Parker v. Commissioner , 31 B.T.A. 644 ( 1934 )

CLARA B. PARKER, EXECUTRIX OF THE ESTATE OF GEORGE D. PARKER, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Parker v. Commissioner

Docket No. 58604.

United States Board of Tax Appeals

31 B.T.A. 644; 1934 BTA LEXIS 1052;

November 21, 1934, Promulgated

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1. Decedent made loans or advances for several years prior to 1927 to a corporation in which he owned a controlling interest, and in that year was allowed a deduction for a loss on that account which was unabsorbed by income of that year. Held, the unabsorbed loss is not a net loss that may be carried forward to the succeeding year as it was not sustained in a trade or business regularly carried on by decedent.

2. The partnership of George D. Parker Co. was composed of five persons, decedent having a one-fourth interest only, as determined in 30 B.T.A. 1231">30 B.T.A. 1231. Held, respondent erred in including in decedent's income anything more than one fourth of the partnership income.

3. No evidence being adduced sufficient to overcome the presumption of the correctness of the respondent's determination that the sum of $8,481.77 should be added to decedent's income for 1928, such determination is approved.

4, 5. Income in 1928 and 1929 derived from community property in California acquired by husband and wife prior to the amendment of the California Civil Code effective July 29, 1927, held taxable to the husband. Hirsch v. United States, 62 Fed.(2d) 128, followed. Where the income from the decedent's business was produced in part by investment in separate property or community property acquired prior to July 29, 1927, and in part by the personal activity, ability and capacity of decedent during the taxable years involved, there should be an apportionment of the earnings between the capital investment and the personal services as required by the laws of California.

6, 7, 8. No sufficient evidence having been offered to overcome the presumption of correctness of respondent's determination upon issues 6, 7, and 8, respondent's determination is approved.

9. The fair market value of Food Machinery Corporation stock at the time it was received by decedent in exchange for Stebler-Parker Co. stock found under the evidence to have been $35 per share, and the respondent was in error in his determination that such stock had a higher value.

Thomas R. Dempsey, Esq. A. Calder Mackay, Esq., Arthur McGregor, Esq., and Wm. C. Kottemann, C.P.A., for the petitioner.

Richard W. Wilson, Esq., for the respondent.

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SEAWELL

The Commissioner determined deficiencies for the years 1927 to 1929, inclusive, as follows: None for 1927, there being a loss in that year; for 1928, $23,227.97; and for 1929, $49,912.95, which amounts are in controversy.

The errors assigned are, in substance, that the respondent erred:

(1) In failing to allow a loss of $55,231.83 sustained by the decedent in his business during 1927 to be carried forward as a deduction from 1928 income.

(2) In failing to recognize a partnership agreement between five certain persons operating under the trade name of George D. Parker Co., for each of the years 1928 and 1929, thereby erroneously increasing decedent's net taxable income by $1,402.09 for 1928 and $1,204.90 for 1929.

(3) In adding to decedent's income for the year 1928 the sum of $8,481.77, representing a loss sustained by the decedent on stock of Parker Lumber & Box Co.

(4) In adding to decedent's income for the year 1928 the sum of $47,720.83, asserted by respondent to represent income from business.

(5) In failing to recognize that one half of income received by decedent in 1928 and 1929 was community income within the meaning of provisions of the Civil Code of California and thereby overstating decedent's income for 1928 by $100,230.33 and for the year 1929 by $93,690.89.

(6) In failing to allow earned income credit for each of the years 1928 and 1929 based on earned income of at least $30,000 for each year.

(7) In adding to decedent's miscellaneous income for 1929 the sum of $278.13.

(8) In failing to allow in 1929, as a deduction, bad debts in the amount of $381.33.

(9) In adding to decedent's net capital gain the amount of $263,058.69 alleged to represent profit from the transfer or exchange of 1,125 shares of Stebler-Parker Co. stock for 6,500 shares of Food Machinery Co. stock and $51,674.42 cash.

FINDINGS OF FACT.

At the hearing in this case, it was stipulated that all the evidence introduced in Docket Nos. 28374, 32369, and 44396 (30 B.T.A. 1231">30 B.T.A. 1231), which cases were between the same parties and involved some of the same issues as in the instant case and related to years prior to those now in issue, might be considered as having been taken in this case. Our findings of fact in the three dockets mentioned, which were consolidated for hearing, in so far as the same are relevant and material in determining the issues herein, are incorporated by reference and summarized as a part of our findings of fact in the instant case. Other facts found from the record herein, deemed pertinent and material to the issues submitted for our determination, are also set forth.

George D. Parker, a resident for many years of Riverside, California, and engaged in the citrus fruit industry, died in August 1930. His wife, Clara B. Parker, to whom he was married in or prior to 1919 and with whom he was living during the years in issue, was appointed and duly qualified as executrix of his estate and as such is the petitioner herein.

Fred Stebler, also a resident of Riverside, California, and George D. Parker were both owners of valuable patents on labor-saving devices useful in the citrus fruit industry, in which both were engaged. For the purpose of consolidating their competing businesses, they in 1921 organized a corporation, Stebler-Parker Co., and for the services rendered to them personally in connection with the consolidation of the businesses and the organization of the corporation, W. B. Clancy and George X. Wendling, in 1922, were each paid $10,000, Stebler and Parker each making payments of $10,000 for said services.

In 1919 C. E, Brown was employed by George D. Parker as a salesman for the Parker automatic box-nailing machines and in 1920 there were some discussions and an understanding between them in reference to a partnership, but not until 1921 were written articles of copartnership drafted, constituting the partnership of George D. Parker Co., composed of George D. Parker and wife, Clara B. Parker, each owning a one-fourth interest therein, and C. E. Brown and wife, Blanche G. Brown, and Catherine Barr, each owning a one-sixth interest.

The George D. Parker Co., during the period from 1920 to 1926, inclusive, became the beneficiary of a very valuable contract for supplying box shook to the Nestle Food Co. and its numerous plants. The Parker Lumber & Box Co., incorporated in February 1920 for the purpose of manufacturing box shook, acquired certain real estate, together with a sawmill and plant equipment formerly owned by the Northern Box & Lumber Co., at Everett, Washington. Two thirds of the capital stock of the Parker Lumber & Box Co. was issued to George D. Parker, its president, and one third to D.E. Brown, its vice president, and certain preferred stock to the preferred stockholders of the Northern Box & Lumber Co. From the date of its organization the Parker Lumber & Box Co.'s financial condition was unsatisfactory. During 1920, 1921, and 1922 the Parker Lumber & Box Co. was advanced $149,256.67 by the George D. Parker Co., to evidence which notes dated January 20, 1923, and payable to the partnership were executed. None of the notes were ever paid. Up to the year 1924 George D. Parker had advanced, in addition to the cost of his stock, the sum of $196,407.79. In 1924 he took a first mortgage on the lumber mill of the Parker Lumber & Box Co. in the amount of $100,000 and in 1925 he advanced an additional sum of $121,169.78 and took a second mortgage of $100,000, leaving due him in 1925 an unsecured balance of $117,577.57. In 1926 withdrawals over advances were $12,291.72. In 1927 George D. Parker assumed obligations to banks, on account of certain loans made by the banks to the Parker Lumber & Box Co. of $87,557.49, making a total of $392,843.34, of which $200,000 was secured by the first and second mortgages referred to above. In reference to these mortgages, the records of the County of Snohomish, State of Washington, disclose in substance the following facts:

First mortgage dated July 11, 1924, the Parker Lumber & Box Co., mortgagor, to Charles E. Prouse, mortgagee; deferred payments of all indebtedness now existing and hereafter to be incurred by the mortgagor to the mortgagee include the sum of $100,000 according to the terms of notes bearing even date therewith. The mortgage was signed by the Parker Lumber & Box Co., by George D. Parker, president, and S. A. Marks, secretary. A second mortgage, dated February 13, 1925, the Parker Lumber & Box Co., mortgagor, to H. L. Thompson, mortgagee, to include all indebtedness now existing and to be hereafter incurred, including $100,000 promissory note of even date, the property secured being identical with that secured in the first mortgage, and statement that the second mortgage is subject to a prior mortgage of July 11, 1924. Complaint on mortgage foreclosure in the Superior Court of Snohomish County, Washington, July 1, 1927, wherein George D. Parker is named plaintiff against the Parker Lumber & Box Co., a corporation, as defendant. The complaint in part states that on May 9, 1925, said Thompson, for a valuable consideration, transferred a note for $100,000 and the mortgage to Clara B. Parker, and that she in turn subsequently assigned and transferred the same to the plaintiff; and that on December 22, 1924, Charles E. Prouse, for a valuable consideration, assigned $42,500 worth of notes to the plaintiff. The defendant failed to answer the summons and a judgment was rendered August 23, 1927, for $233,867, plus $5,000 attorney's fees, interest and costs, and the property of the defendant involved in the litigation was sold by the sheriff October 1, 1927, and purchased by George D. Parker for $240,375.75, the amount of his judgment, plus items above mentioned. (In the amended petition it is alleged property so sold and purchased was not worth exceeding $100,000.) Another suit was filed in the Superior Court of the same county in the State of Washington by George D. Parker against the Parker Lumber & Box Co., defendant, on March 1, 1928, on four promissory notes of $1,000 each (so recited in the record, though $10,000 each may have been intended), dated January 31, 1927, and due July 31, 1928, the notes signed by the Parker Lumber & Box Co., by George D. Parker, president, payable to the Citizens National Bank of Riverside, California, endorsed: "Without recourse, pay to the Order of S. A. Marks, Citizens National Bank of Riverside, California, by C. E. Prouse, President, S. A. Marks and George D. Parker." On March 24, 1928, E. A. Poyneer was appointed receiver. A receiver's report dated April 5, 1928, disclosed that the property consisted of 23.29 acres of land and was sold under mortgage foreclosure October 1, 1927, for the amount of the judgment, costs, and attorney's fees, etc., aggregating $240,375.75. The receiver reported he was familiar with the "plat" and in his opinion it was not worth the sale price and that the equity of redemption was worth nothing, and furthermore that it had indebtedness shown by the books of $506,066.83, including the mortgage. Another judgment in favor of Parker against the defendant was filed on June 7, 1928, for $43,308.06; and upon the execution the sheriff reported no property of the Parker Lumber & Box Co. "subject to execution" found and the receiver was discharged.

A deduction of $192,843.34 loss, due to loans or advances made to the Parker Lumber & Box Co., was taken by the decedent in his return for 1927 and was allowed by the respondent, resulting, as shown on the return, in an alleged net loss by decedent in that year of $54,853.16, stated in the assignment of error as $55,231.83. Deductions claimed in decedent's 1927 return, exclusive of the loss of $192,843.34, amounted to $23,560.73. Gross income for 1927 was $161,550.91.

The petitioner contends that the alleged net loss should be carried forward as a deduction from decedent's income for 1928. The respondent insists that it is not the character of loss falling within the scope of section 117 of the Revenue Act of 1928 and may not be carried forward.

In the respondent's adjustments to the decedent's (George D. Parker's) taxable income for the years 1928 and 1929 he did not recognize George D. Parker Co. as a five-party partnership, but attributed two thirds of the profits of the partnership to the decedent Parker and one third to C. E. Brown.

The decedent, George D. Parker, in 1920 acquired 420 shares of the stock of the Parker Lumber & Box Co. for $42,195.11 and 35 shares of the same stock for $3,500, making the total cost $45,695.11. In his 1928 individual return he treated the aforesaid cost, plus the asserted cost of certain other items (consisting of oil stocks, abandoned oil lease, etc.), amounting in the aggregate to $67,426.68, as being the cost of community property, and in computing his taxable income for 1928 he deducted as a loss on "worthless stocks and oil leases" one half of the total cost, or the amount of $33,713.34 (the other half being claimed as a deduction by his wife), which amount of alleged loss the respondent in his adjustment, as shown by the deficiency notice, reduced to $25,231.57. The respondent in his deficiency notice and on brief makes no reference to the above 35 shares of stock, but in his brief it is argued that the 420 shares of Parker Lumber & Box Co. stock became worthless prior to 1928 and must have been so known to the decedent, and for that reason was disallowed by the respondent. The cost of the stock, $42,195.11, taken from the aforesaid aggregate asserted loss of $67,426.68, leaves the $25,231.57 shown in the deficiency notice as the correct amount deductible in 1928 on account of "worthless stocks and oil leases." The amount of $25,231.57 being $8,481.77 less than the amount of $33,713.34 deducted by decedent, the respondent increased decedent's income for 1928 by adding thereto $8,481.77.

The taxable income of the decedent for the years 1928 and 1929 was equally divided and reported on separate returns by decedent and his wife, Clara B. Parker.

The respondent included practically all income of the decedent for 1928 and 1929 - except one half of the decedent's salary of $6,000 received from the Parker Machine Works for each year - in the decedent's taxable income.

It is undisputed that the decedent's taxable income for 1928 and 1929 resulted from personal services and capital investments.

It was stipulated between counsel for the respective parties that royalties paid on patents licensed to the Stebler-Parker Co. from and including 1924 to June 15, 1929, were as follows: 1924, $48,119.20; 1925, $41,112.60; 1926, $45,301.42; 1927, $34,479.38; 1928, $31,410.24; 1929, $12,650.58.

For the year 1928 the respondent allowed the decedent an earned income credit of $245.14, and for 1929 an earned income credit of $335.82.

The petitioner insists that respondent should have allowed earned income credit for the years 1928 and 1929 based on an earned income of at least $30,000 for each year. The record does not show directly on what earned income the respondent based and allowed income credits, but the deficiency notice shows such credit for 1928 was $245.14 and for 1929 was $335.82, and such credits would be produced or result from earned net incomes of $21,555.63 for 1928 and $26,884.20 for 1929, and such the respondent, by computations set out in his brief, so shows.

The John Bean Manufacturing Co. was incorporated in July or August 1928. Subsequent thereto its name was changed to Food Machinery Corporation.

The company was engaged in the manufacture of machines for the spraying of orchards and the washing of fruits. A consolidation was effected with the Anderson-Barngrover Manufacturing Co. and, later, with the Sprague Sales Corporation, of Illinois.

In 1929 the John Bean Manufacturing Co. acquired all of the capital stock of the Stebler-Parker Co., in accordance with the terms of a written contract dated May 3, 1929, which in part, was as follows:

With reference to the sale and transfer of our stockholdings in the Stebler-Parker Co., be advised that we hereby offer to sell and transfer to you our respective holdings in the Stebler-Parker Co. for Fifteen Thousand (15,000) shares of the common capital stock of the John Bean Mfg. Co., plus the profits that have been earned by the Stebler-Parker Co. for the month of April, 1929, as reflected by the books and together with the amount of royalties that are due and payable to May first, 1929, under and by virtue of a certain license and manufacturing agreement under which the Stebler-Parker Co. is operating.

It is understood that the net worth of the Stebler-Parker Co. as of March 31st, 1929 shall be approximately the sum of $349,000.00 * * *.

* * *

Upon the completion of any audit made by your accountants of the affairs of the Stebler-Parker Co. which said audit must be completed prior to June 15th, 1929, that we are to have the option, in exchange for our interest in the Stebler-Parker Co. to accept in lieu of fifteen Thousand (15,000) shares of the common capital stock of the Stebler-Parker Co., to require your company to pay to the undersigned such sum in cash not exceeding the sum of One Hundred Thousand Dollars ($100,000.00) or such proportion thereof as we desire to accept at the rate of $50.00 per share of your common capital stock, plus Thirteen Thousand (13,000) shares of your common capital stock.

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It is further understood that any and all patents and patent applications in which we have any interest, subject, however, to any and all agreements heretofore entered into regarding the use of the same and which said patents pertain to the business of the Stebler-Parker Co. shall be assigned and transferred to your company, which said transfer and assignment shall be subject to the approval of Messrs. Lyon and Lyon of Los Angeles, California.

* * *

It is further understood that this offer is subject to your obtaining the approval of the Corporation Commissioner of the State of California for leave and authority to carry this offer into effect and in the event the approval of said Commissioner is obtained and said stock in the amounts as may be selected by us are transferred to us, we agree to deposit the same under the terms and conditions of an escrow similar to the one heretofore entered into with your Executive Officers, which said escrow shall end and terminate not later than September 15th, 1929.

* * *

It is further understood that in any event you are to obtain the permission and authority of the Corporation Commissioner of the State of California for leave and authority to effect the sale and transfer as above set forth, on or before the 15th day of June, 1929 and that said shares and cash as above set forth are to be delivered to the undersigned on or before the 30th day of June, 1929 and in the event said delivery and payment is made, as above set forth, on or before said time, we are to transfer to you the shares belonging to us in the Stebler-Parker Co. on June 30th, 1929.

* * *

It is further understood that in the event of your failure, neglect or refusal to carry out the terms and provisions hereinabove set forth on or before the 30th day of June, 1929 this agreement shall be of no effect whatsoever and shall be null and void.

The stock of the Stebler-Parker Co. was obtained as the result of an exchange whereby 14,000 shares of stock of the John Bean Manufacturing Co., plus $51,674.42 in cash, was given for all the stock of the Stebler-Parker Co. plus certain patents and profits.

As the result of this exchange, the decedent, owner of 1,125 shares of the capital stock of the Stebler-Parker Co., and certain patents - acquired by him at an aggregate cost of $113,614.73 - received 6,500 shares of the capital stock of the John Bean Manufacturing Co. plus $51,674.42 in cash.

The stock of the John Bean Manufacturing Co. (Food Machinery Corporation) was listed on the stock exchange in Los Angeles about the middle of 1929, and had been listed on the stock exchange in San Francisco prior thereto.

The cost to the decedent of his 1,125 shares of stock of the Stebler-Parker Co. was $112,500. The profit to the decedent on this exchange of stock and patents for stock and cash, as insisted by respondent, is as follows:

Amount received:
	Cash		$51,674.42
	Stock of Food Machinery Corporation,
	6,500 shares at $50 per share		325,000.00
			-----------
	Total		376,674.42
Less: Cost -
	Stebler-Parker Co. stock	$112,500.00
	Patents (net)	1,114.73
		------------	113,614.73
			-----------
	Profit		263,059.69

At the time of the acquisition by the decedent of the John Bean Manufacturing Co. or Food Machinery Corporation stock it was understood by those receiving the stock, including the decedent, according to the testimony of the president of the corporation, that the stock would not be sold during the years 1928, 1929, or 1930. Such understanding or restriction against such sale of the stock was not, however, embodied in the aforesaid written contract of May 3, 1929, which was carried out according to its terms. Fred Stebler testified in the instant case, but was not asked about and made no statement relative to any restriction being imposed upon the sale of the stock or the existence of any gentleman's agreement not to sell same in 1928 or 1929. The book value of the stock was about $20 per share, but during 1929 the stock was boosted to $55 per share.

The stock of the Food Machinery Corporation, successor to the John Bean Manufacturing Co., at the time of its receipt by the decedent had a fair market value of $35 per share.

During the years 1928 and 1929 here involved, the partnership of George D. Parker Co. was still in process of liquidation, its principal income being interest on the excess withdrawals made by the decedent and C. E. Brown. The decedent returned as income for the year 1928 the sum of $841.24 and for the year 1929 the sum of $834.20, being one fourth of the partnership income as shown on the partnership return.

The respondent in computing decedent's taxable income added to such income for the year 1928 the sum of $1,402.09, representing one fourth of the partnership profits, allocable to Clara B. Parker, or $841.25, and one sixth of the profits, allocable to the estate of Catherine Barr, or $560.84. The respondent took similar action in the year 1929, adding $1,204.90 to the decedent's taxable income.

The decedent Parker transacted his business on the accrual basis.

The partnership of George D. Parker Co. filed returns for each of the years in issue.

In behalf of the petitioner it is contended that the loaning of large amounts of money by the decedent to the Parker Lumber & Box Co. over a period of years, under the circumstances shown, constituted a business regularly carried on and was as much a part of decedent's trade or business as any other matters engaging his attention and requiring his services.

The average investment of George D. Parker in the Parker Machine Works during the years 1928 and 1929, according to his books, was $170,870.12 and $208,036.63, respectively. The net income from such individual business, as shown by his books, was $90,786.91 for 1928 and $92,930.51 for 1929.

The evidence indicates that a net return of 7 percent would be a fair return on capital investments.

The Parker records show that at the end of the year 1927 he had a net investment in his business, exclusive of his investments in stocks, bonds, securities, and other similar investments, of $138,417.39.

His books or records show that at the end of the year 1928 he had a net investment of $203,322.86 in his business and in 1929 a net investment of $212,750.41.

The decedent Parker gave close and constant attention to the Parker Machine Works business during the years in issue. About fifty or sixty persons were employed there. Parker inspected and supervised the work of all. He received a salary of $6,000 for the services he rendered at the Parker Machine Works. The record does not disclose what, under all the circumstances, would have been a reasonable salary for his services, if an annual salary of $6,000 was not such. One witness expressed the opinion that $500 per month was moderate for a man of decedent's ability. The record indicates that for a number of years decedent had received that salary and it is not shown that he considered it inadequate for the services he rendered there. He had other interests and rendered other services in connection with them, receiving income therefrom.

A comparative statement of the assets, liabilities, and net worth of the Parker Lumber & Box Co., as of December 31, 1920-1928, inclusive, is printed at the top of page 1240 of 30 B.T.A., heretofore referred to.

OPINION.

SEAWELL: (1) The first error assigned is that the respondent failed to allow the decedent to carry forward and deduct from 1928 income an alleged net loss of $55,231.83 sustained by the decedent in his business in 1927.

It is not disputed that in 1927 and prior years (1920-1927, inclusive) the decedent, George D. Parker, advanced to the Parker Lumber ber & Box Co. $192,843.34, which amount in 1927 he wrote off his books as a worthless or bad debt and claimed the same as a deduction in his return for the year 1927, which was allowed by the respondent. It is alleged in the amended petition that this chargeoff resulted "in a net loss for the year 1927 which the respondent has erroneously and illegally failed to allow as a deduction from 1928 income in accordance with the provisions of section 117 of the Revenue Act of 1928."

The respondent admits that the decedent sustained a loss in 1927 as stated, but he insists the decedent is not, in the circumstances of the instant case, entitled to have same carried forward and deducted as a net loss in the computation of his tax liability for 1928 as claimed by petitioner. The respondent contends that the loaning or advancing of $192,843.34 to the Parker Lumber & Box Co. did not, under the circumstances shown, constitute the operation of a trade or business regularly carried on by decedent, and, such being true, no net loss for 1927, within the meaning of the Revenue Act of 1928, section 117 or any of its subsections, resulted, as petitioner insists.

In behalf of the petitioner it is argued that the large advances made by the decedent to the Parker Lumber & Box Co. over a period of years were not merely isolated or occasional transactions, but were so numerous, constant, and closely connected with his own private and individual business as to constitute such a part of his trade or business. We, however, think differently and are of the opinion and hold that on this issue the decision in Burnet v. Clark,287 U.S. 410">287 U.S. 410, is controlling, and that the loaning or advancing of money by the decedent Parker to the Parker Lumber & Box Co., which occasioned or resulted in the loss of $192,843.34 to Parker, under the circumstances disclosed by the record, did not, within the meaning of the Revenue Act of 1928, constitute the operation by the decedent of a trade or business regularly carried on. See also Joseph Cavedon,30 B.T.A. 364">30 B.T.A. 364. Cf. Ames v. Commissioner, 68 Fed.(2d) 301; certiorari denied, 292 U.S. 635">292 U.S. 635.

Notwithstanding the allegations in the amended petition as to the loss and charge-off on his books in 1927 of the $192,843.34 by the decedent and a bad debt deduction taken therefor in his 1927 return and allowed by the respondent, on brief in behalf of the petitioner it is argued that the facts show the losses on the aforesaid advancements to the Parker Lumber & Box Co. were sustained during 1928 and should be allowed as deductions in that year. That such were not so allowed by the respondent is not, however, assigned as error. In the light of the facts shown by the record, we are of the opinion and hold, as heretofore indicated, that in dealing with the alleged loss by the decedent of $192,843.34 the respondent did not commit error and his action in refusing to allow the alleged net loss of $55,231.83, or any part thereof, to be carried forward as a deduction from 1928 income, is approved.

(2) The second assignment of error is based on the fact of the failure of the respondent to recognize George D. Parker Co. for the years 1928 and 1929 as a five-party partnership, the respondent continuing, as in prior years, to deal with it as a two-party partnership, in which George D. Parker had a two-thirds interest and C. E. Brown a one-third interest.

Having, in the heretofore-mentioned consolidated cases, held that George D. Parker Co. was a five-party partnership and the record showing that the same during the years now in issue was in process of liquidation and that the increase by respondent of decedent's net taxable income from the partnership in said years was due to considering and computing Parker's partnership interest as being two thirds instead of one fourth, as it really was under the five-party partnership agreement, we are of the opinion and hold that the respondent erred as alleged in the second assignment of error and his determinations increasing the decedent's net taxable income from the partnership in the amounts of $1,402.09 and $1,204.90 for the years 1928 and 1929, respectively, are disapproved.

(3) With respect to the third assignment of error, the record shows that George D. Parker considered the aforesaid cost of his stock in the Parker Lumber & Box Co. plus certain other items (consisting of certain oil stock, abandoned oil lease, etc.), aggregating $67,426.68, as a total loss in 1928 and in his return for that year treated the property on which loss was asserted as community property, deducting as a loss on "worthless stocks and oil leases' one half of the total cost thereof, or the amount of $33,713.34.

It is insisted by the respondent that such stock became worthless prior to 1828, to wit, in 1927, and at that time must have been so known to the decedent.

It has been shown that the decedent claimed and was allowed a loss of $192,843.34 in 1927, that amount representing unpaid and unsecured advances made by the decedent to the Parker Lumber & Box Co. The record shows that the decedent purchased in October 1927, at the sheriff's sale, under judgment he obtained upon foreclosure of the aforesaid mortgages on the company's property, substantially all the corporate assets, which in the amended petition are alleged to have been of a fair market value of not exceeding $100,000. Under such circumstances, taken in connection with other facts shown in the record, it appears to us that it must have been apparent to the decedent Parker at the time of the sale by the sheriff that the equity of redemption in the property, having a value of only $100,000, which was sold and bid in to satisfy a judgment of $240,375.75, was worth nothing and that there was no basis for a reasonable belief that he would ever realize anything on his stock; that it was then evident that his stock was as worthless as his claim of $192,843.34 for advances, which was charged off by him as a worthless debt in 1927 and allowed as such by the respondent.

In our opinion, and we so hold, the aforesaid third assignment of error is not sustained by any evidence sufficient to overcome the presumption of the correctness of the respondent's determination in reference to the alleged loss and in adding the sum of $8,481.77 to the decedent's income for 1928 as an overstatement of loss, and respondent's action in so doing is approved.

(4) and (5) Errors four and five raise the issue whether or not the respondent committed error in refusing to allow the decedent to include in his returns for 1928 and 1929 only one half of the total gross income actually received by him during those years. It is not disputed that for 1928 and 1929 the decedent and his wife filed separate returns, each returning one half of the asserted income received by the decedent, on the theory that all income received by the decedent was community property.

The respondent refused to allow such division, with the single exception of salary of the decedent for services at the Parket Machine Works, amounting to $6,000, and added to decedent's gross income the one half of such income which was reported by his wife.

Petitioner's ultimate contention with respect to these two assignments of error is that the respondent has overstated decedent's income for the year 1928 by $39,413, and has overstated decedent's income for the year 1929 by $39,183.97, by failing to recognize petitioner's contention that these amounts represented the wife's share of community income for those years.

It is now well settled that since July 29, 1927, divisible community income of California husband and wife taxpayers is limited to income from community property acquired after July 29, 1927, and to all salaries, wages, and fees earned by either spouse on and after that date. See section 161 a, Civil Code of California, effective July 29, 1927; United States v. Malcolm,282 U.S. 792">282 U.S. 792; Hirsch v. United States, 62 Fed.(2d) 128; certiorari denied, 289 U.S. 735">289 U.S. 735; Helen N. Winchester, Administratrix,27 B.T.A. 798">27 B.T.A. 798; and Gouverneur Morris,31 B.T.A. 178">31 B.T.A. 178.

Petitioner, in setting forth her contention that decedent's income for 1928 and 1929 is overstated by the amounts of $39,413 and $39,183.97, respectively, does not take issue with the proposition of law, as stated in the previous paragraph. In fact, she has to rely upon that proposition in order to sustain her position.

Petitioner's proposition is that in California, on and after July 29, 1927, where income which the husband receives from a business in which either his separate property or community property acquired prior to July 29, 1927, is invested is the result of both (1) such investment and (2) his own personal services, then such income should be segregated and apportioned between the two sources, with the result that all income which is essentially attributable to such investment should be taxed to the husband, and all income which is essentially attributable to his services should be taxed equally to the husband and wife as community property.

This is practically the same question as was before the Board in Julius Shafer,2 B.T.A. 640">2 B.T.A. 640, which, however, involved the law of the State of Washington rather than California. There the closing paragraph of our opinion was as follows:

Summarizing our decision, it is that, under the laws of the State of Washington, income arising in part from separate property and in part from community effort should be apportioned; that where an apportionment has been made by the taxpayer which the Commissioner accepts and which appears to be reasonable, such apportionment will not be disturbed.

In G.C.M. 9825 (X-2 C.B. 146) the General Counsel, in an extended opinion on the proper method of determining the earned income credit provided for by section 31 of the Revenue Act of 1928, when the income was derived from a combination of personal services and capital, in part, said:

In California the situation is complicated by the construction placed on the community property laws by the courts of that State. It has been held that inasmuch as the income from a partnership between the husband and a third party was in part attributable to his separate capital and in part to his personal labor or effort, such part of the profit as accrues from the use of capital is separate property and such part as is due to the personal activity, ability, and capacity of the husband is community property. (Pereira v. Pereira, 156 Cal., 1, 103 Pac., 488; McDuff v. McDuff, 48 Cal. A., 175, 191 Pac., 957; In re Gold's Estate, 170 Cal., 621, 151 Pac., 12.) In Pereira v. Pereira, in discussing the apportionment of income between that part attributable to the use of the capital of the husband and that part attributable to the activity, ability, and capacity of the husband, the supreme Court of the State used the following language:

* * * The separate property should have been credited with some amount as profit on this capital. It was not a losing business, but a very profitable one. It is true that it is very clearly shown that the principal part of the large income was due to the personal character, energy, ability, and capacity of the husband. This share of the earnings was, of course, community property; but without capital he could not have carried on the business. In the absence of circumstances showing a different result, it is to be presumed that some of the profits were justly due to the capital invested. There is nothing to show that all of it was due to defendant's efforts alone. The probable contribution of the capital to the income should have been determined from all the circumstances of the case, and, as the business was profitable, it would amount at least to the usual interest on a long investment well secured. * * * [Italics supplied.]

Furthermore, the Supreme Court of California in In re Gold's Estate stated as follows:

The plaintiffs claim that Gold's share of the partnership profits made after the marriage became Gold's separate property by reason of the fact that the partnership was formed prior to the marriage. Where a business has been carried on and capital has been invested therein before marriage, the entire profits therefrom, after marriage, are not necessarily separate property of the husband. The rules regarding the character of such property were considered in Pereira v. Pereira (156 Cal., 1, 103 Pac., 488, 23 L.R.A. (N.S.), 880, 134 Am.St.Rep., 107.) The principle there stated is that the interest of the husband in the capital of the partnership, as it was at the time of his marriage, is the husband's separate property, and that the question what part of the subsequent profits arises from the use of this capital and what part from the personal activity, ability, and capacity of the husband is to be determined by the court from the circumstances appearing in the case, that whatever accrues from the latter source is community property, and that the remaining profits must be classed as separate estate. * * *

It is necessary, therefore, in the audit of returns in the State of California, where the husband is a member of a partnership in which both personal services and capital are income-producing factors (and the wife is not a member of the partnership), that effect be given to section 31 of the Revenue Act of 1928 and to the law of the State as set forth in the court decisions referred to above. * * *

Cf. Rucker v. Blair, 32 Fed.(2d) 222; Anna L. Compton, Execu trix,11 B.T.A. 26">11 B.T.A. 26.

The evidence indicates that the average capital investment in the decedent's box-nailing machine business operated under the name of Parker Machine Works for 1928 and 1929 was $170,870.12 and $208,036.63, respectively; and that the net business income for those years was $90,786.91 and $92,930.51, respectively. It is also shown that a return of 7 percent would be a fair return on the capital investment in that business and that $6,000 was reasonable compensation for decedent's services in each of said years.

With respect to assignments of error four and five, we are of the opinion and hold, therefore, that the total net business income of each of the years 1928 and 1929 should be apportioned on the basis of a fair return on decedent's said investment and his reasonable compensation of $6,000 as above indicated, in accordance with the method outlined in G.C.M. 9825, supra, which we think is based on the correct principle and should be computed, as follows:

For the year 1928
11,960.91/17,960.91 of $90,786.91 equals $60,458.74, or the amount essentially
attributable to decedent's investment.
6,000.00/17,960.91 of $90,786.91 equals $30,328.17, or the amount essentially
attributable to the personal services rendered by the decedent, and, therefore,
community income.
Correct community income	$30,328.17
Amount determined by respondent as community income	6,000.00
	-------------
Additional community income	24,328.17
1/2 taxable to the wife	12,164.09
For the year 1929
14,562.56/20,562.56 of $92,930.51 equals $70,677.30, or the amount essentially
attributable to decedent's investment.
6,000.00/20,562.56 of $92,930.51 equals $22,253.21, or the amount essentially
attributable to the personal services rendered by decedent, and, therefore,
community income.
Correct community income	$22,253.21
Amount determined by respondent	6,000.00
Additional community income	16,253.21
1/2 taxable to the wife	8,126.61

(6) In reference to the sixth assignment of error little need be said. It is undisputed that the decedent during the years in issue was engaged in a trade or business in which both personal service and capital investment are material income-producing factors and under such circumstances, in computing earned income credit to the decedent, he was limited to the 20 percent allowance provided in section 31(a)(1), (2), (3) and (b) of the Revenue Act of 1928. The respondent's deficiency notice shows a credit of 25 percent for earned net income in the amount of $245.14 for the year 1928 and in the amount of $335.82 for 1929. These earned income credits result from the respondent's determination that earned net income of the decedent in the year 1928 was $21,555.63, or 20 percent of a net income from business of $107,778.14, and that earned net income for the year 1929 was $26,884.20, or 20 percent of a net income from business of $134,421.01. The petitioner insists that earned income credit for each year should be based on earned income of at least $30,000. The computation of net income as made by the respondent, resulting in earned income credits for 1928 and 1929 in the respective amounts stated, is not in evidence, nor does the record show wherein the respondent committed error in his computations, if error was made therein.

In our opinion and we so hold, the evidence in the record is not sufficient to overturn the presumption of the correctness of the respondent's determination with respect to earned income credits.

(7) and (8) Relative to assignments of error seven and eight, there is no reference nor argument made in petitioner's brief to sustain same and in our view no evidence adduced overcoming the presumption of the correctness of the respondent's determination in reference thereto. Therefore, we are of the opinion and hold that as regards those assignments the determinations of the respondent are correct and his action is accordingly approved.

(9) The decedent and Fred Stebler organized the Stebler-Parker Co. about 1921. Each of them acquired 50 percent of the corporation's stock. The decedent's basis of his 1,125 shares (exclusive of the $10,000 paid by him in 1922 to George X. Wendling for services in the matter of the organization of the Stebler-Parker Co.) was $112,500. The John Bean Manufacturing Co. (name later changed to Food Machinery Corporation) was organized about 1928 for the purpose of acquiring the business of several corporations.

In 1929 the John Bean Manufacturing Co. acquired all the capital stock of the Stebler-Parker Co. from decedent and Stebler (including certain patents owned by decedent, but which pertained to the business of Stebler-Parker Co.) for 14,000 shares of its own common stock and $51,674.42 in cash. Decedent's basis for the patents owned by him was $1,114.73. Decedent received 6,500 shares of the common stock of the John Bean Manufacturing Co. and all the cash of $51,674.42; Stebler received the remaining 7,500 shares of stock. Respondent determined and contends that decedent realized a profit on the transaction of $263,059.69, as set forth in our findings of fact.

Petitioner contends that (1) no gain whatever should be recognized because the transaction was "well within section 112 of the Revenue Act of 1928"; (2) that if held not to be within section 112, then no gain whatever should be recognized because decedent was under a gentleman's agreement not to sell any of the 6,500 shares during 1928, 1929, or 1930, which agreement precluded the stock from having any fair market value; and (3) that in any event the stock did not have a fair market value in 1929 in excess of $20 per share.

The record does not show whether the John Bean Manufacturing Co. took over the assets of the Stebler-Parker Co. and dissolved it or whether the latter company continued in existence. The facts in the instant case with respect to the transaction by which the John Bean Manufacturing Co. acquired all the stock of the Stebler-Parker Co. are analogous to the facts in John J. Watts,28 B.T.A. 1056">28 B.T.A. 1056, and, in accordance with our determination therein, we are of the opinion and hold that the transaction by which the John Bean Manufacturing Co. acquired the stock of Stebler-Parker Co. did not constitute a reorganization within the meaning of section 112(i)(1) of the Revenue Act of 1928, as insisted in behalf of the petitioner. See also A. L. Miller,29 B.T.A. 1061">29 B.T.A. 1061; A. T. Evans,30 B.T.A. 746">30 B.T.A. 746; Alice V. St. Onge,31 B.T.A. 295">31 B.T.A. 295. Cf. C. H. Mead Coal Co. v. Commissioner, 72 Fed.(2d) 22; W. C. Coleman,31 B.T.A. 319">31 B.T.A. 319.

The written agreement of May 3, 1929, discloses that the parties thereto were contemplating an exchange on a basis of the stock of the John Bean Manufacturing Co. having a then fair market value of $50 per share.

It is undisputed that the terms and provisions of the written agreement of May 3, 1929, were carried out. That agreement contains a provision with respect to placing the stock to be received by Stebler and the decedent in escrow. The escrow agreement, assuming that it was in fact executed, was not introduced in evidence at the hearing. Whether such an instrument, if executed, contained any clause with respect to a restriction on the sale of the John Bean Manufacturing Co. stock is not shown, but it is apparent that the escrow agreement, whatever its terms may have been, terminated not later than September 15, 1929, as specifically provided in the agreement of May 3, 1929.

The intention of the parties to the agreement is clearly disclosed, and the purpose sought to be accomplished by the contract is free from any ambiguity. If there was in fact any understanding intended to be absolutely binding on the parties to the agreement to the effect that no sale of John Bean Manufacturing Co. stock should be made by Stebler or Parker or others in 1928 or 1929, it appears inconsistent and unreasonable that the written contract made no mention of any such restriction.

Fred Stebler received 7,500 shares of the stock of the John Bean Manufacturing Co. under the terms of the identical contract by which the decedent received 6,500 shares of the stock. Stebler testified in the instant case, but the record fails to disclose that he was asked or stated anything about the alleged restriction or agreement that the decedent and Stebler were not to sell during 1928 or 1929 any of the John Bean Manufacturing Co. (Food Machinery Corporation) stock acquired by them in the manner heretofore described. Stebler was certainly well qualified to testify as to the existence of any restriction put upon the sale of the stock if such was imposed thereon at the time of its acquisition by him and the decedent.

Viewing the record as a whole, we think, as heretofore stated, that the John Bean Manufacturing Co. (Food Machinery Corporation) stock when received by the decedent in exchange for his Stebler-Parker Co. stock had a fair market value of $35 per share and we are of the opinion and hold that the profit to the decedent on the exchange should be recomputed on that basis instead of $50 per share as determined by the respondent.

With respect to the $10,000 paid in 1922 to George X. Wendling by the decedent Parker for services rendered him in the matter of the organization of the Stebler-Parker Co., which we have held (in 30 B.T.A. 1231">30 B.T.A. 1231, supra ) was not deductible as an ordinary and necessary expense of carrying on business and which in the instant case is sought to be added to the cost of the decedent's stockholdings in the Stebler-Parker Co. and recognized in determining the profit or loss resulting from the exchange in 1929 of Stebler-Parker Co. stock for John Bean Manufacturing Co. stock, we are of the opinion and hold that the petitioner should be permitted to add that amount to the basis of decedent's Stebler-Parker Co. stock in determining the gain involved in the exchange of Stebler-Parker Co. stock for John Bean Manufacturing Co. (Food Machinery Corporation) stock. Malta Temple Association,16 B.T.A. 409">16 B.T.A. 409.

Judgment will be entered under Rule 50