Court Opinion

ID: 4621381
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:44:33.291599+00
Date Added: 2024-06-11T07:55:59.616643
License: Public Domain

DORCAS G. REHTZ, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Rehtz v. CommissionerDocket No. 54187.United States Board of Tax Appeals26 B.T.A. 807; 1932 BTA LEXIS 1246; August 15, 1932, Promulgated *1246  An amount paid by the petitioner to a retiring partner in connection with the acquisition by the petitioner and her husband of such retiring partner's interest in a partnership, of which they were all members, held to be a capital expenditure and as such not an allowable deduction in determining taxable net income.  John T. Kennedy, Esq., for the petitioner.  I. Graff, Esq., for the respondent.  TRAMMELL *807  This proceeding is for the redetermination of a deficiency in income tax of $1,727.90 for 1928.  Errors assigned by the petitioner are as follows: I.  The Commissioner erred in finding that the deduction of $11,875.00 taken by taxpayer was not a loss paid out of gross profits of the business in which this taxpayer was engaged.  II.  The Commissioner erred in holding that this taxpayer was not under legal obligation in making the payment of the $11,875.00 in question.  FINDINGS OF FACT.  Prior to June 18, 1926, Henry Rehtz, his wife, the petitioner, Christine Plusch, and Dora Harvier were members of a partnership engaged in the business of selling gowns and wraps for women in New York City.  The business was conducted under the*1247  firm name of D. Maxon and Company, and each of the partners had a one-fourth interest in the capital and profits of the firm.  On June 18, 1926, by written agreement the petitioner and her husband, therein designated as parties of the first part, acquired the interests in the partnership of Christine Plusch, designated as party of the second part, and Dora Harvier, designated as party of the third part.  With respect to the consideration paid for such interests, the agreement provided as follows: The party of the second part [Christine Plusch] does hereby acknowledge receipt of a deed duly made and executed by Henry Rehtz and Dorcas G. Rehtz, his wife, transferring and conveying unto her lots Nos. 3 to 11 inclusive, and Nos. 13 to 48 inclusive in Block 12, according to a plat of Lauderdale, as recorded in Transcript Plat Book No. 1, page 20, of the Public Records of Broward County, Florida, in full payment and satisfaction of her interest in the said copartnership, and the party of the second part grants to the parties of the first part, or either of them, the option to buy the said real property for Thirty thousand dollars ($30,000.) at any time within two years of the date*1248  of this agreement.  *808  The parties of the first part do hereby agree to pay the party of the third part, [Dora Harvier] in full payment and satisfaction of her interest in the said copartnership, the sum of Thirty Thousand ($30,000) Dollars, as follows: One thousand ($1,000) Dollars on the signing of this agreement, receipt whereof is hereby acknowledged, and the balance thereof in instalments of Five Thousand ($5,000) Dollars or more, (at the option of the parties of the first part) per annum, until the full sum of Thirty Thousand ($30,000) Dollars has been paid.  The unpaid balance shall bear interest at the rate of six (6%) per cent. per annum, payable annually.  At the time the foregoing agreement was entered into the petitioner was of the opinion that the lots conveyed to Christine Plusch by that agreement were worth the full amount of $30,000.  After the acquisition of the interests of Christine Plusch and Dora Harvier as set forth above the petitioner and her husband continued to conduct the business as partners until November 17, 1927, when he died.  The petitioner acquired by inheritance his interest in the partnership and since then has conducted the business*1249  as a sole proprietorship.  Upon returning from Florida in the early part of 1928, Christine Plusch informed the petitioner that the lots which had been conveyed to her in 1926 in connection with the sale of her partnership interest had greatly depreciated in value as a result of a storm which had occurred subsequent to the time they were conveyed to her.  She contended that the lots previously conveyed to her were intended only as security for the payment to her of the amount of $30,000 by the petitioner and Henry Rehtz for her interest in the partnership and demanded that the petitioner pay her the difference between the amount of $30,000 and the then value of the lots.  The petitioner contended that the conveyance of the lots was intended to be as recited in the agreement of June 18, 1926, namely, in full payment and satisfaction of Christine Plusch's interest in the partnership.  While the petitioner took the position that she was not legally obligated to pay any additional amount, she was of the opinion that she was morally obligated to do so, since Christine Plusch was to get for her interest in the partnership the same amount as the other retiring partner, $30,000.  She consulted*1250  counsel about the matter and was advised to pay the amount in controversy because of the arrangement between her husband and Christine Plusch.  The petitioner was also of the opinion that if her husband had lived he would have made payment of the additional amount demanded and she felt that she should do so.  She felt that litigation with respect to the matter might cause embarrassment to her and her business, and this was one of the causes moving her to make payment.  The controversy was settled by an agreement entered into on May 18, 1928, whereby the petitioner and the National City Bank of New York, as executors of the will of Henry Rehtz, conveyed to Christine *809  Plusch, at an agreed value of $1,250, three additional lots situated in the same block as those previously conveyed to her, which it was agreed had a value of $16,875, and the payment to her of $11,875.  The amount of $11,875 was paid by the petitioner to Christine Plusch by a check dated May 16, 1928.  In her income-tax return for 1928 the petitioner deducted as a loss the amount of $11,875 paid by her to Christine Plusch in settlement of the controversy.  In determining the deficiency here involved the*1251  respondent disallowed the deduction.  OPINION.  TRAMMELL: The petition in this proceeding presents two issues: (1) Whether the petitioner was under legal obligation to make payment of the $11,875 paid by her to Christine Plusch in May, 1928, under the circumstances set out in our findings of fact, and (2) whether the petitioner is entitled to deduct from her gross income for the taxable year the amount thus paid.  The real question is whether the amount paid out is deductible in determining taxable income.  Whether there was a legal or moral obligation to make the payment may fairly be considered in determining the question, but we do not regard that as being an issue in and of itself.  It may well be that if there was no legal or moral obligation to make the payment, it might have been a gift.  In any event, even if this question were considered an issue in the pleadings, it apparently has been abandoned and the proceedings are disposed of by our decision on the other issue in the petition.  The petitioner contends that the amount here in controversy was not an additioval cost of Christine Plusch's interest in the partnership, but was an ordinary or necessary business expense*1252  or a loss arising from a transaction entered into for profit and therefore an allowable deduction.  The respondent contends that the amount represented an additional sum paid by the petitioner to Christine Plusch for the conveyance of the latter's interest in the partnership and that it is, therefore, a capital expenditure and as such is not an allowable deduction.  In support of her contention the petitioner urges that the amount was paid solely for the purpose of settling a controversy, avoiding litigation and fulfilling what she deemed to be a moral obligation arising out of a transaction entered into respecting the business.  In , affirming , the court said: It is contended on behalf of the petitioners that because any liability on the part of the coal companies to the railroad was denied, and the payments only made by way of compromise to avoid litigation, they constituted expense and not capital expenditures.  We think not.  The fact that a payment is made *810  voluntarily or involuntarily, in the course of legal proceedings or as a result of a compromise*1253  settlement does not change the nature of the transaction.  The real test is the character of the transaction that occasions the payment.  What was the character of the transaction that occasioned the payment by the petitioner to Christine Plusch?  We think it is clear that it was the acquisition by the petitioner and her husband of property, the one-fourth interest of Christine Plusch in the petitioner that occasioned the payment.  The demand for payment was based on the transaction by which they became the owners of such interest.  Neither the demand nor the payment was based upon any transaction arising out of or connected with the management or operation of the business either by the petitioner or her deceased husband either before or after June 18, 1926, but both demand and payment were founded upon the acquisition of a retiring partner's interest in the firm.  The petitioner's testimony shows that Christine Plusch was to get for her interest in the firm the same amount as the other retiring partner, $30,000.  While in negotiating a settlement of the controversy the petitioner disclaimed any legal liability in the matter, she recognized her moral obligation to make the payment*1254  demanded.  Irrespective of whether the petitioner considered her liability to be a legal liability or a purely moral obligation, the fact remains that the payment was made primarily in connection with the petitioner's acquisition of an interest in the partnership, and the fact that the controversy was thereby settled and possible litigation avoided was only incidental.  Under the facts in the case we think the amount of $11,875 here in controversy constituted an additional payment for Christine Plusch's interest in the partnership and therefore a capital expenditure, and, as such, is not an allowable deduction in computing the petitioner's taxable income.  The petitioner having continued to hold, at the end of the taxable year, the interest which she and her husband had acquired from Christine Plusch, we do not perceive and basis for allowing the amount in controversy as a loss.  The action of the respondent is sustained.  Judgment will be entered for the respondent.