Marcus et al. v. Commissioner of Internal Revenue, 201 F.2d 850 (5th Cir. 1953)

This is an appeal from a decision of the tax court determining deficiencies in income taxes for the calendar years ending December, 1943, 1944, and 1945. It presents for our decision the single question whether the tax court erred in finding and holding that the petitioners did not in good faith form a valid partnership with their wives within the holdings and teachings of Culbertson v. Commissioner, 337 U.S. 733, 69 S. Ct. 1210, 93 L. Ed. 1659, and the cases from our court¹  construing and applying the income tax laws in accordance with the principles that case lays down.

Another in the long line of family partnership cases, in which a deficiency having been incorrectly determined by the commissioner and as incorrectly redetermined by the tax court, upon the authority of Tower and Lusthaus²  and by the mechanical and rigid application of their so-called tests, this is perhaps the last of such cases which will have to be dealt with by this court. Cf. Clarence B. Ford, 19 T.C. 29.

In par. IV-B of their petition to the tax court, filed May 2, 1949, the complaining taxpayers alleged that the commissioner, in allocating to them the portions of the income belonging to their wives as partners in the Marcus Furniture Company, had erroneously predicated his determination "upon the principles enunciated in the now famous Tower and Lusthaus cases."

The commissioner, in his answer filed June 13, 1949, thus pleaded to the soft impeachment, "Admits that respondent relies upon Commissioner v. Tower, 327 U.S. 280, 66 S. Ct. 532, 90 L. Ed. 670, and Lusthaus v. Commissioner, 327 U.S. 293, 66 S. Ct. 539, 90 L. Ed. 679, for his position set forth in the statutory notice of deficiency * * *, that Mrs. Reva K. Marcus and Mrs. Rosalie P. Marcus were not members of the partnership."

Further, when the case was heard and decided in the tax court, though the opinion in Commissioner v. Culbertson, supra, had by then come down and the Supreme Court had in it clarified the meaning and effect of those decisions and pointed out the error of commissioner and tax court in interpreting and applying their so-called tests, the case was heard and decided by the tax court judge as though this had not been done.

Apparently ignoring the limiting and clarifying effect of the Culbertson decision upon these so-called tests, the tax court judge stated, at Record p. 127:

"* * * the question of law has been set forth by the Supreme Court in the Tower and Lusthaus cases and lately in the Culbertson case, and I presume you know what the tests are which have been laid down in those cases." Again, at Record p. 55, she stated:

"Another relevant factor is that the evidence shows that no capital not available for use in the business was brought into it by the alleged inclusion of the wives as partners."

It was, therefore, inevitable that, in her approach to the decision of the case, it was not the voice of Culbertson which guided her but the dead hand of Tower and Lusthaus, as commissioner and tax court, even after Culbertson, had persisted in misinterpreting and misapplying them.

It was inevitable, too, that, so guided, she would, in the face of the undisputed facts:³  that the partnership was a limited one under Mississippi law, Sec. 5560, 1942 Code of Mississippi; that each wife furnished one-fourth of the capital as she had agreed in writing to do; and that the business was one dependent for its earnings upon the contributions of capital made by each partner; affirm the commissioner's determination, under the Tower and Lusthaus cases as interpreted and applied by him, that there was no valid partnership.

Pointing all these things out to us as the record reveals them, petitioners are here insisting that the judgment appealed from was arrived at by the application of wholly erroneous tests and may not stand.

We agree. The record undisputedly establishes: that, upon the death of their father, valid gifts of property were made by petitioners to their wives; that a limited partnership, valid under the Mississippi statutes, was created; that the wives contributed to the partnership the amount or value they had agreed to contribute; and that thereafter the business was conducted as a limited partnership, the parties each reporting, as his or her income, the distributive share of the net profits belonging to each in accordance with the agreement.

This being so, it is not at all material, as the tax court judge seemed to think it was, that the capital the wives contributed to the partnership came to them as gifts from their husbands or that the wives did not, as indeed they could not under Mississippi limited partnership laws, exercise any management or control over the business. Contrary to the view of the tax court judge, it is also immaterial that in drawing cash from the business for their personal use, the partners did not draw equally. These were matters merely of bookkeeping. In view of the undisputed fact, that the agreement was in writing and recorded, what is material here is not what each partner did in fact draw from the business for his or her own use, but what, under the contract, each was entitled to draw.

Particularly is it true that it was not for the commissioner and the judge to substitute their ideas for what the partners ought, in creating the partnership, to have provided in respect to sharing its profits. This, as the Supreme Court, in the Culbertson case, and we, in later cases, have pointed out, was for the determination of the partners if made by them in good faith, that is as a reality and not as a sham.

Because in recent cases decided by us we have repeatedly pointed out and made clear the error of tax court and commissioner in persisting in this way of thinking, despite the decisions of the Supreme Court and of this court, and the reports of the Finance Committees of Senate and House, we will not further labor the matter here. Referring to the Culbertson case and the cases from our court cited in note 1, supra, and to the decision of the tax court, speaking this time through Judge Black, in Clarence B. Ford Estate, supra, we will content ourselves with saying that the record affords no basis for the determination of commissioner and tax court that deficiencies exist, and that the judgments must be reversed with directions to disallow the deficiencies.

Reversed with directions.