of the partnership, shall be returned to her upon the dissolution of the partnership or her earlier ceasing to be a partner in the partnership, unless the same shall be subject to the lien of the partnership provided in Article 8 of the partnership's Articles of Copartnership hereinafter mentioned, and except as otherwise provided in Paragraph Seventh hereof. The general partners who shall be liable hereunder for the payment of partnership losses shall be jointly and severally so liable to her, for the repayment of such contribution.
The source of the partnership income was commissions and interest on debit balances. Commissions income consisted of the charge to customers for purchase and sale of securities. Interest on debit balances was the charge to customers for money customers owed the partnership on securities which the partnership held for the account of customers. The policy of the firm has always been to have ample capital to take over firms embarrassed for lack of capital, and in 10 years the partnership has taken over 5 firms and added 3,000 accounts. In order to carry securities of clients, it is necessary to have a ratio of capital to debit balances of 15 to 1.
Robert C. Winmill and petitioner are the dominant partners in the firm of Gude, Winmill Co. and have control of its policies. Petitioner shared management with nine other partners, he and Robert Winmill having final decision only in the event of a dispute, but admission of new partners and the terms of their admission depended on the agreement of the ten general partners.
The matter of decisions on questions of management is covered in article 4 of the articles of copartnership, as follows:
ART. 4. Decisions on Questions of Management. If a difference of opinion should arise among the partners upon any question relating to the management of the partnership business or to such business, the decision of said Robert C. Winmill and said John A. Morris or of the survivor of them shall be controlling and binding upon all the partners; and no partner shall intentionally do any act in relation thereto contrary to such decision.
Petitioner's net income for 1944 as disclosed by his return was $111,046.46. His net income for 1944 as adjusted by the deficiency notice was $120,923.26.
Petitioner, his wife, and the other members of the brokerage firm formed a bona fide partnership and really and truly intended to join together for the purpose of carrying on the business as a partnership.
OPINION.
ARUNDELL, Judge:
The issues in this case are whether the wife of the petitioner was a bona fide partner in the brokerage firm for the purpose of carrying on a business and sharing in its profits, or whether the partnership was a mere sham, utilized for the purpose of reducing taxpayer's true tax liability by a pretended distribution of income; or, in the alternative, whether the wife of the petitioner was a bona fide creditor of the partnership.
We have found that Edna B. Morris, wife of the petitioner, was a bona fide partner in the brokerage firm. In so finding we have been guided by the tests suggested by the Supreme Court in Commissioner v. Culbertson, 337 U.S. 733, 742, wherein it is stated:
* * * The question is not whether the services or capital contributed by a partner are of sufficient importance to meet some objective standard supposedly established by the Tower case, but whether, considering all the facts — the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent — the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.
The partnership agreement provided that Edna B. Morris was to be a limited partner, and, as such, she was precluded by New York Partnership Law, art. 8, sec. 93, from rendering services to the brokerage firm, and consequently no attempt has been made by petitioner to show that his wife in fact rendered services other than of the most casual or trivial nature. But a partnership may yet exist where only capital and no services are contributed. Commissioner v. Culbertson, supra.
McKinney's Consolidated Laws of New York, Ann., Book 38.
It is respondent's position, however, that Mrs. Morris' capital contribution had its origin in gifts from her husband, the petitioner, and consequently it did not represent an independent capital contribution on her part sufficient to justify her recognition as a bona fide partner. This contention, we think, is no longer tenable since Culbertson, as the following quoted language from that opinion makes clear:
The Tax Court's isolation of "original capital" as an essential of membership in a family partnership also indicates an erroneous reading of the Tower opinion. We did not say that the donee of an intra-family gift could never become a partner through investment of the capital in the family partnership, any more than we said that all family trusts are invalid for tax purposes in Helvering v. Clifford, supra. The facts may indicate, on the contrary, that the amount thus contributed and the income therefrom should be considered the property of the donee for tax, as well as general law, purposes.
The petitioner made an absolute gift to his wife of securities and cash, the total of which represented but 5 or 6 per cent of his total wealth. In making the gifts, petitioner had told his wife that she was to have absolute control of the securities and money as he wanted to interest her in their management because she would undoubtedly inherit a substantial estate from him. He retained no control and stated no limitations or controls over her ownership. The respondent has not attempted to show the contrary. Instead, counsel for respondent has said that he knows of "no question about the complete and unfettered transfer of the stocks, and the cash to her credit."
Petitioner and his wife at all times maintained separate bank accounts and had no joint bank accounts. Neither had a power of attorney in respect to any of the cash, securities, or other property of the other, nor did Mrs. Morris ever return any part of the gifts, above referred to, to petitioner, and the accounts of petitioner and his wife were kept separately on the books of the partnership.
The use that Edna B. Morris made of the income derived from her capital contribution also is indicative of the genuineness of the partnership. The petitioner exercised no control over the withdrawal or use of that money by his wife. The money received by Mrs. Morris was put in her personal bank account and was expended as she saw fit. It was not used to discharge family obligations that were properly the petitioner's, but the money was devoted to her own personal uses, for her own social activities, to purchase personal luxuries, to make gifts to her friends, to contribute to charities in which she was interested, to pay taxes, and to increase her personal securities portfolio. Petitioner continued to discharge his family obligations, to pay household expenses such as rent, wages of three family servants, a child's clothing and expenses, and the major expenses of maintaining his wife's wardrobe.
Circumstances surrounding the partnership agreement also indicate a valid business purpose. Thus, the method of forming the partnership, viz., by means of a limited partnership, is a common method of financing stock brokerage houses in New York. By actual count, about 40 per cent of the houses on the New York Stock Exchange have limited partners. Again, while it is apparent that petitioner, along with Robert C. Winmill, was one of the firm's two dominant partners and had the final decision in business policy matters, the action with respect to the admission of a new partner, Edna B. Morris, had to meet with the approval of all ten partners in the firm. While all the partners, limited or general, received 6 per cent interest on the sums invested in the business, the sliding scale of profits which gave to the active partners a greater share in the profits is not without significance in showing the business basis of the agreement. Nor was petitioner's participation in the profits of the business lessened when his wife became a partner, but, on the contrary, his share of the profits was increased from 10 per cent to 11 1/2 per cent.
The Supreme Court said in the Culbertson case (p. 744):
* * * If, upon a consideration of all the facts, it is found that the partners joined together in good faith to conduct a business, having agreed that the services or capital to be contributed presently by each is of such value to the partnership that the contributor should participate in the distribution of profits, that is sufficient. [Emphasis supplied.]
We think that under the facts as detailed in our findings of fact and under the rationale of the Supreme Court's decision in the Culbertson case, Edna B. Morris should be recognized as a partner in the partnership of Gude, Winmill Co.
It has been suggested that the conclusion we have reached here is contrary to our holding in Ralph C. Hitchcock, 12 T.C. 22, wherein we refused to recognize for income tax purposes the validity of the limited partnership involved in that case. In the Hitchcock case we took the view that the petitioner, as donor, never intended to absolutely and irrevocably divest himself of the dominion and control of the subject matter of his purported gifts to his children, and we pointed out that the children were not at liberty at any time to withdraw or assign their interests in the business or possessed of an unqualified right to receive their full share of each year's earnings. In the instant case petitioner's gift to his wife of cash and securities was complete and absolute prior to the formation of the partnership, and Mrs. Morris received each year her share of the partnership earnings and disposed of them as she saw fit. We think on the facts the cases are clearly distinguishable.
Because the second issue raised by the petitioner, viz., whether or not Edna B. Morris is a bona fide creditor of the firm, is in the alternative, it is rendered moot by our finding with respect to the wife's status as a bona fide partner.
Since we have found that the petitioner's wife was a bona fide partner in the firm during the calendar year 1944, the amounts of $8,741.48 of ordinary income and $242.65 of net short term capital gain reported by her as distributable income from that business are properly taxable to her rather than petitioner. On this issue the Commissioner is reversed.
Reviewed by the Court.
Decision will be entered under Rule 50.
HILL, J., dissenting:
The brokerage firm of Gude, Winmill Co. was, in my view, a partnership only of its members designated "general partners." All of such general partners, among whom petitioner was included, contributed services in the operation of the firm's business. Only four of them contributed capital. Such contribution constituted capital investments which were subject to the risks of the business. In the distribution of the partnership profits it was provided in the partnership contract that interest on such capital investments at the rate of 6 per cent per annum should be paid and that the remaining profits should be apportioned on the basis of stipulated percentages thereof. Such percentages were obviously computed and determined solely upon the estimated value to the firm of the services of the respective general partners. Thus, it appears that such arrangement embraces all the elements necessary to constitute a partnership in fact and in law.
It is my opinion that Edna B. Morris, wife of the petitioner, and Viola T. Winmill, wife of the general partner Robert C. Winmill, who are named in the partnership agreement of Gude, Winmill Co. as limited partners, do not, under the facts here, qualify in any sense as partners in such firm. The status of Viola T. Winmill in this connection is mentioned only because her status is the same as that of Edna B. Morris, with which we are here concerned. Neither of the so-called limited partners made a contribution to the capital of the firm. Neither of them had at any time a capital investment in the firm. Each merely loaned money to the firm. The money so loaned bore interest at the rate of 6 per cent per annum and was not subject to the risk of the business of the firm. Each of the limited partners could have legally demanded a return of her loan at the end of the partnership term, to wit, April 30, 1945. Not only do the articles of copartnership provide for the repayment of the loans, but also provide in effect that the general partners shall hold the limited partners harmless from partnership losses.
Under the articles of copartnership the limited partners were to perform no services for the partnership and were to have no voice in the formulation of the policies or the conduct of the business of the firm. In fact, they performed no services and took no part whatever in the conduct of the firm's business.
The rate of interest provided for the use of the money loaned by the limited partners was by agreement of the partners fixed as a fair compensation for such use.
There was paid to Edna B. Morris monthly during the tax year involved the specified rate of interest on her loan. In addition thereto there was credited to her on the books of the firm the stipulated 2 per cent participation in the profits of the firm's business, no part of which was used in the firm's business. It was used to pay her taxes and to purchase securities in her name and for her account.
I think it clear on the above recital of facts, which is supported by the record, that Edna B. Morris did not contribute either capital or services to the partnership and that she did not join or intend to "join together in the present conduct of the enterprise" of the partnership, and that she did not act "with a business purpose" for the partnership in advancing the $80,000 loan. The only business purpose which she had in making such loan was the personal purpose of receiving profit from such advancement as a loan.
It can not be seriously contended under the facts here that Edna B. Morris earned or contributed to the earning of the profits of the partnership either by service rendered or by the money loaned. I think, therefore, it must be held that the profits which she received under the 2 per cent participation arrangement are attributable solely to the earnings of her husband, the petitioner herein, and, accordingly, that he is taxable thereon.
HARRON and OPPER, JJ., agree with this dissent.
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