Court Opinion

ID: 4628000
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:02:25.758216+00
Date Added: 2024-06-11T07:57:08.433835
License: Public Domain

Isadore Louis Rosenberg, Petitioner, v. Commissioner of Internal Revenue, Respondent.  Lorene Ann Rosenberg, Petitioner, v. Commissioner of Internal Revenue, RespondentRosenberg v. CommissionerDocket Nos. 19796, 19797United States Tax Court15 T.C. 1; 1950 U.S. Tax Ct. LEXIS 130; July 11, 1950, Promulgated 1950 U.S. Tax Ct. LEXIS 130">*130 Decisions will be entered under Rule 50.  On the facts, held, petitioner was not a partner of Selber Bros. Inc. during the taxable year involved.  Joseph A. Hoskins, Esq., for the petitioner.Elmer L. Corbin, Esq., for the respondent.  Hill, Judge.  HILL15 T.C. 1">*1  The respondent determined deficiencies in petitioners' income tax for the taxable year ended December 31, 1943, as follows:Docket No.Deficiency19796Isadore Louis Rosenberg1,529.3519797Lorene Ann Rosenberg1,536.82The questions for determination are:(1) Did Isadore Louis Rosenberg, hereinafter referred to as petitioner, and Selber Bros. Inc., hereinafter sometimes referred to as Selber, do business as a partnership during the period involved?(2) If so, was the gain realized by petitioner in 1943 upon the termination of his business relationship with Selber1950 U.S. Tax Ct. LEXIS 130">*131  taxable as capital gain under section 117 of the Internal Revenue Code or as ordinary income?(3) Did the respondent err in including in petitioner's net income for 1943 the amount of $ 2,150 received by petitioner in 1942 from Selber pursuant to the terms of a contract between them dated December 31, 1938?Although the deficiencies relate only to the year 1943, 1942 is also involved because of the Current Tax Payment Act of 1943.An adjustment made by the respondent in petitioners' income tax liability for the year 1943 is not in issue.  Respondent conceded on brief that if the first issue is decided against petitioner, the amount of $ 2,150 which petitioner withdrew from the business involved in 1942 constituted ordinary income includible in petitioner's income for 1942, as petitioner contends.15 T.C. 1">*2  FINDINGS OF FACT.Petitioners are individuals with residence in Shreveport, Louisiana.  Their returns for the periods here involved were filed on a community property basis with the collector of internal revenue at Shreveport, Louisiana.Selber Bros. Inc., is a ready-to-wear business in Shreveport, Louisiana, operated by four brothers, Louis, Mandel, Aaron and Isadore (now deceased). 1950 U.S. Tax Ct. LEXIS 130">*132  Selber, prior to 1938, had not engaged in the shoe business.  However, it owned a lease covering a storeroom adjoining the space used for its ready-to-wear business.  This storeroom had been occupied by a shoe store for many years, but in the latter part of 1938 was unoccupied.  The storeroom was in the same building as Selber, but was not used in the business.  Selber owned the leasehold on other storerooms in this business which it sublet for different business purposes.Petitioner had formerly operated, with his uncle, a shoe business in the storeroom referred to.  The name "Rosenberg" was still imbedded in the sidewalk in front of the store.  Much of the equipment in the storeroom had formerly belonged to the Rosenbergs.As of 1938, petitioner had had 20 years' experience in the shoe business, having been engaged therein more or less continuously since 1916.  Petitioner was experienced in buying and selling shoes, and in the management and operation of the shoe business, all of which is necessary and important for the proper selection of styles, shoe lines and stock, and the merchandising of shoes.Petitioner learned that Selber planned to put in a shoe store in the storeroom 1950 U.S. Tax Ct. LEXIS 130">*133  referred to.  He was interested in becoming associated with Selber in this business.  He discussed the matter with the Selber brothers, most of the discussion being with Louis Selber, president of Selber Bros. Inc.  These discussions resulted in an agreement termed a "contract of employment" entered into between Selber, as party of the first part, and petitioner, as party of the second part, on December 31, 1938.  The agreement provides as follows:THAT, WHEREAS, Party of the First Part proposes to equip part of the premises located at 425 Milam Street, Shreveport, Louisiana, for the operation of a women's and girls' retail shoe department of its business, providing therein adequate furniture and fixtures and an inventory of shoes; andWHEREAS, Second Party is desirous of securing employment as manager of said retail shoe department upon the terms and conditions hereinafter set forth:NOW, THEREFORE, THIS AGREEMENT WITNESSETH:I.First Party employs Second Party as manager of its retail shoe department at a salary of $ 45.00 per week.  Second Party shall devote his entire time to such employment.15 T.C. 1">*3  II.In addition to the salary specified in Paragraph I, Second Party desires to1950 U.S. Tax Ct. LEXIS 130">*134  secure participation in the net profits or losses of the said retail shoe department, and for that purpose has this day paid to First Party the sum of One Thousand Five Hundred ($ 1,500.00) Dollars in cash, the receipt thereof being hereby acknowledged.  It is agreed that Second Party's participation in the profits or losses of said venture shall be 50% of the net profits as hereafter defined and 50% of the losses; but until Second Party's credit to Bonus Account hereinafter mentioned shall equal 50% of the average net capital employed in the business, Second Party shall be credited in Bonus Account merely and shall not be at liberty to withdraw or receive any part thereof.  The average capital employed in the business shall be ascertained by averaging the physical inventory (including merchandise and other property used in the business) at costs, found to be on hand at time of the monthly inventories hereinafter provided for.  Upon termination or cancellation of this agreement, the amount then credited to Bonus Account shall be returned to Second Party.  At the end of each fiscal year there shall be credited to Second Party, interest at the rate of six (6%) per cent per annum upon1950 U.S. Tax Ct. LEXIS 130">*135  the amount of credit to Bonus Account.  Second Party's participation in losses shall be for the purpose of adjusting Bonus Account only and shall not involve personal responsibility for debts of the venture.III.There is hereby created an account in First Party's accounting system to be called "Bonus Account".  This account shall be credited with the One Thousand, Five Hundred ($ 1,500.00) Dollars provided by Article II and Second Party's share of the profits and losses of the retail shoe department shall be credited or charged thereto, as the case may be.  All moneys credited to Bonus Account shall be available to First Party for use in its business without restriction, and according to its own judgment.  [Sic.]IV.When the credit balance in said Bonus Account shall equal 50% of the average capital investment in the business, determined as specified under Article II herein, plus interest thereon at the rate of six percent per annum; thereafter, during the life of this agreement or subsequent renewals thereof, while such balance is maintained, Second Party's bonus for each fiscal year thereafter shall be paid to him in cash after the close of the accounts for the fiscal year.1950 U.S. Tax Ct. LEXIS 130">*136  V.In determining net operating results from the operation of said retail shoe department, the following formula shall be applied:(a) From net sales of the department during the fiscal year, there shall be deducted the cost of sales as determined under accepted principles of accounting.(b) From the resulting gross profit there shall be deducted all direct expenses attributable to the operation of the department, including a fixed charge as rental of the premises, equal to ten percent of all cash sales and twelve percent of all charge sales, said percentages to be figured upon the basis of gross sales less returns and allowances.  This charge shall be considered not only as rent, but in lieu of the actual cost of heat, light, janitor service, wrapping paper, window trimming and delivery service.15 T.C. 1">*4  (c) Second Party's salary specified under Article I, shall be deducted as an expense in arriving at the net profits, but Second Party's bonus, as computed hereunder shall not be so considered.(d) The remaining items of overhead expense, such as taxes and licenses insurance, salaries, advertising, etc., shall be charged directly against the retail shoe department where the expenditure1950 U.S. Tax Ct. LEXIS 130">*137  belongs exclusively thereto; where the nature of the expenditure is such that benefits are received by other departments of First Party's business, a reasonable apportionment shall be made thereof, as between departments, according to the value received by each of them.(e) There shall be also considered as an expense simple interest at the rate of six percent per annum, computed upon the average capital employed in the department, as determined under Article II hereof.VI.The duties of said Second Party as manager shall be such as are assigned to him by First Party.  Initially there shall be included among his duties and authority the selection of a stock of merchandise for this venture; schedule of purchases to be submitted and subject to advance approval by First Party and copies of proposed orders shall be submitted to First Party to be passed upon and approved.  Selections for current replacements for stock and purchases for new season requirements shall likewise be made by Second Party, subject to prior approval by and submission of orders to First Party in the same manner as is above provided for the initial stock. Second Party shall also keep a perpetual inventory of merchandise1950 U.S. Tax Ct. LEXIS 130">*138  on hand and take a monthly physical inventory. Second Party likewise shall have full authority to employ and discharge employees of the business, subject to approval of First Party.  Second Party will refer all disputed claims, not allowed by him, for adjustments or returns on complaints, to First Party.  The duties and authority hereby conferred are subject to change at the pleasure of First Party.VII.First Party may place hose, purses and other merchandise in said department, but Second Party shall participate in profit from only the sales of women's and girls' shoes.VIII.First Party reserves the right to alter its premises as it sees fit, and to remove its said retail shoe department to any location it may wish.IX.This agreement is purely personal to Second Party and he shall have no right to assign, transfer, pledge or otherwise affect any interest thereunder nor any of the monies credited to Bonus Account or to become due to him by reason of the terms hereof.X.Second Party recognizes that First Party maintains a policy of permitting employees and others to purchase at a discount of 20% on regular retail price.  Second Party agrees that such policy as it presently exists1950 U.S. Tax Ct. LEXIS 130">*139  or as it may be modified hereafter shall be applicable to the business conducted under this agreement 15 T.C. 1">*5  as well as to other business of First Party.  In like manner, First Party agrees that there shall be no discrimination in respect to the right to make purchases at a discount as against employees in the retail shoe department herein referred to and that such employees shall be accorded the same rights and privileges with reference to purchases in First Party's business generally as other employees of First Party's are permitted.XI.This agreement shall become effective January 1, 1939, and shall terminate one year thereafter, provided that it may be extended from year to year thereafter by mutual consent, given in writing within thirty days of the expiration date hereof.WITNESS our hands this 31st day of December, 1939.SELBER BROS. INC.By Louis Selber (Signed)President(Party of the First Part)I. Rosenberg (Signed)(Party of the Second Part)When petitioner was shown the agreement above set forth he objected to its form, stating that it differed from his oral agreement with Selber.  The instrument had been drafted by an attorney named Fred Simon, a brother-in-law1950 U.S. Tax Ct. LEXIS 130">*140  of the Selber brothers.  Petitioner saw Simon about this matter and the latter said he could not act as petitioner's attorney, but that as a friend his advice was that he should sign the agreement, which petitioner did.Petitioner operated the store as manager under the supervision of the Selber brothers.  Because of his experience in this business he was given authority for purchasing stock and wide managerial duties. He went on buying trips to the various shoe markets.The shoe department started with a storeroom equipped with fixtures, $ 10,000 in capital, but no merchandise. Fifteen hundred dollars of this amount was contributed by petitioner.A bonus account in Selber's books of account was set up and the $ 1,500 deposited by petitioner plus his share of the profits of the shoe department were credited to his account in such books.The shoe department had a regular set of books on a fiscal year basis ending January 31, separate from Selber, and a separate, regular checking account distinct from Selber.  The money contributed by both parties and the proceeds of the business were deposited in this separate account.  All of these books were kept by the accounting department of1950 U.S. Tax Ct. LEXIS 130">*141  Selber.The terms of the contract were carried out.  The original agreement was extended to January 31, 1941, January 31, 1942, January 31, 1943, July 31, 1943, and from August 1, 1943 to July 31, 1944.15 T.C. 1">*6  The total profits and petitioner's share of profits of the shoe business resulting under the contract, from its inception to and including July 31, 1943, were as follows:SELBERI. Rosenberg,PeriodProfit50 per centJan. 31, 1940$ 700.75$ 350.38Jan. 31, 19412,128.941,064.47Jan. 31, 19425,109.082,554.54Jan. 31, 19437,004.653,502.33Feb. 1, 1943 to July 31, 194315,240.927,620.46SELBERI. Rosenberg,Total toPeriodInterestI. RosenbergJan. 31, 1940$ 90.00$ 440.38Jan. 31, 1941119.161,183.63Jan. 31, 1942173.392,727.93Jan. 31, 1943268.863,771.19Feb. 1, 1943 to July 31, 1943101.097,721.55Total$ 15,844.58Rosenberg's withdrawals1940$ 45.001941650.0019422,150.0019433,950.00194315,000.00Total$ 21,795.00In addition to the above remuneration petitioner was paid a salary by Selber in accordance with the terms of the contract of employment of December1950 U.S. Tax Ct. LEXIS 130">*142  31, 1939, and its yearly extensions.In July 1943 Selber Bros. Inc. dissolved and a partnership agreement was entered into among the Selber brothers.  Thereafter the ready-to-wear business, including the shoe department, was operated as a partnership. Petitioner was not a member of that partnership.In August 1943 a conflict developed between petitioner and Selber.  As a result of this controversy petitioner and Selber agreed to terminate their employer-employee relationship.  This was accomplished by an agreement entered into on September 6, 1943.  That agreement is incorporated herein by this reference.  It provides in part as follows:THIS AGREEMENT WITNESSETH:That, Whereas, Selber Bros. Inc., a Louisiana corporation, entered into a contract with I. Rosenberg, a resident of Shreveport, Louisiana, on or about December 31, 1939, said contract being for the management of the retail shoe department of said Selber Bros. Inc.; and,Whereas, Selber Brothers, a partnership, and said I. Rosenberg, adopted the said contract as a contract between them, by agreement executed on or about July 31, 1943; and,Whereas, differences have arisen between the said parties and the said contract has1950 U.S. Tax Ct. LEXIS 130">*143  been terminated by mutual consent as of July 31, 1943, and it is desired by the parties to settle and compromise all claims, accounts and differences between the said Selber Bros. Inc., Selber Brothers, a partnership, and I. Rosenberg;Now, Therefore, the said parties do hereby mutually consent and agree as follows:Said Selber Bros. Inc. has this day paid to the said I. Rosenberg the sum of Fifteen Thousand ($ 15,000.00) Dollars cash, receipt of which is hereby acknowledged, 15 T.C. 1">*7  and the parties hereto terminate the said contract as of July 31, 1943.  Said Selber Brothers, a partnership, and the said I. Rosenberg agree that the said contract no longer exists between them.For and in consideration of the said sum, the said I. Rosenberg does hereby compromise, settle and adjust all claims and differences between the said Selber Bros. Inc. and Selber Brothers, a partnership, on the one hand, and the said I. Rosenberg on the other, and the said I. Rosenberg does hereby acknowledge full acquittance and discharge of any and all debts, liability or responsibility of the said Selber Bros. Inc. and the said Selber Brothers, a partnership, to him, arising under or pertaining to the said1950 U.S. Tax Ct. LEXIS 130">*144  contract, and accepts the said sum as full and final compromise, settlement and accounting between the said parties; hereby giving the said parties full release and discharge from any further responsibility thereunder.* * * *In their returns for the calendar year 1943 petitioners reported $ 13,500 capital gain on the sale by petitioner of his interest in the partnership paying tax on 50 per cent of the gain, or $ 6,750.Selber Bros. Inc. treated the $ 15,000 as an expense in their tax return for their fiscal year 1943.Petitioner keeps his books and records on the basis of a calendar year and on the cash receipts and disbursements basis.  Selber kept its books on the basis of a fiscal year ending January 31.  On April 15, 1942, petitioner withdrew $ 1,000 from the business.  On June 18, 1942, he withdrew $ 300, and during eight months of the year 1942 he withdrew $ 850, making a total of $ 2,150 withdrawn during 1942.In the statement attached to the notice of deficiency respondent stated as follows concerning the adjustments in question:(a) It is held after careful consideration of the evidence of record that the transaction terminating your contract of employment with Selber 1950 U.S. Tax Ct. LEXIS 130">*145  Bros., Shreveport, La., in 1943 was not the sale or exchange of a capital asset under the provisions of Section 117 of the Internal Revenue Code.  Therefore, the amount of $ 13,500.00 representing the profit from that transaction is considered as ordinary income to the community and not long-term capital gain, taxable one-half to your wife, Lorene Ann Rosenberg, and one-half to you.(b) It has been determined that the salary income of the community for the year 1943 from Selber Bros. amounted to $ 7,850.00 rather than $ 5,500.00 as reported on your return.Petitioner did not really and truly intend to join together with Selber Bros. Inc. in the conduct of a partnership business at any time from December 31, 1938, through the taxable years in question.  During such years petitioner was an employee of Selber, serving as manager of its shoe department.OPINION.The respondent urges that there was never any partnership for Federal tax purposes between petitioner and Selber and that consequently $ 13,500 of the $ 15,000 which petitioner received in 15 T.C. 1">*8  accordance with the compromise agreement between petitioner and Selber of September 6, 1943, is taxable as ordinary income.  The $ 1,500, 1950 U.S. Tax Ct. LEXIS 130">*146  which petitioner deposited with Selber at the beginning of his employment, was held by the respondent to be tax-free as a return of capital.  His position is based upon the contract of employment, which is set forth in our findings, and the testimony of Louis Selber, president of Selber Bros. Inc., which was to the effect that petitioner was always an employee of Selber and never a partner.Petitioner, however, claims that by the recognized tests for determining whether a partnership exists for Federal tax purposes, petitioner and Selber did enter into a partnership when they signed the contract of employment on December 31, 1939.  He states on brief as follows:Petitioners respectfully submit that, by every test stated, Rosenberg and Selbers entered into a valid and binding partnership. Thus there was 1. A joining together of money, goods, labor and skill for the purpose of carrying on a business.  An investment of capital by the partner.2. Substantial contribution to the control and management.  * * * Mutual management and control by the partners * * *.3. Personal liability by each, Rosenberg and Selbers, for losses suffered by the business.  Mutual sharing of all profits1950 U.S. Tax Ct. LEXIS 130">*147  * * *.  A community of interest in the profits and losses.  * * *4. Dissolution upon any change of partners * * *Petitioner cites in support of his statement, Commissioner v. Tower, 320 U.S. 280">320 U.S. 280, and Montgomery, Federal Taxes -- Corporations and Partnerships 1948-1949.The test for determining the validity of partnerships was stated in Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733. The question is:* * * 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.  * * *Using this test we have found as a fact that petitioner did not really and truly intend to form a partnership with Selber.  In the first place, the contract under which the shoe business was conducted is1950 U.S. Tax Ct. LEXIS 130">*148  not designated a partnership agreement; it is termed a contract of employment, providing for petitioner's employment as manager of the retail shoe department of Selber.  When petitioner signed that agreement he knew it was a contract of employment rather than a partnership agreement. He objected to its terms, discussed it with Selber's attorney, but nevertheless signed it.By its terms petitioner was not to share personal responsibility for the debts of the business, his participation in any losses being for the 15 T.C. 1">*9  purpose only of adjusting the bonus account.  Moreover, petitioner's responsibilities and duties under the contract were definitely limited to only those which were assigned to him by Selber.  Under the terms of the agreement all the duties and authority of petitioner were subject to change at the pleasure of Selber.That petitioner had no proprietary interest in the business is demonstrated by paragraph III of the agreement which provides that:* * * All moneys credited to Bonus Account shall be available to First Party [Selber] for use in its business without restriction, and according to its own judgment.  [Sic].In addition, paragraph IX of the agreement1950 U.S. Tax Ct. LEXIS 130">*149  states that petitioner should* * * have no right to assign, transfer, pledge or otherwise affect any * * * of the monies credited to Bonus Account or to become due to him by reason of the terms hereof.It is thus apparent that the 50 per cent share in the net profits accrued to petitioner as compensation for services and not through a vested and continued interest in a joint venture or partnership.The testimony of Louis Selber was that the provisions of the agreement were carried out, that petitioner was always considered an employee of Selber and never a partner, and that the shoe department was merely a department in the general clothing business of Selber Bros. Inc.  He testified as follows with respect to the intention of Selber in connection with the agreement involved:Q. What was your intention in making this contract?A. An employment agreement.Q. What was the purpose of this employment?A. To what extent do you mean, just what --Q. Did you seek to employ his services as manager?A. As manager of the department; yes.Q. And the terms of that employment are set forth in this contract, is that correct?A. That is right.Q. Were the provisions of this contract carried out? 1950 U.S. Tax Ct. LEXIS 130">*150  A. They were.Louis Selber also stated that the books of the shoe business were kept by the accountant employed by Selber which is convincing evidence that the shoe business was merely a department of Selber's ready-to-wear business.We think it significant, too, that when Selber Bros. Inc. dissolved in July 1943 and a partnership method of doing business was adopted by the Selber brothers, petitioner was not, so far as the record shows, a participant in any of the decisions leading to such change.  Certainly if his status was that of a partner in 1943 he should have been 15 T.C. 1">*10  consulted about that change and also included in the agreement as a partner of Selber Brothers.The above factors, together with the consideration that according to the prevailing law, a corporation has no implied power to become a partner with an individual or another corporation (see 13 American Jurisprudence, section 823), L. J. Mestier & Co. v. A. Chevalier Paving Co. Ltd., 108 La. 562">108 La. 562, 32 So. 520">32 So. 520; 1Tatum et al. v. Acadian Production Corp. of Louisiana, 35 Fed. Supp. 40, 2 leads us to the conclusion that no partnership1950 U.S. Tax Ct. LEXIS 130">*151  between petitioner and Selber existed during the period in question.We therefore hold that $ 13,500 of the $ 15,000 which petitioner received on the termination of his employment with Selber is taxable as ordinary income and we hold further, as respondent has conceded, in view of our holding on the partnership issue, that he erred in including in petitioner's net income for 1943 the amount of $ 2,150, which is properly includible1950 U.S. Tax Ct. LEXIS 130">*152  in his income for 1942.In view of our conclusion it is not necessary to discuss issue (2), for the basis of petitioner's contention that capital gain treatment under section 117 should be accorded to the $ 15,000 which he received from the compromise settlement is based upon the premise that he was a partner of Selber in 1943.Decisions will be entered under Rule 50.  Footnotes1. The Court stated in part as follows:* * * True, this corporation could not be a member of a partnership. It had no such power, yet it could bind itself to the extent of dividing profits as a consideration for advances made, as we understand was done in this case.↩2. The Court stated in part as follows:* * * a corporation has no implied power to form a partnership with an individual; nevertheless, if the formation of such partnership is actually attempted and the partnership contract is fully executed, the individual↩ can not set up the legal invalidity of such contract.  * * *