Nichols v. Commissioner , 42 B.T.A. 618 ( 1940 )

J. C. NICHOLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Nichols v. Commissioner

Docket No. 89169.

United States Board of Tax Appeals

42 B.T.A. 618; 1940 BTA LEXIS 976;

August 27, 1940, Promulgated

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1. Petitioner withdrew certain amounts from a partnership of which he was a member, such withdrawals being carried on the books of the partnership as overdrafts in his personal drawing account. At December 31, 1932, his overdrafts amounted to $31,554.96, for which petitioner on that date gave his promissory note. During 1934, the taxable year, a portion of the indebtedness evidenced by the note was canceled and written off the books. Held, under the facts shown, that the petitioner realized taxable income in the amount so canceled and written off.

2. During 1934 petitioner received $2,400, $200 each month, from the partnership, allegedly for traveling and automobile expenses. On the evidence, we conclude that the amount expended for business purposes did not exceed $1,200 and that the remaining $1,200 constituted taxable income to petitioner.

Arthur R. Foss, Esq., for the petitioner.

David Altman, Esq., and Albert B. Peterson, Esq., for the respondent.

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TURNER

The respondent determined a deficiency in income tax for the year 1934 in the amount of $1,415.69. Two issues are presented: First, whether petitioner's indebtedness to a partnership of which he was a member was canceled during the taxable year and thereby resulted in the receipt of taxable income by him, and, second, whether respondent erred in including in petitioner's income an item of $2,400 representing amounts received by him from the partnership, but which he claims was spent for traveling and automobile expenses in carrying on the partnership business.

FINDINGS OF FACT.

The petitioner is an individual, who during the taxable year resided in River Forest, Illinois, a suburb of Chicago. In about 1920 he had entered the business of selling rotary cut (veneer) lumber on a brokerage basis. His business prospered and he was soon disposing of the entire output of three southern lumber mills. In about 1923 he incorporated his business under the laws of Illinois and thereafter held substantially all of the stock. The corporation in turn owned controlling interests in the three southern lumber mills, the Foxworth Veneer Co., the Acme Veneer Co., and the Beaumont Veneer Co., each of which was a separate corporation.

In 1925 petitioner caused the corporation to be dissolved and its business to be taken over and continued by J. C. Nichols, a partnership which was created by an agreement dated April 12, 1925. The details of the transaction were handled by a certified public accountant, who signed the partnership agreement as a notary public and whose firm prepared the petitioner's return for 1934. The partnership agreement provided as follows:

PURPOSE: The purpose of the co-partnership will be to engage in manufacturing, selling, marketing, or distributing Roofers' Supplies and allied commodities.

PERIOD: The period of this co-partnership agreement shall begin on the Twelfth Day of April, A.D., 1925, and terminate on the Thirty-first Day of December, A.D. 1935, unless sooner terminated by mutual consent, or by the operation of law.

DUTIES: It shall be the duty of the partners to use their best efforts to promote the welfare of the business, as follows:

J. C. Nichols, Manager and in Charge of Sales. J. Toussaint, Office Manager, in Charge of Accts. G. A. Nichols P. G. Nichols Promotional and Advisory Capacity.

SALARIES: The salaries are to be as follows:

J. C. Nichols - $16,000.00 per annum J. Toussaint - $3,900.00 per annum

G. A. Nichols and P. G. Nichols will receive advances from time to time against future profits. In addition to the foregoing, J. C. Nichols is to be allowed all necessary traveling, entertaining and promotional expenses for the furtherance of the business.

Salaries may be changed by mutual consent of all partners.

CAPITALIZATION: The capital of the partnership is to be contributed as follows:

J. C. Nichols J. Toussaint G. A. Nichols P. G. Nichols

PROFITS & LOSSES: After all operating expenses having been charged against the business, and after charging the salaries of J. C. Nichols and J. Toussaint, as an operating expense, the balance, net income or deficit, is to be distributed as follows:

J. C. Nichols	25%
J. Toussaint	25%
G. A. Nichols	25%
P. G. Nichols	25%

BOOKS: Regular books of account are to be kept, wherein will be recorded all transactions pertaining to the affairs of the co-partnership, and statements will be submitted at regular intervals showing the results of operations as well as the financial condition of the company.

J. Toussaint was petitioner's brother-in-law and was brought to Chicago from Washington to be office manager. P. G. Nichols, petitioner's brother, became assistant manager of the Foxworth Veneer Co. G. A. Nichols was petitioner's father, and in 1925 was 65 years of age and had retired from active business. He had never been engaged in the rotary cut lumber business. Each of the three gave his noninterest-bearing demand note for $47,000 to petitioner as consideration for a one-fourth interest in the business. These three notes were payable to petitioner individually and were kept in the vault in the partnership office. J. Toussaint had no means to pay the note, and the record fails to show the financial status of petitioner's father and brother. No part of any of the notes has ever been paid. Petitioner's offer to take his father into the business was because of his appreciation for what his father had done in the past in helping him get started in business by a loan of money which petitioner had fully repaid prior to 1925.

An account designated as "Capital Account" was opened on the partnership books in the name of each of the four parties signing the partnership agreement. The opening entry in each account was an undescribed credit entry under date of April 14, 1925, in the amount of $29,344.93. Approximately two years later, under date of February 16, 1927, each of these accounts was reduced by a debit in the amount of $14,506.55, described as "Share Good-Will Charged Off." Common to the capital accounts of G. A. Nichols, P. G. Nichols, and J. Toussaint appear other similar of identical debits. On each of the accounts of the three, and under date of April 19, 1930, appear debits described as "Loan to J. C. Nichols", the amounts being $3,652.98 in the case of G. A. Nichols, $22,073.11 in the case of P. G. Nichols, and $21,899.97 in the case of J. Toussaint. The transactions described by those entries were bookkeeping transactions, the balancing entries appearing as credits under the same date on the capital account of J. C. Nichols. It does not appear from the record herein that any amount has been paid by J. C. Nichols in satisfaction of any such loans or that any reversing entries with respect thereto have ever been made on any of the accounts in question. Under date of October 17, 1930, a debit in the amount of $4,000, described as "O. R. Nichols", appears on the capital account of G. A. Nichols, P. G. Nichols, and J. Toussaint. No such debit appears on the capital account of J. C. Nichols. Under date of July 1, 1930, a debit of $1,562.50, described as "J. C. Nichols (Wittmer)", appears on the capital accounts of J. Toussaint and G. A. Nichols. No similar entry appears on the accounts of either P. G. Nichols or J. C. Nichols.

In the capital account of J. Toussaint, the total credits through 1934 amounted to $124,034.22, the total debits to $60,893.53, leaving a credit balance on December 31, 1934, of $63,140.69. Of the total credits, $29,344.93 was the opening entry; $81,275.15 represents 25 percent of the profits of the business during that period; $7,901.42 represents the proceeds from the sale of stocks; and $4,986.25 represents two bank loans, while the remaining few hundred dollars represent an income tax refund in the amount of $40.82 and adjustments common to each of the four capital accounts. Of the total debits the entries of $14,506.55, $21,899.97, $4,000, and $1,562.50 have been described above; $3,240.92 represents income tax payments made during the various years; $7,513 appears to have been related to the purchase of stocks or loans thereon; $500 was described as a payment to the credit of J. C. Nichols in the Boulevard Bridge Bank, and $1,000 apparently was a payment on a bank loan; and a few small items represented interest paid, while he nature or significance of the remaining debits is not apparent. Toussaint's account was closed out on December 31, 1935, by transfer of the credit balance amounting to $66,008.62 to the J. C. Nichols capital account. From December 31, 1934, to the date the account was closed, only two credit entries were made, one in the amount of $303.64, described as "Share Fire Loss Acct.", and the second in the amount of $3,309.92, described as "Share 1935 Profits." The debit entries for 1935, exclusive of the closing entry, amounted to only $745.63. Two hundred dollars of this amount apparently represented a withdrawal by Toussaint, while the remaining debits covered payment of income taxes.

In the capital account of P. G. Nichols, the total credits through 1934 amounted to $111,105.76 and the total debits to $50,719.76, leaving a credit balance on December 31, 1934, of $60,386. Of the total credits, $29,344.93 was the opening entry and $81,275.17 represented 25 percent of the profits of the business during that period, while the remaining $485.66 represented adjustments common to each of the four capital accounts. Of the total debits, the entries of $14,506.55, $22,073.11, and $4,000 have been described above; $1,913.34 covers the payment of income taxes during the various years; $400 appears to have been paid to J. C. Nichols; and $873.75 apparently represented insurance premiums, while the nature or significance of the remaining debits is not apparent. The capital account of P. G. Nichols is still an open account. The credits subsequent to December 31, 1934, are composed almost entirely of one-fourth of the profits of the business, while all of the debits during the same period were apparently in payment of income taxes. The credit balance at December 31, 1938, was $78,140.74.

In the account of G. A. Nichols the total credits through 1934 amounted to $113,580.99 and the total debits to $60,463, leaving a credit balance on December 31, 1934, of $53,117.99. Of the total credits, $29,344.93 was the opening entry; $81,275.21 represented 25 percent of the profits of the business during that period; $1,000 was described as cash; and $485.65 covered adjustments common to each of the four capital accounts, while $1,475.20 covered two items the exact nature of which is not readily apparent. Of the total debits, the entries of $14,506.55, $3,652.98, $4,000, and $1,562.50 have been described above; $13,030 covered monthly withdrawals ranging from $100 to $150; $12,500 apparently represented payments to J. C. Nichols on December 31, 1925, and January 7, 1926, possibly covering purchases of some character; and $1,622.34 covered income tax payments, while the remaining debits, totaling $9,598.63, were for small amounts and appear to have covered payments in the nature of utility bills, house furnishings, interest, insurance premiums, doctor bills, and the like. G. A. Nichols' account was closed out at December 31, 1937, by a transfer of the credit balance "To D. E. Nichols Capital a/c", the said balance at that date being $63,306.17. From December 31, 1934, to the date the account was closed the credit entries purported to cover one-fourth of the profits of the business and two or three small items, and the debits for the same period amounted to $3,715.17, of which $3,350 covered the monthly withdrawals of G. A. Nichols, while of the remaining $365.17, $133.33 represented income tax payments.

D. E. Nichols is the son of petitioner and the grandson of G. A. Nichols. No money passed by reason of the transfer of the abovementioned credit balance from G. A. Nichols to D. E. Nichols. D. E. Nichols merely assumed whatever obligations G. A. Nichols. had with respect to a one-fourth interest in the business. After the transfer, however, and down to the date of the hearing, G. A. Nichols apparently continued to draw $100 per month from the business, the withdrawals being charged against the D. E. Nichols account.

In the J. C. Nichols capital account the total credits through 1934 amounted to $159,731.90 and the total debits to $139,233.54, leaving a credit balance at December 31, 1934, of $20,498.36. Of the total credits, $29,344.95 was the opening entry; $81,275.23 represented 25 percent of the profits of the business during that period; $1,000, under date of December 28, 1931, was a transfer from the J. Toussaint capital account, which was described on that account as a balance for stock; and $485.66 covered adjustments common to each of the four capital accounts, while the remaining $47,626.06 represented transfers under date of April 19, 1930, from the capital accounts of J. Toussaint, P. G. Nichols, and G. A. Nichols in the respective amounts of $21,899.97, $22,073.11, and $3,652.98, each transfer being described as a loan from the individual named. Of the total debits, the entry of $14,506.56 has been described above as a charge-off of good will; $4,700 apparently represented a payment for stock; and $107,679.56 represents debits made to cover overdrafts in petitioner's drawing account at December 31, 1925, 1929, and 1930, in the amounts of $22,420.27, $44,827.54, and $40,431.75, respectively, while the remaining $12,347.42 covers income tax payments. Subsequent to December 31, 1934, and through December 1938, the total credits amounted to $99,784.83, of which $33,309.28 represented one-fourth of the profits of the business for the year 1935 and one-half of the profits for 1936, 1937, and 1938, and $86,008.62 covered the transfer of the credit balance in the J. Toussaint account as of December 31, 1935. The remaining $466.93 covered minor adjustments. During the same period from and after December 31, 1934, the total debits amounted to $53,374.42, of which $47,280.63 was an entry to cover the deficit in petitioner's drawing account at December 31, 1935. The remaining debits of $6,093.79 apparently covered withdrawals for tax purposes. At December 31, 1938, the J. C. Nichols capital account disclosed a credit balance in the amount of $66,908.77.

The balance in the capital account of J. C. Nichols as shown by the books for each year from 1925 through 1938 and such balance for each such year less the "loans" from the J. Toussaint, P. G. Nichols, and G. A. Nichols capital accounts under date of April 19, 1930, and less the credit balance in the J. Toussaint account at December 31, 1935, transferred to the J. C. Nichols capital account on that date, is as follows:

	Balance
Year	Shown by the books	As shown by the books less "loans" or transfers from capital accounts of other individuals
1925	$18,868.82	$18,868.82
1926	29,715.51	29,715.51
1927	18,573.24	18,573.24
1928	27,614.39	27,614.39
1929	1,961.53	1,961.53
1930	12,643.95	1 (34,982.11)
1931	13,345.48	1 (34,280.58)
1932	$15,215.38	1 ($32,410.68)
1933	18,232.43	1 (29,393.63)
1934	20,498.36	1 (27,127.70)
1935	42,360.69	1 (71,273.99)
1936	48,321.54	1 (65,313.14)
1937	60,435.23	1 (53,199.45)
1938	66,908.77	1 (46,725.91)

On December 31, 1932, petitioner's drawing account disclosed an overdraft in the amount of $31,554.96. On that date petitioner gave the partnership his promissory note for that amount and it was entered on the partnership books in a notes receivable account and the petitioner's personal drawing account was credited with the same amount. The record does not show when the note was payable or whether it bore interest.

On December 28, 1933, the notes receivable account was written down by a credit of $22,500 and compensating entries were made by writing up on the same date certain stocks carried as assets in the stocks and bonds account of the partnership, namely, stock of the Foxworth Veneer Co., $9,000, and of the Acme Veneer Co., $13,500.

On December 12, 1934, the notes receivable account of the partnership showed a balance due on petitioner's promissory note in the amount of $9,054.96. On that date this amount was written off the account and on the same date the stock of the Beaumont Veneer Co., which was carried as an asset in the stocks and bonds account, was written up in the amount of $8,900, the difference of $154.96 being charged to petitioner's personal drawing account. At the time these bookkeeping entries were made, the partnership returned petitioner's promissory note to him and it was destroyed.

The petitioner at no time executed any notes to the other partners purporting to reimburse them for the cancellation by the partnership of its claim against him for the $8,900 debt which was thus stricken from the books of the partnership on December 12, 1934. No written memorandum of any kind was made to show that petitioner still owed the debt to the partnership or to any of the partners and no part thereof has ever been paid to the partnership or to any of the partners.

At the beginning of 1934 petitioner's drawing account on the books of the partnership showed an overdraft of $3,694.17. During that year the credit entries on this account, which included his salary allowance, amounted to the total amount of $50,404.90. The debit entries, which represented over 500 withdrawals for various purposes, amounted to the total amount of $77,129.76. At the end of the year the account showed an overdraft in the amount of $30,419.03.

At the end of 1935 J. Toussaint withdrew from the partnership and petitioner returned to him his $47,000 note; also another note or notes for $6,500 which had been given petitioner for a personal loan. The credit balance in J. Toussaint's capital account in the amount of $66,008.62 was thereupon transferred to petitioner's capital account, but no settlement or adjustment was made in respect of the difference between the face value of the two notes and the credit balance in Toussaint's capital account. No payment has ever been made by petitioner to Toussaint in respect of the cancellation of petitioner's debt to the partnership and the record is silent as to the disposition, if any, of the "loan" represented by the transfer, under date of April 19, 1930, from Toussaint's capital account to that of petitioner.

In 1934 petitioner received a salary of $14,400 from the partnership. He was a man of some resources and was financially solvent at all times material hereto. In the taxable year he did all the selling for the partnership and was chiefly responsible for its policies and activities. He dominated the business and its management.

The profits of the business for 1934 as shown by the books amounted to $12,292.69 and was credited to the accounts of Toussaint, G. A. Nichols, and P. G. Nichols in the amount of $3,073.17 each and to the account of petitioner in the amount of $3,073.18.

During 1934 petitioner had the use of an automobile which was owned by the partnership. Throughout the year a chauffeur was employed to operate the car. Petitioner used the car to make trips in connection with his selling activities, which required him to travel to various places around the country. Some of his traveling was in connection with the operation of the three southern lumber companies, which he usually visited twice each year. A substantial portion of petitioner's traveling in 1934 was between Chicago and Detroit, and was made in connection with obtaining a new customer for the partnership. When the car was in Chicago it was used to some extent for transporting and entertaining customers in and about the city. Petitioner's family had a private car and the partnership car was not used by them. It was used, however, to transport petitioner back and forth from his home to his office. The chauffeur was an employee of the partnership but was not carried as such on the partnership's books. During 1934 there were two chauffeurs employed, one succeeding the other. Each of the chauffeurs was paid a salary of $100 per month, part of which was paid by partnership checks which were sent to their respective homes and the balance of which was paid in cash by petitioner. The salary checks were charged to the personal drawing account of petitioner and during 1934 amounted to a total of $964.95.

During 1934 petitioner received, in addition to his regular salary, $2,400 from the partnership in the form of monthly credits of $200 to his drawing account. During 1934 petitioner kept no record in respect of any amounts given to his chauffeur. The partnership kept a separate account for automobile expenses and depreciation thereon. It was petitioner's practice in 1934, while traveling for the partnership, to write checks on the partnership's bank account for his expenses, which amounts were charged to a particular account entitled "Traveling Expenses." This account on the partnership books shows that during 1934 petitioner received the amount of $4,667.36 for traveling expenses. Most of the entries in this account do not show whether his travel was by rail, plane, or automobile, but at least one entry, on March 29, 1934, for $300, is described as "J. C. N. Auto trip to all mills."

OPINION.

TURNER: In his determination of the deficiency the respondent concluded that the partnership during 1934 had forgiven the petitioner his indebtedness to the extent of $8,900, within the meaning of article 22(a)-14 of Regulations 86 ¹ and that this forgiveness of indebtedness constituted income to the petitioner for that year. On brief it is pointed out that petitioner dominated the partnership and its business and was the principal producer of its income and that the release of petitioner from the said indebtedness was a further payment for services rendered, which payments under article 183-1 of Regulations 86 are "held to represent a division of partnership profits." The respondent further contends that as the result of petitioner's overdrafts his capital investment in the partnership had been completely exhausted prior to the taxable year; that the release of the indebtedness here in question amounted to a distribution to petitioner by the partnership, and, petitioner having previously recovered the full amount of his capital investment, the said distribution was in any event income to him. .

In the amended petition it is alleged that petitioner was not relieved of liability for the $8,900 in question, "but he either remained fully liable to the said partnership or he became and remained indebted to his other partners individually." It is now contended that he is indebted to each of the other partners for one-fourth of the $8,900 written off the partnership books. It is further contended that petitioner, having a one-fourth interest in the partnership, owned one-fourth of the debt and to that extent could not under any circumstances be said to have realized gain. The latter proposition suggests the question as to whether or not a partnership is to be regarded as an entity separate and apart from its members for the purpose of determining the separate income of a member in respect of transactions between it and such member. In the view we take of the case, however, it will not be necessary to consider that proposition. See, however, , and ; affd., .

Considering the relationship of the parties, the source of the capital of the business, the actual withdrawals by the four individuals, the treatment of petitioner's overdrafts, the conduct of the business, and the disposition and terms of disposition of the interests of J. Toussaint and G. A. Nichols, it might be forcefully argued that no actual partnership ever existed or was intended. Be that as it may, the respondent in making his determination of deficiency and the parties in trying this proceeding have assumed the existence of a partnership, and in reaching our conclusion we shall do the same. By so doing, however, we are not required to close our eyes to the facts and to determine the income of the individual partners according to the ratios or terms originally prescribed in the partnership agreement if the subsequent acts and conduct of the parltners themselves show that actual participation in the fruits of the business has been placed on a different basis. Our task here is to determine the income of J. C. Nichols, one of the partners, and if, by reason of his dominant position in the business and because of personal or business relations between him and the other partners, he was able to obtain and did obtain a greater portion of the partnership profits than was originally indicated in the partnership agreement, actual events must control and any additional amount so acquired should be included in his income, regardless of whether it be described as an increased share of profits, compensation for services rendered, or indebtedness forgiven.

According to the partnership agreement a partnership under the firm name J. C. Nichols was organized under date of April 12, 1925, wich J. C. Nichols, J. Toussaint, P. G. Nichols, and G. A. Nichols each having a 25 percent interest therein. J. C. Nichols was to be manager in charge of sales and J. Toussaint office manager in charge of accounts, while G. A. Nichols and P. G. Nichols were to act in a promotional and advisory capacity. J. C. Nichols was to receive a salary of $16,000 per annum and J. Toussaint a salary of $3,900, while G. A. Nichols and P. G. Nichols were to be entitled to receive advances against furture profits. It was provided that salaries might be changed by mutual consent of all parties. A capital account was opened on the books of the company in the name of each of the four individuals. These accounts purport to show that on April 14, 1925, each of the individuals named paid into the business in cash or property the total amount of $29,344.93. That a substantial portion of these payments was in the nature of good will is indicated by a debit appearing in each of the accounts some two years later, described scribed as a charge-off of good will, in the amount of $14,506.55.

While the above agreement tends to show that a partnership in the profits of which the four individuals were to share equally was organized in 1925 and the capital accounts on their face indicate capital contributions by the four in equal amounts, the record shows that the capital was in fact advanced by petitioner and that amounts substantially in excess of 25 percent of the profits were appropriated to petitioner's personal needs and uses. In 1925 petitioner, according to his testimony, invited his father, his brother, and his brother-in-law to become partners in an established business for the selling of veneer or rotary cut lumber. None of these individuals actually put anything in the business, and with respect to Toussaint the record certainly indicates that he had no means from which such a capital investment might have been made. The business had been built up by the petitioner through his own efforts and no other person, unless it was his father, G. A. Nichols, owned any part or share therein, and any interest that his father might have had was obviously not substantial. J. Toussaint, P. G. Nichols, and G. A. Nichols each gave petitioner his noninterest-bearing demand note for $47,000, but we would hesitate to conclude in the light of subsequent events that it was ever intended that anything should be paid thereon, and we do know that after approximately 14 years nothing had been paid. The business was successful from its inception and the profits were credited in equal shares to the capital accounts of the partners, and by the close of 1934, the taxable year, the total profits shown in each such account amounted to $81,275.21. During that same period the petitioner had withdrawn substantially more than the 25 percent of the profits credited to his account. In 1930 transfers were made from the accounts of the other three partners of a total amount of $47,626.06 to bolster petitioner's capital account, which in turn was used to absorb overdrafts in his personal drawing account. By December 31, 1930, such overdrafts totaled $107,679.56, all of which as of that date had been debited to his capital account. By the end of 1932 he was again overdrawn, in the amount of $31,554.96, for which he executed his promissory note, but during the following year the note was written off the partnership books to the extent of $22,500 through a corresponding write-up of certain stock owned by the partnership, while on December 12, 1934, the balance of the note was similarly written off to the extent of $8,900, and the remaining $154.96 was charged back to petitioner's personal drawing account. At the same time his drawing account had again become substantially overdrawn and at December 31, 1934, the overdrafts amounted to $30,419.03.

On the record here it is impossible to tell with certainty the exact amounts appropriated by the other three partners for their own use and benefit, but the facts are sufficient to show that they were not in any way comparable to those appropriated by petitioner, and, in the case of J. Toussaint and P. G. Nichols, were quite small. The total charges against the capital accounts of J. Toussaint, P. G. Nichols, and G. A. Nichols from the beginning of the partnership to December 31, 1934, were $60,893.53, $50,719.76, and $60,463, respectively, but of those charges $14,506.55 in each account covered the charge-off of good will and $21,899.97, $22,073.11, and $3,652.98 covered respective transfers to petitioner's capital account.

Exclusive of the charges explained in the preceding paragraph and which obviously did not represent appropriations to his personal use, the debits to J. Toussaint's account for the period from April 14, 1925, to December 31, 1934, amounted to $24,487.01 and might possibly have been appropriated for his personal use, but even if that should be true such withdrawals were offset to the extent of $12,887.67 by bank loans and proceeds from the sale of stock deposited in the account. Also, common to the capital accounts of each of the partners except petitioner, there is a debit of $4,000 in favor of O. R. Nichols whose relationship has not been explained but who it may reasonably be presumed was another member of the family circle. If the O. R. Nichols debit be eliminated, Toussaint's net personal withdrawals up to the close of the taxable year did not exceed $7,600.34 as compared to similar withdrawals by petitioner approximating $150,000, and yet according to the record Toussaint was, during that period, experiencing financial difficulties.

Exclusive of the good will charge-off and the transfer to the capital account of the petitioner, the total debits to the capital account of P. G. Nichols at December 31, 1934, amounted to only $14,140.10, and if the debit of $4,000 in favor of O. R. Nichols, previously discussed, should also be eliminated and it be concluded that the remaining withdrawals were for the personal use and benefit of P. G. Nichols, those withdrawals for the period from April, 14, 1925, to December 31, 1934, amounted to only $10,140.10. From December 31, 1934, through 1938, his withdrawals amounted to only $963.38 and apparently covered the payment of income tax. For the same period the credits amounted to $18,718.12, and, except for four items totaling only $408.55, represented one-fourth of the profits of the business during the period described.

The debits in the account of G. A. Nichols which may be said to have been appropriated to his personal use and benefit are more substantial. Exclusive of the good will charge-off and the transfer to petitioner's capital account under date of April 19, 1930, the total debits amounted to $42,303.57, and if we further eliminate the $4,000 debit in favor of O. R. Nichols, previously discussed, there is still a balance of $38,303.57, which possibly may have been appropriated by G. A. Nichols to his personal use. It is to be noted, however, that the total profits from the business credited to his account during the same period were more than twice that amount, and, further, that G. A. Nichols, on December 31, 1937, transferred his entire interest in the partnership, including further accumulated earnings, to petitioner's son and his grandson without consideration other than the possible assumption of his $47,000 noninterest-bearing demand note which the petitioner had held since 1925, and in view of the further fact shown by the record that G. A. Nichols continued to make monthly withdrawals from the business after the transfer of his interest to his grandson, such withdrawals being charged against the interest so transferred, it might be reasonably argued that the withdrawals for his personal use during the entire period from the beginning of the partnership were in the nature of gratuities from petitioner.

We also think the disposition and terms of disposition of Toussaint's interest in the partnership is of significance. On December 31, 1935, his capital account was closed by transferring the credit balance of $66,008.62 to petitioner's capital account, in return for which, according to the testimony, Toussaint received his previously described noninterest-bearing demand note for $47,000 and a further note or notes for $6,500 covering loans made to him by petitioner. A prior transfer of $21,899.97 under date of April 19, 1930, described as a loan, had already been made from Toussaint's capital account to the capital account of petitioner. The record is silent as to the effect of the transaction of December 31, 1935, on that item, and there is no showing whether or not Toussaint thereafter retained any claim for that amount. In his reply brief, however, petitioner classifies any consideration of the $21,899.97 in connection with the closing of Toussaint's capital account as obvious error and suggests that the interest in the partnership transferred by Toussaint to the petitioner at the time of his withdrawal was worth approximately the amount of his indebtedness to the petitioner, namely, $53,500. As we understand it, it is the petitioner's claim that the interest transferred by Toussaint to petitioner was a full one-fourth interest in the business and the profits therefrom. It that is correct, Toussaint transferred to petitioner a one-fourth interest in a business which had been successful from the beginning, a business which during the period from April 14, 1925, to December 31, 1935, had produced profits in the amount of $338,340.52, a one-fourth share therein being $84,585.13, and further Toussaint was not only giving up an interest which had such an earning record but was also handing over to petitioner as a part of the same transaction and without additional consideration his right to past earnings amounting at least to $38,282.57. This amount is arrived at by excluding from consideration the $21,899.97 transferred in April 1930, with respect to which the record is silent, and by eliminating from the credit balance transferred on December 31, 1935 $14,838.38 representing the balance of the original capital entry after the charge-off of good will in 1927, also $12,887.67, being the amount of bank loans and proceeds from the sale of stock which had been deposited presumably by Toussaint in the said account.

It is true the transfers in April 1930 to petitioner's capital account were described as loans from the other three partners, and, while the partnership accounts show no continuing obligation of petitioner with respect to the note of December 31, 1932, which was written off in 1933 and 1934 by a write-up of certain partnership assets, there is testimony to the effect that when $22,500 thereof was written off in 1933 petitioner gave notes to each of the other three partners for one-fourth of the amount written off and when the $8,900 item involved in this proceeding was written off in 1934 there was an intent to give similar notes. The fact is, however, that no notes were given with respect to the $8,900, there is no showing that it was entered on the accounts of any of the parties as a continuing liability of petitioner, and nothing has ever been paid thereon. It is equally true that all of the partners consistently refrained from making any payments on any of the apparent obligations arising out of or in connection with the partnership arrangement, and not only were no payments made, but, even though there were numerous cases of the overlapping of paper obligations, no balance was ever struck between the petitioner and any of the partners, not even when Toussaint withdrew from the business in 1935 and G. A. Nichols withdrew in 1937. During all that time the petitioner continued his practice of overdrawing his purported one-fourth share of the profits, while the other partners were taking only a small part of their purported shares.

Our particular problem has to do with the $8,900, being that portion of the note of December 31, 1932, written off in 1934. With respect to the origin of the note and the reasons for writing it off there is considerable confusion. The petitioner stated that the write-off and the form it took was suggested by an official at a bank with which the partnership did business, the reason for the banker's suggestion being that the presence of petitioner's obligation on the partnership books made the partnership's financial statement look bad. Toussaint testified that the suggestion for the write-up of the partnership assets as a means of eliminating the note came from the partnership auditor. Petitioner and Toussaint seemed to be in agreement, however, that, regardless of where the idea to write up partnership assets came from, the elimination of petitioner's obligation under the note both in 1933 and in 1934 came from the bank official, the purpose being to improve the partnership's financial statement. During 1934, however, when petitioner was so seeking to satisfy the bank and improve the partnership's financial statement by the elimination of a $8,900 liability under a note, he was accumulating a much larger overdraft in his personal drawing account, which at December 31, 1934, amounted to $30,419.03. Accordingly we are not greatly impressed with the explanation given for the write-off. Taking into consideration the manner in which the partnership was formed, the source of its capital, the continued practice of the petitioner to withdraw amounts far in excess of one-fourth of the partnership profits, the method of eliminating his overdrafts, the comparatively small withdrawals by the other partners, the consistency with which petitioner has refrained from making any repayment to the partnership or any of the partners with respect to his overdrafts written off the partnership books, the equal consistency with which the other partners refrained from making any payments on their notes of $47,000 each given to petitioner when the partnership was formed in 1925, and the care with which Toussaint and petitioner have indicated that no offsets were made or intended by reason of the overlapping liabilities, it is our conclusion that, while the partnership profits were regularly entered in the four capital accounts, the shares of Toussaint, P. G. Nichols, and G. A. Nichols were intended to be and at all times were subject to the needs and demands of petitioner. Our case here involves only the $8,900 eliminated from the books in 1934, which petitioner maintains he still owes pro rata to the partners, and we are not called upon to determine the tax effect of other adjustments. It is our opinion that any thought on the part of petitioner to ever make payment, to the partnership or any of the partners, of the $8,900 written off the partnership books on December 12, 1934, was too remote to justify any conclusion that there was any continuing obligation therefor, and we accordingly conclude that the cancellation of the note did result in a realization by petitioner in 1934 of additional income in the amount of the $8,900 written off, regardless of whether it be said that such realization was effected through the forgiveness of indebtedness, the payment of increased compensation by mutual consent of the partners, or by apportionment of the 1934 profits.

The second question presented is whether respondent erred in including in petitioner's taxable income $2,400 which was received by him in the form of monthly credits of $200 each to his personal drawing account, allegedly for traveling and automobile expenses. The record shows that $1,200 of this amount was in fact paid to a chauffeur employed by the partnership to operate a partnership automobile, $964.95 of which was paid by partnership checks charged to petitioner's personal account and the remainder of which was paid in cash out of petitioner's pocket. While the chauffeur was not carried as an employee on the books of the partnership, we think the evidence establishes that he was in fact an employee of the partnership, and we do not think the petitioner's income should include the $1,200 paid to him as salary. With respect to the remaining $1,200, which was supposed to represent the amount of small payments made by petitioner to the chauffeur from time to time to cover traveling expenses, the evidence is not convincing. The partnership maintained a separate account on its books to cover automobile expenses and also a separate account to cover petitioner's traveling expenses. Most of the entries in this latter account fail to disclose the manner in which petitioner traveled, but at least one entry, in the amount of $300, is described as an "auto trip to all mills." In view of the fact that petitioner kept no record of his expenditures while traveling and in further view of the manner in which his traveling expenses were kept in a separate account on the partnership books, we are not convinced that the remaining $1,200 was in fact used in the partnership business and that the respondent erred in determining that this $1,200 should be included in petitioner's income. To that extent his determination is sustained.

Decision will be entered under Rule 50.

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Footnotes

• 1. Deficit. ↩

• 1. ART. 22(a)-14. Cancellation of indebtedness.↩ - The cancellation of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. * * *