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Lusthaus v. Commissioner of Internal Revenue.

decided.: April 11, 1945.


Author: Mclaughlin

Before GOODRICH and McLAUGHLIN, Circuit Judges, and FAKE, District Judge.

McLAUGHLIN, Circuit Judge.

The question presented is whether the asserted partnership of the taxpayer and his wife should be so recognized for federal income tax purposes. The year involved is 1940.

It is conceded for the petitioner that the facts as found by the Tax Court are substantially correct. Briefly these are: For several years prior to 1940, the petitioner owned and operated a retail furniture business, consisting of two stores, both in Unitontown, Pennsylvania. In 1939 petitioner conferred several times with an accountant and an attorney and it was decided that he would "sell" to his wife a one-half interest in his business and make her an equal partner as of January 1, 1940. The net worth of the business, excluding goodwill and after a withdrawal of $20,000 by petitioner, was determined to be $210,000. Petitioner decided to make a gift to his wife of $50,000 so that she would have it as part of the purchase money for the one-half interest. After some delay, in June, 1940, the petitioner executed a bill of sale to his wife for a one-half undivided interest in his furniture business. The stated consideration was $105,253.81, representing one-half of the estimated value of the business on December 31, 1939. Mrs. Lusthaus, at or about the same time, executed a partnership agreement. A few days later the petitioner borrowed $25,000 from a bank. He gave his wife a check for $50,000, which sum was made up from the proceeds of the loan and from money previously withdrawn from the business. Then Mrs. Lusthaus gave petitioner her check for $50,253.81 together with eleven promissory notes totalling $55,000, as the purchase price. At that time Mrs. Lusthaus owned her own home valued at $25,000 and at least $20,000 of securities. On July 31, 1940, a certificate authorizing the petitioner and his wife to carry on business under the fictitious name of "Household Furniture Co." was issued by the Commonwealth of Pennsylvania. A gift tax return for 1940 was filed by the petitioner and this reported a gift to his wife of $50,000 on January 1, 1940.

Thereafter the business proceeded in much the same fashion as prior to the partnership transaction.Petitioner, as always, managed the business. Such management was specifically provided for in the partnership agreement. The wife who had assisted in the store, or stores, prior to the partnership arrangement, continued that practice. She received no salary at any time. Prior to 1940 Mr. and Mrs. Lusthaus had maintained a joint bank account. In 1940 they opened separate accounts. There was a third account for the Household Furniture Co. In 1940 the petitioner withdrew $4,604.76 from the business and the wife withdrew $59.61. In 1941 the petitioner withdrew $19,198.69 and the wife $16,317.86. The profits of the business were credited equally at the close of each year. Mrs. Lusthaus has paid three of the promissory notes. In 1940 a partnership return was filed in the name of "Household Furniture Co." showing a net profit of $80,280.20. Petitioner and his wife each reported one-half of that amount less partnership contributions, etc., in their individual returns for 1940.

On these facts the Tax Court found that the petitioner is taxable on all of the profits from the said furniture business in 1940. That Court said: "The evidence here discloses another of those superficial arrangements whereby a husband undertakes to make his wife a partner in his business for the obvious, if not the sole, purpose of reducing his income taxes."

On behalf of the petitioner it is asserted that the Tax Court erred as a matter of law in so concluding from the facts. It is urged that the facts show a legitimate, operating partnership business under general law and under the Partnership Act of the Commonwealth of Pennsylvania. 59 P.S.ยง 1 et seq. Even assuming that the arrangement more or less complied with the formalities of the Pennsylvania law, that would not necessarily be binding for tax purposes. The cases hold that the status must be genuine, with a change in economic interest. Gregory v. Helvering, 293 U.S. 465, 55 S. Ct. 266, 79 L. Ed. 596, 97 A.L.R. 1355; Helvering v. Clifford, 309 U.S. 331, 60 S. Ct. 554, 84 L. Ed. 788; Higgins v. Smith, 308 U.S. 473, 60 S. Ct. 355, 84 L. Ed. 406; Griffiths v. Commissioner of Internal Revenue, 308 U.S. 355, 60 S. Ct. 277, 84 L. Ed. 319. It is well settled that taxation is a practical matter in which substance controls the form. Harrison v. Schaffner, 312 U.S. 579, 61 S. Ct. 759, 85 L. Ed. 1055; United States v. Phellis, 257 U.S. 156, 42 S. Ct. 63, 66 L. Ed. 180; Weiss v. Stearn, 265 U.S. 242, 44 S. Ct. 490, 68 L. Ed. 1001, 33 A.L.R. 520.

The one real problem is whether there was substantial evidence to support the Tax Court's conclusion. If there was, then we are not at liberty to re-weigh the evidence or to choose between conflicting inferences. Commissioner of Internal Revenue v. Scottish American Investment Co., Limited, 65 S. Ct. 169; Dobson v. Commissioner of Internal Revenue, 320 U.S. 489, 64 S. Ct. 239, 88 L. Ed. 248, rehearing denied 321 U.S. 231, 64 S. Ct. 495, 88 L. Ed. 691.

It could be inferred from the evidence that there was no real contribution of capital by Mrs. Lusthaus. The circumstances surrounding the $50,000 incident, with the money immediately returned to the petitioner, could be construed as indicating that the latter had not divested himself irrevocably of the subject matter of the gift. Mrs. Lusthaus' services to the partnership were virtually the same as she had rendered in the stores prior to 1940. The testimony could be taken to indicate that the conduct of the parties with reference to the furniture company did not change. In Earp v. Jones, 10 Cir., 131 F.2d 292, certiorari denied, 318 U.S. 764, 63 S. Ct. 665, 87 L. Ed. 1136, the Court said at page 294:

"One may not merely change the form but do business in substantially the same way. An essentially new and different economic unit must be formed."

Other evidence not specifically set out in the findings of fact tends to justify the Tax Court's decision. For example, the bank with which the company had its account was not given the right to accept Mrs. Lusthaus as a partner of the concern with authority to draw checks until 1943. The petitioner continued to file social security tax returns as owner of the business through 1940 and up until June of 1941.

As the Supreme Court says in its Scottish American opinion, supra [65 S. Ct. 172], "Our examination of the record convinces us that the factual inferences and conclusions of the Tax Court are supported by substantial evidence * * *." We cannot say here that the Tax Court's conclusion to the effect that the alleged partnership was not bona fide, is unreasonable. The decision of the Tax Court is, therefore, affirmed.

FAKE, District Judge (dissenting).

This is not the first time a partnership between husband and wife has been dealt with by the Federal Courts as bearing on the payment of income taxes. If, however, there is any one sphere wherein the axiom should be followed that every case must be decided upon ...

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