Pomeroy v. Commissioner , 24 B.T.A. 488 ( 1931 )

LILLIE C. POMEROY, GEORGE S. POMEROY, JR., AND ROBERT G. BUSHONG, EXECUTORS OF THE ESTATE OF GEORGE S. POMEROY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Pomeroy v. Commissioner

Docket No. 29664.

United States Board of Tax Appeals

24 B.T.A. 488; 1931 BTA LEXIS 1632;

October 27, 1931, Promulgated

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Earnings of partnership business accumulated from date of death of one partner to date of settlement of his interest in partnership, divided and included in income of surviving partner on basis of agreement subsequently made between surviving partner and representatives of deceased partner's estate.

R. M. Heth, Esq., for the petitioners.

John D. Foley, Esq., for the respondent.

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GOODRICH

This proceeding relates to the income-tax liability of the petitioners, as executors of the estate of George S. Pomeroy, deceased, upon income received by said Pomeroy during his lifetime. Deficiencies are asserted as follows:

1922	$106,234.92
1923	9,908.39
1924	25.61

Petitioners admit as correct the deficiency asserted for the year 1924.

The sole issue is as to the correct allocation between Pomeroy and the estate of Josiah Dives of the net profits derived from the operation of a business conducted under the name of Dives, Pomeroy & Stewart for the periods September 21 to December 31, 1922, and January 1 to June 30, 1923. The case was submitted upon a long stipulation of facts, containing various exhibits, from which we make the following findings of fact.

FINDINGS OF FACT.

For many years prior to September 21, 1922, there existed a partnership composed of Josiah Dives and George S. Pomeroy, which, under the name of Dives, Pomeroy & Stewart, conducted department stores in Reading, Harrisburg, Pottsville and Pottstown, Pa. The partners shared equally in the profits of the partnership. For the purposes of this case, the accounting period for the partnership and for each of said partners individually was on the cash and calendar year basis.

On September 21, 1922, said Josiah Dives died, testate. By his will, after various specific bequests, he left one-third of his estate to his wife for life and two-thirds in equal shares to his sons, Edward J. and Arthur M. Dives, together with the reversionary interest in the one-third bequeathed to their mother. Clause 8 of said will read as follows:

Eighth While my interest in the business of Dives Pomeroy & Stewart will upon my death be subject to settlement and adjustment under the terms of the partnership agreement existing between my partner and myself, yet in order to enable my executors to take all necessary action and to secure a satisfactory administration of my estate, I authorize and empower my executors to sell transfer & convey any personal, mixed or real property and estate which they may find it necessary or prudent to convey for payments of debts or legacies or the proper settlement & distribution of my estate.

Thereafter, said Edward and Arthur Dives duly qualified as executors of the will of their father.

On September 13, 1925, said George S. Pomeroy died, whereupon Lillie C. Pomeroy, George S. Pomeroy, Jr., and Robert G. Bushong, the petitioners herein, duly qualified as the executors of his estate.

The agreement of partnership referred to in clause 8 of Dives' will was a contract of March 30, 1903, between himself and Pomeroy, which was intended to provide for the continuation and operation of the business of the partnership in the event either of the partners should die, and for the settlement of the interest of the deceased partner. As recited, its primary object was to give the survivor "a controlling interest in the business," but at the same time to "preserve the equities of the decedent so far as the same can be provided for without in any way hampering the survivor. " The partners agreed:

1st. That should the decedent's representatives be willing to sell, the survivor should pay for the business, exclusive of the real-estate, an amount not less than that of which 12 1/2 per cent should be equal to the annual net profit of the business for the past five years, as shown by the semi-annual inventories for that period.

2nd. That the amount each had in the business should be ascertained by crediting to the account of each a prorata share of the profits earned from the date of the last preceding inventory to the death of either partner.

3rd. That if no agreement to purchase by the survivor could be reached between him and representatives of the decedent, and if no agreement for the joint ownership and continuation of the business could be reached by the parties, then the survivor should have the right to incorporate the business and issue stock to its value, ascertained by the method above provided.

4th. That if the business were incorporated, the survivor might buy preferred or common stock or both to the value of $30,000, the remainder of the stock to be divided equally for sale to the survivor and to decedent's representatives; that the stock of the corporation should consist of an issue of 5 per cent cumulative preferred and an equal amount of common, both classes to have equal voting power; that decedent's representatives might take all their interest in preferred stock if they so desired but should not be required to take more than half their interest in such stock if they desired to hold common stock also.

5th. That whoever succeeded to the business should be entitled to occupy all real estate for a period of 10 years at an annual rental of 8 per cent of the cost value thereof as shown by the books, either party having the right in the meantime to buy the other's interest in the real estate, or to sell his own interest therein to any one else, subject to said occupancy.

6th. That the agreement "shall be binding upon both or either of us, our heirs, executors and administrators, any will, agreement or contract either of us may have or make to the contrary notwithstanding."

Under date of April 7, 1903, a supplemental agreement was entered into by Dives and Pomeroy, which set out various computations in explanation and illustration of the terms of the original contract. Except as showing what the parties had in mind as to the method of computing the value of the business and their respective shares thereof, this supplemental agreement is here immaterial. A second supplemental agreement was entered into on September 13, 1911, effecting some minor changes in the original agreement of March 30, 1903 (which was otherwise fully reaffirmed), of which the most important provided for a change in the classes and privileges of the stock of the prospective corporation.

As of December 30, 1911, adjusting entries were made on the partnership books to further explain the desires of the partners as to the methods of making computations under their original agreement, particularly as to the values of the several parcels of real estate owned and used by the partnership.

Following Dives' death, his sons, as executors of his will, entered into a contract with Pomeroy under date of April 23, 1923, the terms of which were consummated and became operative with full force and effect on July 2, 1923. This agreement recited that Pomeroy was the surviving member of the partnership which was terminated by Dives' death; that Edward and Arthur Dives were empowered by clause 8 of Dives' will, and by the fact that individually they were the residuary legatees thereunder, to enter into the same; and that all prior contracts, expressly mentioning that of March 30, 1903, and the supplements thereto, should be superseded and become null and void upon the execution hereof. It set out further:

1. That Pomeroy should cause to be organized a corporation, duly empowered to engage in the business conducted by the partnership with a capitalization of $6,000,000, divided into shares having a par value of $100 each, of which $3,750,000 or 37,500 shares should be 6 per cent cumulative first preferred stock, to be redeemed over a period of 25 years, or earlier at the option of the company, from a sinking fund provided for that purpose. Full provision was made against all possible contingencies to secure the payment of the dividends on and the redemption of this stock, and upon default thereof said stock would become entitled to vote and the owners thereof could take over the company. The balance of the authorized capital was to be issued as junior preferred or common stock.

2. That the executors grant, bargain and sell, etc., to Pomeroy "all the right, title and interest of Josiah Dives in the partnership between himself and Pomeroy" including all assets, real and personal, of every description and wheresoever located, excepting

a. Land & buildings located at Millmont and used in connection with the operation of the Chantrell Hardware & Tool Co.

b. All indebtedness owed by Chantrell Hdw. & Tool Co. to the partnership.

c. All stock held by the partnership of the Chantrell Hdw. & Tool Co.

d. (Clause 8.) An amount of money which shall be paid to the executors, said amount to be ascertained by taking six per cent. (6%) of $3,750,000 from the date of the death of Josiah Dives on September 21, 1922, to the date of settlement, less the sum of $40,000.00 which the executors agree to pay the survivor as compensation as liquidating trustee and as salary for conducting the partnership business from September 21, 1922, to the date of settlement, which said amount shall be paid to the executors in full settlement of any claim they may have for profits accrued on the partnership business from the date of death of said Josiah Dives.

3. That as payment for the transfer of Dives' interest in the partnership as above set out, Pomeroy should cause the corporation to issue to the executors the 37,500 shares to 1st preferred stock above described; should join in conveying to the Chantrell Hardware & Tool Company the land and buildings at Millmont used in connection with its buildings; should join in forgiving to said company the indebtedness against it held by the partnership; and should transfer to the executors the capital stock of said company held by the partnership.

4. That Pomeroy should bear all expenses in connection with the organization of the corporation and transfer to it of the partnership assets; that he should transfer to the corporation all his own interest in the partnership and accept as payment therefor junior preferred or common stock of the corporation.

5. That the corporation assume all liabilities of the partnership, including its Federal tax liabilities.

This, in effect, was the settlement between Pomeroy and the Dives estate, whereby the claims of both parties to the partnership assets were terminated. It was not in accord with the contract of March 30, 1903, existing at the time of Dives' death.

Following Dives' death, Pomeroy filed timely income-tax returns in the name of the partnership, one showing the income of the partnership from January 1 to September 20, 1922, another covering the period from September 20 to December 31, 1922, and a third covering the period from January 1 to June 30, 1923. These returns divided the income of the business equally between Pomeroy and the Dives estate. The correct net income of the business carried on in the partnership name for these periods is as follows:

Jan. 1 to Sept. 20, 1922	(Loss)	$5,287.69
Sept. 20 to Dec. 31, 1922		361,447.54
Jan. 1 to June 30, 1923		191,223.93

No part of this income of the business was paid as income to the Dives estate, but the executors were permitted to make certain withdrawals and were credited with certain amounts as reflected in the book account of the estate as follows:

ESTATE OF J. DIVES, DECEASED, IN
ACCOUNT WITH DIVES, POMEROY & STEWART.
By interest Sept. 21, 1922, to July 2,		$176,250.00
1923, per agreement
To withdrawals:
1922, Sept. 21st to 30th	$651.25
October	7,426.43
November	5,853.55
December	27,970.41
1923 January	13,744.27
February	21,731.36
March	2,411.68
April 26th	10,317.00
	90,105.95
Account of Edward J. Dives	12,893.88
Account of Arthur M. Dives	85.70
One half share of compensation to George	40,000.00
S. Pomeroy		143,085.53
		33,164.47

These advances and credits were taken into account in the final settlement between the parties under this contract.

Respondent has allocated net income of the business to Pomeroy as follows:

Jan. 1 to Sept. 20, 1922	(Loss)	$3,875.06
Sept. 20 to Dec. 31, 1922		309,490.66
Jan. 1 to June 30, 1923		105,302.37

The net worth of the Chantrell Hardware & Tool Company on December 31, 1922, was $296,038.49. The amount of indebtedness due by this company to Dives, Pomeroy & Stewart is not disclosed.

The entire stipulation of facts agreed to by the parties, together with the various exhibits thereto attached, is made a part of our findings by reference.

OPINION.

GOODRICH: The net income of the business conducted under the name of Dives, Pomeroy & Stewart for the period from September 21, 1922, the date of Dives' death, to June 30, 1923, the closing business day before the agreement between Pomeroy and the executors of Dives' estate became effective, was $552,671.47. We are asked to make an allocation of these earnings between the estate of the deceased partner and the survivor, not for the purpose of distributing the money, but to fix the basis upon which the tax liability resulting from the receipt of or the right to receive the money may be determined.

Petitioners contend that these earnings should be divided equally between these parties, for the reason that a partnership, with division of the earnings thereof upon an equal basis, existed between them during this period. In support of this contention it is urged that the agreement of March 30, 1903, discloses an intention that the business should be continued as an equal partnership until a settlement of the interest of the deceased partner could be effected by one of the methods set forth therein; that respondent is bound by statements made in the reports of his revenue agents treating the business as a partnership during this period and stating that it terminated upon the operation of the agreement of April 23, 1923; and that Hellman v. United States,70 Ct.Cls. 498, is controlling of the case at bar and requires that the tax returns filed by Pomeroy reporting the business during this period upon the basis of an equal partnership must be accepted as correct.

With this contention we can not agree. The partnership between Dives and Pomeroy was terminated by Dives' death. The contract of March 30, 1903, provided various methods by which a settlement of his interest in the partnership might be effected, but as to the division of earnings between the date of death and the date of settlement it was silent. While the agreement contained no express provision permitting the survivor to continue the business after the death of his partner, the implication was that the business should be continued until the deceased's interest could be settled, since it was stated that one of the purposes of the contract was to obviate "interruption to business." But the fact that the operation was to be continued does not mean that the division of earnings should continue on the same basis as before. The agreement contains no provision entitling the estate of the decedent to a portion of the profits during the period from his death to the settlement of his interest. At the time the agreement was reached, the partners easily could have provided for the distribution of profits during this period, but they did not do so. We can not now write into the contract such a provision for them, nor can we, by inference, set up a partnership between the survivor and the estate of the deceased partner when the contract failed expressly so to do. As we read that agreement, it is purely a contract for the acquisition by the survivor of the interest of his deceased partner, giving a choice of terms, conditions and methods of acquisition, and we find therein nothing to show that the parties intended that earnings subsequent to the death of one partner should be divided upon an equal basis, as petitioners contend. Moreover, that contract was expressly nullified by the agreement of April 23, 1923.

We attach no importance to petitioner's argument that the statements made in the revenue agent's report relative to the termination of the partnership are controlling of this case. The rule that the conclusions of law of the revenue agent are in nowise binding upon respondent or upon this Board is too well established to merit citation or further discussion.

Petitioners' position is not sustained by the opinion of Hallman v. United States, supra. In that case the Commissioner of Internal Revenue sought to change the amounts chargeable as distributable income to the various members of a partnership from that disclosed by the partnership books and the tax returns on the ground that, in the case of one partner, the amount so disclosed was in excess of the percentage to which that partner was entitled under the partnership agreement. The discrepancy not being explained by the evidence, the court held that his distributable share had been shown by the best evidence available and refused to deviate from the amounts reflected by the books and tax returns of the partnership. We have no such question in the case at bar.

There is no question but that the Dives estate had the right to some share of these earnings. It was entitled to an accounting, and a distribution of the partnership assets and earnings, and could have obtained the same in a court of equity had the parties been unable to agree upon a reasonable basis of division. But here the parties did agree upon such a division. We have no doubt that the court would be guided by an agreement between the parties and that, if the parties themselves were satisfied therewith, equity would be satisfied. We ask no better guide for ourselves in the solution of the problem before us. The contract of April 23, 1923, clearly provides, inter alia, (1) that Pomeroy is to be paid $40,000 as compensation for his services as liquidating trustee and for conducting the business from the date of Dives' death to the date of settlement, and (2) that $176,250 is to be paid to the Dives estate "in full settlement of any claim * * * for profits accrued on the partnership business from the date of the death of said Josiah Dives." These items we regard as separate and distinct, believing that the language used indicates merely the method of payment and not that the former serves to reduce the amount of the latter. We see no reason for disturbing the division of profits which the parties themselves have made and carried out. Except for this $176,250, the profits accruing to the business during the period intervening between Dives' death and the settlement under the contract remained in the business, which was taken over by the corporation, controlled by Pomeroy. The transfer to the Dives estate of the stock of the Chantrell Hardware & Tool Company, the real estate used by that company, and the indebtedness of that company to the partnership, was a partial payment of the purchase price of the Dives interest. We are not here concerned with the price paid for Dives' interest in the business.

In accordance with our conclusions, the profits earned by the business during the periods September 20 to December 31, 1922, and January 1 to June 30, 1923, should be taxed to Pomeroy, except $176,250 thereof, which should be allocated to and deducted from the earnings during each of said periods in accordance with the ratio of earnings of said periods.

Respondent, in his brief, urges that Pomeroy's taxable income be increased in the amounts of $51,316.88 for the period September 20 to December 31, 1922, and $84,933.12 for the period January 1 to June 30, 1923, on the ground that these amounts are interest, determined under clause 8 of the contract of April 23, 1923, and represented, not Dives' share of the profits of the business, but a part of the purchase price of the Dives interest therein, and are therefore not deductible from Pomeroy's income, under the authority of Willard C. Hill et al.,14 B.T.A. 572">14 B.T.A. 572. While we fully recognize the principle of that case, we think it is not here applicable. In the case at bar the computation of interest on the sum of $3,750,000 served merely as a method of determining the portion of accumulated earnings to be paid the Dives estate. The amount of $176,250 was not interest, nor a part of the purchase price of Dives' share of the partnership assets, but it was that portion of the accumulated earnings to which the parties agreed the estate was entitled.

Petitioners point out that by the deficiency notice Pomeroy is twice taxed upon the item of $40,000 paid him as compensation for his services as liquidating trustee and as salary for conducting the business during the period intervening between Dives' death and the settlement of his interest, since it is included in the profits of the business allocated to him and again included in his "salaries, wages, etc.," which are a part of his gross income. This error should be corrected.

Reviewed by the Board.

Judgment will be entered pursuant to Rule 50.

MURDOCK

MURDOCK, dissenting: The prevailing opinion holds that the Pomeroy estate is liable for tax on some income, but it does not disclose whether it holds that that income represents Pomeroy's distributive share of the income of a partnership, or his share of the income of a joint venture. The opinion permits the amount of taxable income for each year to be fixed retroactively by an agreement of the parties. This agreement was not intended to settle the rights of the parties to income as of the end of each year in question, but was a complete adjustment of their rights in the business. In my judgment, Pomeroy's tax liability for each year should be determined on the basis of and is fixed by his rights at the end of that year, and does not depend upon any subsequent agreement of the parties. The parties may give up certain rights under a subsequent agreement, but they can not retroactively change their tax liability.

MARQUETTE, SMITH, and STERNHAGEN agree with this dissent.

MATTHEWS, dissenting: The partners shared equally in the partnership profits, notwithstanding the fact that Dives' interest in the business was greater than Pomeroy's. In 1903, Dives' interest was $522,046.94 and Pomeroy's interest $444,552.99. At the death of Dives, his interest (net worth) in the business, as reflected on the books, was $2,697,499.47, while Pomeroy's interest (net worth) was $2,176,511.07, a difference of more than $500,000. These figures are taken from the exhibits which were attached to the stipulation and made a part of the findings of fact by reference.

Dives' interest passed to his estate on his death, and from that date until the settlement on June 30, 1923, the estate was entitled at least to the same proportion of profits of the business as Dives would have been entitled to had he lived, namely, one-half of the income arising from the business. The fact that the executors did not withdraw one-half of the profits or that one-half was not actually distributed to such executors, does not alter the situation. The earnings of the estate's share were constructively received by the executors. Pomeroy had also constructively received his share, although we do not know whether he drew it out of the business or not. That Pomeroy and the Dives estate were each entitled to one-half the profits in the business is evidenced by the fact that Pomeroy so treated the income in partnership returns filed for the periods involved between the death of Dives and the settlement of the estate. I do not think it necessary to determine the legal term to apply to the relation between Pomeroy and the Dives estate during the period subsequent to Dives' death. Neither is it necessary to determine whether Pomeroy was required to file a return of the income of the business on a partnership form or on a fiduciary form in order to determine the issue in this case, which is, how much of the earnings of the business subsequent to Dives' death and prior to the transfer of the business to the corporation are taxable to Pomeroy. The earnings of the business during this period belonged to the owners, Pomeroy and the Dives estate, and I think that a division of the earnings in the same proportion that they were distributed prior to the death of Dives is all that the executors of Dives could have demanded, notwithstanding the fact that Dives' interest was greater than Pomeroy's. Pomeroy could certainly have demanded no more than one-half the earnings.

At the time of the settlement effected on July 2, 1923, the Dives estate had the right to a certain portion of the assets and also a claim for the profits earned on that interest subsequent to Dives' death. The claim of the estate for the profits accrued on the estate's interest was settled for $176,250, an amount of money equal to 6 per cent of $3,750,000 from the date of death of Dives to the date of settlement, and this amount of money was excluded from the assets of the partnership which both the Dives estate and Pomeroy joined in conveying to the corporation. I see nothing in the fact that the estate's claim for its share of the profits earned between the date of death of Dives and the date of settlement was, under the circumstances, settled for a less amount than one-half the actual earnings of the period, to justify the conclusion that at the time the income accrued the Dives estate had no claim to more than the amount subsequently agreed upon in settlement. The very language used in the agreement of settlement justifies the inference that the Dives estate had a claim for more than the amount agreed upon in settlement of the claim - "which said amount shall be paid to the executors in full settlement of any claim they may have for profits accrued on the partnership business from the date of death of Josiah Dives."

In my opinion, therefore, Pomeroy should not be taxed on more than one-half the earnings of the business during the period involved.