The opinion of the court was delivered by: SHAW
Plaintiffs filed an Income Tax Return for the year, 1956, reporting as capital gain an amount of $ 45,000 derived from the sale of all interest which plaintiff, Charles Shilowitz (hereinafter referred to as 'Shilowitz' or 'the taxpayer'),
held in two corporations. The Commissioner of Internal Revenue determined that this item did not constitute capital gain and should be treated, for tax purposes, as ordinary income. Accordingly, there was an assessment of alleged tax deficiency in the amount of $ 18,463.71,
which plaintiffs paid. This action is now brought, pursuant to 28 U.S.C.A. § 1346(a) (1), to recover that amount, with interest, on the ground that it was erroneously assessed and collected. It is conceded that plaintiffs have complied with conditions precedent (26 U.S.C.A. § 7422(a)) to the right to bring this action.
The matter was submitted on Stipulation for disposition by the Court without a trial. The evidence, by Stipulation, consists of certain stipulated facts, testimony taken on depositions, exhibits identified during the course of taking such depositions, and a medical certificate of Dr. Robert Rubenstein.
The pertinent facts, as I find them from the record, may be summarized briefly as follows: On or about March 17, 1955, plaintiff Shilowitz and one Morris Rosenstein entered into an agreement whereby they created two corporations for the purpose of building and owning an apartment-house project known as Harclay House in East Orange, New Jersey. One corporation, Witsor Corp., was to serve as general contractor, and the other, Harclay House, as the project owner. Each of the parties took fifty per cent of the shares of stock in each corporation. No consideration was paid by either party for the stock.
Shilowitz was an experienced architect. Prior to the above-mentioned agreement which he entered upon with Rosenstein, he had completed construction of two apartment-house projects and was completing a third, all of which he held for long-term investment and income purposes and not for sale. He prepared the plans and specifications for the construction of the Harclay House project, obtained an option for purchase of the site, and arranged a commitment for a conventional construction mortgage from the Brooklyn Savings Bank.
Rosenstein was a retired builder whom Shilowitz had known for a number of years. After Shilowitz had assembled what was described as a 'package deal' for the Harclay House project, he approached Rosenstein to induce him to become a partner in the venture because he lacked the funds to undertake it alone and also needed the experience of a builder to supervise the construction. Rosenstein agreed to advance on loan the amount of $ 150,000 to Harclay House, and it was agreed by the parties that Shilowitz would receive $ 11,800, as a fee for the preparation of the plans and specifications, to be paid after Rosenstein was reimbursed for the $ 150,000 advanced and all creditors were paid.
Construction of Harclay House commenced shortly after the execution of the agreement between Shilowitz and Rosenstein and continued without incident until October, 1955, when Shilowitz had a heart attack. Rosenstein supervised construction, and Shilowitz was available for consultation with respect to drawings and specifications and periodic visitation at the job site when problems arose. He also negotiated subcontracts and handled progress payments, using his own office facilities for the work which he performed. As a result of his heart attack, he was confined to the hospital for seven weeks and, thereafter, to his apartment for a period of time with a nurse in attendance. From January, 1956, to March 10, 1956, he was convalescing in Connecticut; part of this time was spent in a wheel chair with a nurse in attendance. The medical certificate of Dr. Robert Rubenstein certified that Shilowitz was under his care for treatment of an acute myocardial infarction and that he had ordered him to 'immediately retire from active practice.'
Construction continued under the sole supervision of Rosenstein during the illness and convalescence of Shilowitz, and, as it progressed, it developed that the project could not be completed without additional financing. Shilowitz was not in a position to advance funds, and his disability made it impossible for him to contribute the services originally contemplated by the parties. In view of the prospect that Shilowitz would be unable to perform any further work on the project and that the amount of $ 150,000 advanced by Rosenstein would have to be increased by him to complete construction, Rosenstein decided that he was not willing to continue with the project as a joint venture. It was his position that, if he had to provide financing over the amount of $ 150,000 to which he had been committed, and also had to assume sole responsibility for the completion of the project without the assistance from Shilowitz, as originally contemplated, he should be the sole owner. With this in mind, he approached Shilowitz and proposed to purchase his entire interest. Shilowitz was not in a position to offer any reasonable objection.
An agreement was reached and formally executed on March 29, 1956, whereby Shilowitz transferred all the shares of stock in Harclay House and Witsor Corp. to Rosenstein and released these corporations from any further claim he might have, including 'claim for services as architect for plans, specifications, and supervision.' The consideration paid for the transfer of stock and the release embodied in the agreement of March 29, 1956, was $ 45,000. It may be inferred from the record that thereafter Rosenstein proceeded with the project for the long-term investment purposes that had been contemplated by him and Shilowitz from inception.
The basic questions presented are:
1. Did the total amount of $ 45,000 which Rosenstein paid to Shilowitz include compensation for the preparation of plans and specifications which would be taxable as ordinary income?
2. Is gain realized by Shilowitz from consideration paid for the sale of his stock gain attributable to the sale of stock of collapsible corporations?
As noted above, the agreement which Shilowitz entered upon with Rosenstein, dated March 29, 1956, pursuant to which the amount of $ 45,000 was paid to Shilowitz, recites that he 'will execute and deliver to Harclay House and Witsor Corp. a release releasing the said corporations of any claim of any nature that he may have with respect to the said two corporations including any claim for services as architect for plans, specifications, and supervision.' In the basic agreement, the value of his services for the preparation of plans and specifications was fixed at the sum of $ 11,800. There is no dispute about the fact that he relinquished any right that he had to be reimbursed for his services in preparation of these plans and specifications and that Rosenstein contemplated, in his agreement to pay the sum of $ 45,000, that payment thereof included compensation to Shilowitz for the preparation of plans and specifications.
Accordingly, it is the opinion of the Court that, of the total sum of $ 45,000 paid to Shilowitz, $ 11,800 represented payment for personal services and is taxable as ordinary income, and that the remaining part of the ...