Stanley v. Commissioner

*158 The respondent has asserted a deficiency of $2,206.48 in income tax for the year 1920, in the determination of which petitioner claims he erred in disallowing as a deduction from gross income an amount paid to W. E. Crapp pursuant to a judgment of the Supreme Court of Kings County, New York, and in treating as income the sum of $5,050, representing the difference between the amount of a certain indebtedness of the petitioner and the amount paid the creditor under an annuity contract entered into in consideration of the discharge of the debt.

FINDINGS OF FACT.

The petitioner, on May 1, 1900, acquired from his father for the sum of $6,000, the latter's business of*2916 collecting grease and selling soaps and janitor supplies under the name of James Stanley. Some time during the year 1902 the petitioner entered into an arrangement with W. E. Crapp, who at that time was an employee in the business as a bookkeeper, whereby Crapp was to receive 25 per cent of the profits of the business. In about 1905 the interest of Crapp was increased to 33 1/3 per cent about one year later it was again increased to 40 per cent of the profits. Crapp neither paid anything to the petitioner nor contributed any capital to the firm for the *159 interest he acquired in the business. No written instrument was ever entered into by the parties.

Thereafter Crapp continued to handle the office work and the petitioner continued to act as the firm's salesman. The business made a profit every year of its existence.

Some time prior to 1913 the firm of James Stanley purchased, for speculation purposes, four pieces of improved real property located, respectively, at 617 and 619 West 48th Street and 235 Water Street, Manhattan, and 348 Livingston Street, Brooklyn. Title to all the property was taken in the name of the petitioner. Crapp contributed 10 per cent of*2917 the purchase price of the properties and the petitioner furnished the remainder. The loss sustained each year in the venture was paid with funds of the business and charged to the personal account of the petitioner.

Under date of September 23, 1913, the petitioner, acting under the theory that Crapp was his employee, "discharged" him, with the result that on the same day Crapp notified Stanley of his election to dissolve the copartnership of James Stanley, and filed a complaint in the Supreme Court of Kings County, New York, for an accounting of the copartnership. The petitioner answered denying that he ever formed a copartnership with Crapp as alleged. The decision of the court was in favor of the complainant, and in its final judgment, entered February 14, 1917, the court held that there was due the petitioner from Crapp, the sum of $553.80, subject to a further adjustment for the real estate and other transactions.

In the accounts submitted to the court the parties agreed upon a valuation for good will of the business as of September 23, 1913, of $9,258.48, this being the amount of good will set up on the books December 31, 1914, by the following entry:

*2918 Good will as fixed in re Crapp and Stanley, 40% allowed W.E.C.

On June 15, 1920, all of the claims of the petitioner and Crapp against each other were settled by the payment of $1,500 by the former to the latter. Some time in 1920 the good will account was charged off the petitioner's books.

On or about January 1, 1908, the petitioner borrowed from his mother the sum of $14,500, with interest at the rate of 10 per cent per annum. In about the year 1912, when the principal amount due under the obligations was $13,000, the petitioner's mother assigned the debt to her husband, James Stanley. Interest payable under the debt was thereafter paid to James Stanley.

*160 On January 9, 1919, when James Stanley was about 76 years of age and in good health, the petitioner, his brother, W. H. Stanley, and his father entered into a written agreement, the pertinent clauses of which read as follows:

WHEREAS the parties of the first and second part have heretofore borrowed certain sums of money from the party of the third part, and

WHEREAS the parties of the first and second part desire to make provision at the present time for a fixed income for the party of the third part*2919 for the remainder of his natural life at a sum in excess of the legal rate of interest on the moneys heretofore loaned to them, and

WHEREAS the party of the third part desires to enter into said arrangement and to cancel any and all obligations and agreements on the part of the parties of the first and second part, to repay or return said moneys heretofore loaned to them,

Now, THEREFORE, in consideration of the premises and the mutual covenants and conditions contained herein, it is covenanted and agreed as follows:

Party of the third part hereby gives and transfers to the parties of the first and second part, the sums of money which he has heretofore loaned to them, to be divided equally between them, and does hereby release and discharge said parties of the first and second part, their heirs, legal representatives and assigns, from any and all liability in regard to said sums and any and all obligations to repay the same, and in consideration of the agreement on the part of the parties of the first and second part hereinafter mentioned, transfers said sums of money to them equally as aforesaid, without trust or reservation of any kind.

Parties of the first and second part*2920 covenant and agree with the party of the third part that in consideration of the agreement of the party of the third part hereinbefore contained, that they will each pay or cause to be paid to the party of the third part during the remainder of his natural life the sum of Seven Hundred twenty-five Dollars ( $725) per year, making a total sum of One Thousand Four Hundred Fifty Dollars ($1,450) a year, in equal monthly installments of One Hundred twenty and 84-100 Dollars ($120.84), payable Sixty and 42-100 Dollars ($60.42) by each party of the first and second part, on the first day of each and every month, beginning February 1, 1919, and continuing during the remainder of the natural life of the party of the third part; and that this agreement shall bind the heirs, executors, administrators and legal representatives of the parties of the first and second part respectively in case of the death of either or both of them prior to the death of the party of the third part, it being the intention of the parties of the first and second part that the third part shall receive said Sum of One Hundred Twenty and 84-100 Dollars ($120.84) a month under any and all circumstances during the remainder*2921 of his natural life.

After the execution of the agreement, the petitioner, in accordance with the terms of the instrument, paid one-half of the loan of $13,000 to his brother.

James Stanley died some time between January 9, 1919, and March 20, 1919, the date on which his last will and testament was probated.

OPINION

ARUNDELL: The petitioner admits that the decision of the Supreme Court of Kings County holding that he and Crapp were partners *161 and that the latter was entitled to an accounting from the former for his copartnership interest, is binding upon him and should be followed by the Board, but argues that inasmuch as he had no intention of making Crapp a partner in his business, the amount he paid the latter as a result of the court's decision is a deductible loss.

In view of the court's decision, it must be regarded as established that the petitioner and Crapp were partners, and that as a result of the dissolution of the relationship, the petitioner was required to account to Crapp for his interest in the firm. The amount paid to Crapp in the year 1920, pursuant to the court's decision, was for either his share of the property of the copartnership or*2922 other interest in the firm. In any event, a payment made under such conditions can not be said to result in a deductible loss.

In increasing petitioner's income by $5,050 for the taxable year 1920, the respondent appears to have proceeded on the ground that the annuitant died in November, 1920, and that there had been paid to him by the petitioner, under the annuity contract, the full amount payable during the years 1919 and 1920, or $1,450. I.T. 1484, C.B. 1-2, p. 66, followed by the respondent in making the determination, provides for the taxing of the excess of the principal over the amount paid, as income in the year in which liability for future payments ceases. Whether we treat the profit realized by the petitioner under the contract as income to him at the time of the execution or termination of the agreement, we must overrule the respondent's action, since the contract was entered into, and the annuitant died in 1919, a year prior to the one before us.

Judgment will be entered under Rule 50.