Shunk v. Commissioner , 10 T.C. 293 ( 1948 )

John Q. Shunk, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Francis R. Shunk, Deceased, John Q. Shunk, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Catherine Fegley, Deceased, John Q. Shunk, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent

Shunk v. Commissioner

Docket Nos. 9540, 9541, 9542

United States Tax Court

10 T.C. 293; 1948 U.S. Tax Ct. LEXIS 263;

February 17, 1948, Promulgated

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Decision will be entered under Rule 50.

The trust estate, taxable as a corporation, sold its assets and business to a partnership composed of the three beneficiaries and two employees who were not beneficiaries. The selling price was the book value of the assets at the close of the fiscal year 1940. No value for good will was carried on the books of the company. The partnership continued the business under the same name. Held, the trust estate transferred good will to the partnership which had a fair market value of $ 110,194.80; held, further, long term notes given to the trust estate had a fair market value equal to their discount value; held, further, the stockholder-beneficiaries received in effect a distribution taxable as a dividend to the extent of the difference between the fair market value of the business and assets and the consideration received therefor.

J. K. Baird, Esq., for the petitioners.

Charles Munz, Esq., for the respondent.

Arnold, Judge. Johnson, J., did not participate in the consideration of or decision in this report.

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ARNOLD

The Commissioner determined income tax deficiencies in each of these consolidated cases for the calendar year 1940. By amended answers he seeks to increase the deficiencies as to each petitioner. The original deficiencies and the increases requested by the Commissioner are as follows:

	Original	Increase	Total
	deficiency
John Q. Shunk	$ 83,175.32	$ 41,551.88	$ 124,727.20
Estate of Francis R. Shunk	13,315.47	8,153.60	21,469.07
Estate of Catherine Fegley	12,715.92	8,055.33	20,771.25

The only issue is whether three individuals, the sole beneficiaries of a trust taxable as a corporation, received taxable distributions upon the sale of the trust business and assets to a partnership, a five-sixths interest in which was owned by them. The Commissioner determined that the taxable distribution was the excess of fair market value, including good will, over the purchase price of the business and assets. As used herein, the term "petitioners" usually refers to the individuals and not to the estates of the deceased.

FINDINGS OF FACT.

During the taxable year John Q. Shunk, Francis R. Shunk, and Catherine Fegley, brothers and sister, resided in Bucyrus, Ohio. Their income tax returns for 1940 were filed with the collector of internal revenue at Toledo, Ohio. Catherine Fegley died October 16, 1941. Francis R. Shunk died May 17, 1943. John Q. Shunk is the executor of both estates.

John Q. Shunk, Francis R. Shunk, and Catherine Fegley were the owners, under a certain trust agreement dated February 16, 1938, of the Shunk Manufacturing Co. of Bucyrus, Ohio. For many years prior to November 1, 1940, the company was an association taxable as a corporation. Prior to 1920 the company was a family partnership, composed of three brothers and a sister. The ownership of the business on October 31, 1940, was, John Q. Shunk, general manager, two-thirds; Francis R. Shunk, one-sixth; Catherine Fegley, one-sixth.

Under date of November 1, 1940, John Q. Shunk, Francis R. Shunk, Catherine Fegley, Mary E. Gardiner, and Gale Fegley entered into a partnership for the purpose of acquiring all the assets and business of the Shunk Manufacturing Co. Mary E. Gardiner was office manager of the company and had been an employee thereof for 40 years. Gale Fegley, a son of Catherine Fegley, had been with the company for about 22 years, and in 1940 was acting as purchasing agent and as sales, advertising, traffic, and production manager for the company. Under the agreement each partner contributed $ 1,000 in cash to the partnership.

The partnership agreement provided that John Q. Shunk should be employed as manager. By reason of the small amount of capital invested, each partner's income or loss derived from the partnership business was to be distributed one-half to a capital account and one-half to a personal account. The provisions relating to the recoupment of losses are deemed immaterial. Any amount standing to the credit of a partner in his or her personal account could be withdrawn by the partner, the withdrawal to be recorded in the partner's personal account. If any partner retired for any reason, such partner's interest "shall be considered to have a value as shown by such partner's personal account and such partner's capital account, as shown by the records of the partnership," plus amounts due and less debts owed as shown by the partnership records. Each partner specifically agreed that "no other thing or things or elements of value shall enter into the computation or determination" of the value of a partner's interest and "no consideration of such items as good will, appreciation of assets, market value of assets, or any other thing other [sic] than that which is hereinbefore expressly stated and set forth, shall enter into such computation or determination of value." Each partner agreed that provisions aforementioned were binding upon him or her, their executors, administrators, heirs at law, legatees, devisees, beneficiaries, or any person claiming to have acquired a partner's interest. Upon dissolution of the partnership for any reason, the remaining partners were given the option of acquiring the share, right, or interest of the partner or partners retiring, withdrawing, or ceasing to be a partner, at the value hereinabove specified for computing a partner's interest. The partners were to share in profits and losses as follows: John Q. Shunk, one-half; Francis R. Shunk, one-sixth; Catherine Fegley, one-sixth; Mary E. Gardiner, one-twelfth; and Gale H. Fegley, one-twelfth. Article XII of the partnership agreement provided:

The interest of each partner in said partnership and the property thereof, shall be as shown by each partner's personal account and capital account on the books of said partnership.

The certificate of partnership was duly acknowledged and filed with the clerk of the Court of Common Pleas of Crawford County, Ohio, on January 22, 1941.

At a meeting held on October 24, 1940, the trustees of the Shunk Manufacturing Co. had authorized John Q. Shunk to proceed with the arrangements to sell the entire assets of the company. At a meeting of the trustees on November 1, 1940, John Q. Shunk informed the owners, trustees, and shareholders that all arrangements for sale of the business and property had been made and "that all the assets and liabilities of the Shunk Manufacturing Company had been sold to a partnership which will operate under the same name * * *." The sale price was to be determined by the books of the company after closing all transactions to and including October 31, 1940, the partnership to take over November 1, 1940. The partnership was to pay $ 3,000 cash plus five notes of approximately equal amounts due two, four, six, eight, and ten years after date. Each note was to bear interest in the sum of $ 100 per annum until fully paid, and no other interest thereon. The trustees ratified the sale at their November 1, 1940, meeting. At a meeting on November 29, 1940, the trustees executed a deed for the real estate and a bill of sale for the personalty to the partnership, each partner being designated as such and each instrument being dated November 1, 1940. The bill of sale included good will and the name as a part of the property transferred, although no value therefor appeared on the books of the trust estate.

Under date of November 1, 1940, the Shunk Manufacturing Co. (partnership) executed five promissory notes maturing two, four, six, eight, and ten years thereafter, in the amount of $ 89,570.25 each and aggregating $ 447,851.24, in favor of the Shunk Manufacturing Co. (trust estate). Each note bore the name of the partnership as maker and the signature of each partner. On November 28, 1940, each of the partners paid $ 1,000 into the partnership. On November 29, 1940, the partnership paid the trust estate $ 3,000 in cash. The books of the trust estate reflect the receipt of the cash and notes on November 30, 1940. The partnership's notes and bills payable account #101 shows the notes outstanding on November 30, 1940. The first note was paid off by partnership payments of $ 32,598.44 in October 1941 and the balance on May 15, 1942. The second note was paid in full July 16, 1942, and the third note on October 21, 1942. The last two notes were paid in full on October 29, 1943.

Each of the aforementioned notes provided for interest at $ 100 per annum, payable on or before October 31 of each year. The interest was fixed upon the advice of the trust estate's accountant and tax consultant that it would effect a savings in the amount of personal property taxes that would otherwise be imposed by the State of Ohio.

The parties have stipulated with respect to the notes that:

* * * if the Court determines that the five notes are to be discounted, and if the Court determines that the discount period is the period set forth on the face of the notes, the notes shall be discounted at three per cent (3%) and the present value of the notes on November 1, 1940 is $ 379,040.26. It is stipulated, considering the business factors existing on November 1, 1940, that a three per cent (3%) rate is a reasonable rate for discount. It is stipulated that if the Court determines that the notes be discounted, and if the Court determines that the period for discounting is the period of time which each note was outstanding and unpaid, then the discount rate shall be three per cent (3%) and the present value of the notes on November 1, 1940 is $ 420,600.00.

Neither the partnership nor the trust estate discounted the notes in maintaining their accounting records, and no charge as interest expense due to discount was made by the partnership.

The Shunk Manufacturing Co. (trust estate) had undistributed earnings and profits on October 31, 1940, accumulated after February 28, 1913, of not less than $ 276,988.48.

The balance sheets of the trust estate appearing in schedule O of its income tax return for the fiscal year ended October 31, 1940, show assets and liabilities at October 31, 1940, as follows:

Assets		Liabilities
Cash	$ 18,958.84	Accounts payable	$ 21,111.32
Notes and accounts receivable	208,196.62	Accrued expenses (taxes,
		pay roll)	16,393.92
Inventories	208,904.25	Due employees	26,223.23
Investments	879.00	Miscellaneous liabilities	41.81
Depreciable assets, less		Earned surplus and
reserve for depreciation	112,435.10	undivided profits	503,129.42
Land	5,216.75	Total	566,899.70
Prepaid insurance	12,309.14
Total	566,899.70

In schedule P of the same income tax return the trust estate reported total "distributions to stockholders charged to earned surplus during the taxable year" as $ 94,575.25. The trust estate's tax return for the fiscal year ended October 31, 1941, shows in schedule L that its only assets at October 31, 1941, were cash in the amount of $ 13,511.62 and notes and accounts receivable of $ 415,252.80. In schedule M of its 1941 return the trust estate shows a depreciation adjustment of $ 52,278.18, which reduced earned surplus and undivided profits at November 1, 1940, to $ 450,851.24. The depreciation adjustment was made by an internal revenue agent and was agreed to by the trust estate.

The schedule below shows the assets, earnings, income taxes, and income of the trust estate for the fiscal years 1932 to 1940, inclusive:

			Net tangible
Year ended --	Total tangible	Net tangible	assets exclusive	Net earnings
	assets	assets	of investment	of company
			assets
10-31-32	$ 390,795.25	$ 374,186.31	$ 357,216.95	-$ 3,927.67
10-31-33	329,100.89	323,105.85	305,824.61	-46,225.10
10-31-34	354,417.81	343,075.32	318,691.96	23,171.25
10-31-35	384,270.40	368,247.36	320,718.15	28,538.29
10-31-36	435,914.00	404,644.83	353,702.50	49,933.58
10-31-37	450,495.66	415,116.10	358,193.77	89,791.53
10-31-38	442,633.57	421,092.92	308,520.59	73,582.90
10-31-39	461,615.95	428,765.56	381,181.79	99,929.18
10-31-40	514,399.70	455,093.54	454,214.54	127,953.09
Total	3,763,643.23	3,533,327.79	3,158,264.86	442,746.55
Average	418,182.58	392,591.98	350,918.32	49,194.56

				Income on
		Net income,	Income from	assets other
Year ended --	Income taxes	less income	investment	than investment
		taxes	assets	assets
10-31-32		-$ 3,927.67	$ 180.14	-$ 4,107.81
10-31-33		-46,225.10	679.56	-46,904.16
10-31-34	$ 3,025.76	20,145.49	860.13	19,285.36
10-31-35	3,708.89	24,829.40	2,735.03	22,094.37
10-31-36	6,255.67	43,677.41	3,741.07	39,936.34
10-31-37	14,201.63	75,589.90	4,472.51	71,117.39
10-31-38	9,988.20	63,594.70	5,422.77	58,171.93
10-31-39	16,457.67	83,471.51	8,614.02	74,857.49
10-31-40	21,759.11	106,193.98	4,524.49	101,669.49
Total	75,396.93	367,349.62	31,229.22	336,120.40
Average	8,377.44	40,816.62	3,469.91	37,346.71

After the transfer of its business and assets to the partnership, the trust estate continued in existence. Its activities consisted primarily of the investment of its funds, care of the purchase money notes, distribution of income to its equity owners who continued to hold their equity shares, the filing of corporate tax returns, and the payment of county taxes.

After November 1, 1940, the partnership continued to engage in the business formerly conducted by the trust estate. Upon the death of Catherine Fegley in October 1941, a new partnership agreement was entered into by the surviving partners and Fremont and Robert Fegley, two sons of Catherine Fegley. Under the new partnership agreement the partnership interests in profits and losses were as follows: John Q. Shunk, one-half; Francis R. Shunk, one-sixth; Mary E. Gardiner, one-twelfth; Gale H. Fegley, five-thirty-sixths; Fremont H. Fegley, and Robert J. Fegley, one-eighteenth each. The material provisions of the new agreement were the same as those of the preceding partnership agreement.

Upon the death of Francis R. Shunk, new articles of copartnership, dated May 17, 1943, were executed by the surviving partners, who were to share in profits and losses as follows: John Q. Shunk, eighteen-thirtieths; Mary E. Gardiner, three-thirtieths; Gale H. Fegley, five-thirtieths; Fremont H. and Robert J. Fegley, two-thirtieths each. The material provisions of the new partnership agreement were the same as those of the two preceding partnership agreements.

The parties have stipulated that the "partnership information income tax returns show the ordinary net income of the business, the partners' earned income for the years indicated as shown below, and the ordinary net income less the partners' earned income is as shown below for the years designated":

	Ordinary net	Earned income	Net earnings
	income
Oct. 31, 1941	$ 341,115.94	$ 47,554.46	$ 293,561.48
Oct. 31, 1942	345,453.46	48,456.51	296,996.95
May 31, 1943 (7 months)	210,223.37	34,781.37	175,442.00

At the end of the first year of partnership operations the profits were distributed to each partner in accordance with the partnership agreement of November 1, 1940. Each partner's share of the profits was credited one-half to his or her personal account and one-half to capital account, as provided in the partnership agreement.

In October 1941 Catherine Fegley's personal and capital accounts were credited with $ 22,620.29 and $ 22,620.30 as her share of partnership earnings. As of October 31, 1941, her personal and capital accounts showed a balance of $ 19,576.09 and $ 23,620.30, respectively. The latter amounts were turned over to her executor as her total interest in the partnership, and they were the entire amount that she received from her participation therein.

In August 1943 John Q. Shunk, Mary E. Gardiner, Gale, Fremont, and Robert Fegley, individually and as copartners, agreed to sell the business and certain assets of the partnership for $ 337,200, and the inventory, including shop supplies, for $ 233,000, or a total of $ 570,200. The assets transferred under the agreement included "all patents, patent applications, licenses, copyrights, trade marks or trade names, good will, orders on hand, and any and all other rights, privileges, options and franchises in or to the business carried on by the Sellers and their predecessors under the name and style of Shunk Manufacturing Company, and the partnership name." The contract price for land, buildings, equipment, etc., was based upon the appraised value thereof made by independent appraisers employed by the purchasers. The appraisers included no amount in their appraisal representing the value of good will. A physical inventory was "priced out" by buyers and sellers, and the contract price of $ 233,000 included no amount for good will. Under the agreement the purchasers did not acquire accounts receivable or assume liabilities. Under the agreement the purchasers acquired all outstanding orders of the partnership, which amounted to approximately $ 1,000,000. The contract of sale was carried out by the parties in accordance with its terms.

The Shunk Manufacturing Co. started business prior to 1900 as a very small enterprise. Its business and the number of its employees increased steadily, so that by 1930 the company had about 50 employees. In 1940 it had 60 to 75 employees and a good business. For many years prior to the sale of its business in August 1943, the company manufactured the same types of products. Its products were sold in competition with the same types of products manufactured by other companies. Solicitation of business was primarily by letters written by employees in the company's office. No regular salesmen were employed to contact customers. Some orders were received without solicitation, from contractors or others who wanted the products manufactured by the company. Approximately 70 per cent of the company's sales in 1940 and prior thereto was attributable to its blades and moldboards used by manufacturers of heavy construction equipment such as road graders, bulldozers, snowplows, and scrapers. Blades and moldboards were sold to state highway departments and construction contractors as replacement parts for their road and construction equipment. Other products manufactured by the company included parts for farm equipment manufacturers and for dealers and agents supplying those parts. During the war the company also performed machining operations for other manufacturers. It had larger earnings during the war years of 1941, 1942, and 1943, due to increased business and the Government contracts of some of its customers. The company had no Government contracts of its own. At November 1, 1940, the company's machinery and equipment was 15 to 25 years old. By August 1943 many pieces of machinery and equipment used by the company had increased in value on an average of 250 to 300 per cent.

The business of the Shunk Manufacturing Co. has always been a family affair. Except for the period of operation as a trust estate, the business has always been operated as a partnership. John Q. Shunk has been general manager of the business for about 50 years. He was born and reared in Bucyrus, a town of about 10,000 inhabitants, and had lived there over 80 years. He was personally acquainted with 90 per cent of the employees and the employer-employee relationship was excellent. Gale Fegley and Mary E. Gardiner were personally acquainted with most of the employees, many of whom had attended school with Fegley. The employees were not unionized. John Q. Shunk spent about half his time in the factory experimenting with different types of steel. All questions of company policy were decided by John Q. Shunk. On occasions he attended conventions of road equipment manufacturers and dealers.

In determining the deficiencies the respondent determined that the trust beneficiaries purchased the assets and business of the Shunk Manufacturing Co. (trust estate) at a price which was $ 187,822.39 less than the fair market value thereof, which excess was held in effect to constitute a distribution of earnings and profits taxable as a dividend proportionately to the beneficiaries.

In his claim for increased deficiencies against the beneficiaries respondent determined that the fair market value on November 1, 1940, of the assets and business sold by the trust estate to the partnership was not less than $ 638,673.63, and that the discounted value of the five promissory notes was $ 358,685.15. The difference between $ 638,673.63, the fair market value of the assets and business sold, and $ 361,685.15, the cash and the discounted value of the notes paid therefor, was held to constitute a distribution of earnings and profits, taxable as a dividend to the beneficiaries.

The parties filed stipulated facts which have been summarized hereinabove. The omitted portions of the stipulated facts are incorporated herein by reference.

On October 31, 1940, the trust estate had an intangible asset, namely, good will, which had a fair market value of $ 110,194.80. The trust estate transferred this asset, together with its business and other assets, to the partnership composed largely of its stockholder-beneficiaries.

The notes given by the partnership to the trust estate for its business and assets, in the face amount of $ 447,851.24, had a fair market value of $ 379,040.26.

The trust estate transferred property for an amount substantially less than the fair market value of the property. The difference between the amount paid for the property and its fair market value, namely, $ 179,005.78, was in effect a distribution of earnings and profits, taxable as a dividend to the stockholder-beneficiaries.

OPINION.

In his brief respondent contends that the business and assets transferred by the trust estate to the partnership had a fair market value of $ 639,372.94. ¹ He contends, further, that the trust estate received only $ 382,040.26 as consideration therefor, and that the difference of $ 257,332.68 was, in effect, a taxable distribution to the beneficiaries of the trust estate under sections 22 (a) and 115 (a) of the Internal Revenue Code. He points to the trust estate's undistributed earnings and profits on November 1, 1940, of not less than $ 276,988.48 as proof of its ability to make the distribution.

Petitioners contend that the fair market value of the business and assets, less liabilities, of the trust estate on November 1, 1940, was not in excess of $ 450,851.24; that the partnership paid $ 450,851.24 for the business and assets of the trust estate by the payment of $ 3,000 cash and notes worth $ 447,851.24; that the sale, even if made at less than fair market value (which petitioners deny), did not effect a distribution by the trust estate to one or more partners "of earnings and profits taxable as a dividend" under sections 22 (a) and 115 (a) of the Internal Revenue Code, or Regulations 103, section 19.22 (a)-1.

The first question to be decided under the opposing contentions is the value of the business and assets transferred. Both parties accept the net worth per books as a yardstick for measuring assets transferred except good will. The dispute between them is over including and valuing good will as one of the assets transferred. Respondent has followed the formula set forth in A. R. M. 34, 2 C. B. 31, except that he allowed a return of 8 per cent on net tangibles and capitalized the remaining earnings at 15 per cent instead of 10 per cent and 20 per cent, as prescribed by A. R. M. 34. The substitution of the rates used for the rates in the formula is justified by respondent by their use in numerous decided cases and by his determination that trust estate's business was not of a hazardous nature.

On the question of good will, petitioners contend, first, that the trust estate had no good will; secondly, that if good will existed, it was personal to John Q. Shunk; and, finally, that if good will is to be valued by a formula, respondent used the wrong rates and period of years.

We agree with respondent that the trust estate had good will. The trust estate's earnings record over a period of years in an industry which the witnesses testified was hazardous or semihazardous speaks eloquently of the existence of good will. The testimony shows, and we have found, that the trust estate employed no solicitors. Its business was secured principally by letters written by office personnel. The management and the products of the trust estate must have been well and favorably known to support a business which has grown steadily for over 50 years in the strongly competitive earthmoving and construction equipment field. The absence of a value for good will on the books of the trust estate does not prove that there was no good will, nor prevent its valuation if good will in fact exists. R. E. Baker, 37 B. T. A. 1135, 1149.

The volume of orders on hand at the time the trust estate transferred its assets and business to the partnership was not established, but it seems clear that it was substantial, in view of the large volume of orders on hand in August 1943, when the partnership's assets and business were sold to outside interests. It is earnestly contended that this sale, within less than three years of October 31, 1940, establishes the nonexistence of a good will asset, since profits between the two transfers greatly exceeded the profits of any year prior to, and including, the fiscal year 1940. The logic of this argument fails before the inescapable fact that the purchasers in 1943 were seeking machinery and equipment difficult, and in some instances, impossible, to acquire, due to the impact of the war. It may well be that as to that sale the situation was comparable to that which existed in Watab Paper Co., 27 B. T. A. 488, 504, where we refused to fix a separate value for good will because of the liberal valuations allowed on the tangible assets transferred. In any event, this record convinces us that the trust estate transferred good will as a part of its assets and business, and that such good will had a value when acquired by the partnership.

Petitioners' second contention with respect to good will is that any good will that existed was personal to John Q. Shunk. It has long been recognized that the personal ability, skill, experience, acquaintanceship, or other characteristics and qualifications of individuals connected with the business do not constitute good will items transferable as property. Providence Mill Supply Co., 2 B. T. A. 791; Howard B. Lawton, 6 T. C. 1093; reversed on other grounds, 164 Fed. (2d) 381; Floyd D. Akers, 6 T. C. 693. Petitioners insist that the earnings of the trust estate in excess of a normal rate of return were attributable to John Q. Shunk's conduct of the business. They point to the low cost of operating, to the excellent employer-employee relationships and nonunion status of the employees, to the fact that the employees were personally known by name to John Q. Shunk, Mary E. Gardiner, and Gale Fegley, all of whom had grown up in Bucyrus, to the family nature of a business conducted in a small town, and to the many personal contacts between management and employees, as proof that the personal element was the principal component of any item of good will. Further, petitioners point to John Q. Shunk's long experience with the trust estate and its predecessors, his experiments with steel to improve the company's products, his attendance at conventions of dealers in road equipment, and his personal acquaintance with road equipment people, as personal attributes of John Q. Shunk from which the business benefited, but which were not susceptible of transfer as a business asset.

Conceding for the sake of argument (and the concession is only for that purpose) that all the things said about John Q. Shunk be true, it is still short of the situation dealt with in the Lawton case, supra, where one of the witnesses testified that, so far as he was concerned, without the Lawtons he didn't know anything about the company. We could concede that John Q. Shunk was an able executive, maintained excellent relations with the employees, and operated the business well, without disproving respondent's determination that the trust estate had a valuable good will. Actually, these attributes should assist in creating good will. Such attributes are expected by business concerns from its management. The record here shows that John Q. Shunk provided the trust estate with competent and able management. The record does not show that John Q. Shunk personally was responsible for the business. We can not, therefore, hold that good will existed only because of John Q. Shunk's personal following, reputation, ability, and experience.

Petitioners' final attack is leveled at the rates and period used by the respondent in valuing good will by a formula. Petitioners argue that the rates should be 10 per cent and 20 per cent, as used in A. R. M. 34. Respondent has used 8 per cent and 15 per cent, as shown in our footnote, supra. Petitioners also argue that the period for averaging income and net tangibles should be the nine fiscal years 1932-1940, inclusive, whereas respondent has used the five-year period preceding the fiscal year 1940. As early as Dwight & Lloyd Sintering Co., 1 B. T. A. 179, we pointed out that the period and the rates to be used were questions to be determined from all existing facts and circumstances. The decided cases repeatedly point out that the use of formulae and the determination of the rates to be used constitute but one method of valuing good will and that all other existing factors of value must be taken into account. ² Considering all factors of record, we have found the value of good will to be $ 110,194.80. The value of the business and assets transferred to the partnership, therefore, was $ 561,046.04.

The next question is whether the notes given by the partnership as part of the consideration for the business and assets had a value equal to their face value of $ 447,851.24.

In view of our decision on the first point, the partnership's assets, when the notes were executed, exceeded $ 560,000, i. e., assets per books, $ 450,851.24, plus good will, $ 110,194.80. In addition the individual partners were liable on the notes. We are uninformed as to the financial ability of each partner to respond, although there is testimony of record as to the property owned by Mary E. Gardiner and Gale Fegley. Nevertheless, we do know that petitioners, as sole owners of the trust estate, would ultimately receive any amounts paid on the notes. On the other hand, as owners of a five-sixths interest in the partnership, petitioners would be personally liable for any default on the notes. The principal parties at interest, therefore, are the petitioners, who are co-makers of the notes and at the same time the only persons beneficially interested in the proceeds therefrom.

We have no doubt that petitioners regarded the face value of the notes as their fair market value. But, as has been repeatedly stated in decisions of this and other courts, the test of fair market value is what the property will bring in a sale between willing parties dealing without compulsion. Considering the substantial asset values behind the notes and the personal liabilities of the several partners on the notes, the principal factor adversely affecting their value is their extended terms. It is well established that the present value of a dollar due at some time in the future decreases as the maturity date is postponed. This principle is recognized in financial and business circles by discount tables at varying rates and periods of time.

The parties here have recognized this business principle by stipulating the rate of discount to be used if we determine that the facts require application of the principle. The parties have also stipulated that at the agreed rate of discount the present value of the notes for their terms at November 1, 1940, was $ 379,040.26; and that the present value of the notes on November 1, 1940, if discounted for the period during which they were outstanding and unpaid, was $ 420,600. While we know now that the notes were paid in full within three years from the date they were executed, a buyer at November 1, 1940, would have had no such assurances. So far as he could tell, he would have to wait ten years for payment of the notes. During this period conditions could change to such an extent that the debtor would be unable to pay. It is unreasonable to suppose, therefore, that the buyer would purchase for more than the discounted value of the notes based on their extended terms. On this point we agree with the respondent that the discounted value of the notes is $ 379,040.26.

The final question is whether the difference of $ 179,005.78 between the fair market value of the business and assets transferred and the selling price should be considered a dividend distribution by the trust estate to its beneficiary-stockholders, the petitioners herein. The transfer effected a business reorganization, but it was not followed by the dissolution of the association taxable as a corporation, as so frequently happens in this type of transaction. See E. C. Huffman, 1 B. T. A. 52; Estate of D. F. Buchmiller, 1 B. T. A. 380. Nor can we say here, as in the last cited cases, that the interests in the successor partnership were identical with the stockholders' interests in the corporation. Here the former stockholders held only a five-sixths interest in the partnership as against the entire interest in the trust estate. This variance in interests owned is not, however, fatal to respondent's contention, nor is the continued existence of the trust estate dispositive of our question.

In Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63, the Supreme Court held that a sale of corporate assets by a corporation to its stockholders "for substantially less than the value of the property sold, may be as effective a means of distributing profits among stockholders as the formal declaration of a dividend. The necessary consequence of the corporate action may be in substance the kind of distribution to stockholders which it is the purpose of section 115 to tax as present income to stockholders, and such a transaction may appropriately be deemed in effect the declaration of a dividend, taxable to the extent that the value of the distributed property exceeds the stipulated price."

The selling price of the business and assets was $ 3,000 cash plus notes having a fair market value of $ 379,040.26. The fair market value of the business and assets transferred by petitioners as sole owners and beneficiaries of the trust estate was $ 561,046.04. Therefore, property was transferred by the trust estate taxable as a corporation to a partnership, a five-sixths interest in which was owned by the former stockholder-beneficiaries. The selling price was substantially less than the fair market value of the property transferred. Having in mind the holding in the Palmer case and other cases of like tenor, ⁴ it is our opinion that the consequence of the trust estate's action was in substance a distribution to its stockholder-beneficiaries which section 115 was designed to reach and tax as present income to the stockholder-beneficiaries. In the light of the Palmer decision, the transaction here "may appropriately be deemed in effect the declaration of a dividend." The "dividend," which under our decision amounted to $ 179,005.78, should be taxed to petitioners in proportion to their interests in the trust estate.

Decision will be entered under Rule 50.

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Footnotes

• 1. Respondent's Exhibit CC shows his valuation of the business and assets, as of November 1, 1940, as follows:

  Capitalization of good will	$ 188,521.70
  Net worth per books	450,851.24
  Total value	639,372.94

  Good will was valued by averaging net tangible assets exclusive of investment assets at the beginning of the fiscal years ended October 31, 1935 to 1939, inclusive, and by averaging income less income taxes for the same fiscal years as follows: Average income, $ 53,235.50; average net tangibles, $ 311,965.39; by allowing an 8 per cent return on net tangibles, or $ 24,957.23; and by attributing the remaining income of $ 28,278.27 to good will, which, capitalized at 15 per cent, gave a fair market value for good will of $ 188,521.70.↩

• 2. Herald-Despatch Co., 4 B. T. A. 1096; Otis Steel Co., 6 B. T. A. 358; Schilling Grain Co., 8 B. T. A. 1048, where Board fixed round sum slightly under figure resulting from capitalization of earnings; Kaltenbach & Stephens, Inc., 12 B. T. A. 1009; Toledo Newspaper Co., 2 T.C. 794">2 T. C. 794; Ushco Manufacturing Co. v. Commissioner, 151 Fed. (2d) 821, affirming Tax Court memorandum opinion; Central National Bank of Lincoln, Nebraska, 29 B. T. A. 719; Shanley & Furness, Inc., 21 B. T. A. 146; St. Louis Screw Co., 2 B. T. A. 649; Mossman, Yarnelle & Co., 9 B. T. A. 45; C. F. Hovey Co., 4 B. T. A. 175↩.

• 4. Timberlake v. Commissioner, 132 Fed. (2d) 259; Elizabeth Susan Strake Trust, 1 T. C. 1131; cf. Langstaff v. Lucas↩, 9 Fed. (2d) 691.