The Friedlander Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent, 216 F.2d 757 (5th Cir. 1954)

This appeal from a tax court decision¹  by a divided court, determining an aggregate net deficiency of $309,195.42, in declared value excess profits taxes and excess profits taxes, for periods ending December 31, 1942, 1943, 1944 and 1945, presents two questions for decision.

The first and principal one is whether the tax court erred in holding that the income of the partnership Friedlander and Sons was attributable for tax purposes not to the partnership but to the petitioner for each of the years in question under Section 22(a) of the Internal Revenue Code.

The second and minor one is whether the tax court erred in sustaining the commissioner's disallowance of a portion of the salaries paid by petitioner in each of the years in question to Irwin and Max Friedlander.

Appealing from the tax court's decision, the petitioner is here urging upon us that the decision is erroneous in that turning as it does entirely upon the conclusion of the tax court that "the primary motive for forming the partnership was to reduce tax liability", it runs counter to settled law as established by the tax court itself²  and by the cases,³  that:

"* * * a taxpayer is free to choose the type of organization or form in which he will cast his business activities to achieve a desired business or tax result. He is not required to adopt or continue with that form of organization which results in the maximum tax upon business income. Meldrum & Fewsmith, Inc., 20 T.C. 790, Moline Properties, Inc. v. Commissioner, 319 U.S. 436 [63 S. Ct. 1132, 87 L. Ed. 1499]. Furthermore, if a taxpayer actually carries on business in the form chosen, the tax collector may not deprive him of the incidental tax benefits flowing therefrom, unless it first be found to be a fiction or a sham. * * *" Polak's Frutal Works, Inc., 21 T.C. 973.

For the reasons hereafter briefly stated, we agreed with petitioner that this is so. The statement of the evidence on which the case was tried to the tax court and on which the appeal is presented here consists of 131 pages of oral and written stipulations and testimony and the findings of fact take up 20 pages of the record. The essential, the controlling, facts,⁴  however, on which the answer to the first question turns are in very brief compass, and there is no dispute as to any of them.

As to the purported findings of fact of the tax court, therefore, the case stands here as it stood in Commissioner of Internal Revenue v. National Carbide Corp., 2 Cir., 167 F.2d 304, 307, affirmed 336 U.S. 422, 69 S. Ct. 726, 93 L. Ed. 799, where the court said:

"The facts are not in dispute, for the argument is plainly untenable that the Tax Court's declaration that the income from the three businesses `was the income and property of Airco as principal' was a finding of fact; on the contrary, that was exactly the issue on which the case turned."

This is so because, while the finding there was in the form of a determination as to whose was the income and property and the finding here upon the undisputed facts was that the partnership of Louis Friedlander and Sons was a sham and because it was the income earned by it and distributed to its members was not really its and their income but the income of the petitioner's corporation, the finding here is to the same extent, in the same way, and for the same reason not a finding of fact but a determination of the issue on which the whole case turned, "whose under the undisputed facts, was the income in question here?". For here the majority, rejecting the stipulated and undisputed facts that the partnership was formally created and activated, and for years carried on a large business, and seizing, as determinative of the question at issue, upon the admitted fact that the partnership was formed because of the advice of a tax accountant and consultant that there would be less liability if the stores were owned by a partnership, and stating: "The primary motive for forming the partnership was to reduce tax liability", concluded in the teeth of the overwhelming, indeed undisputed, oral and physical evidence to the contrary, that "The parties did not in good faith and acting with a business purpose intend to join together as partners in the present conduct of an enterprise". So concluding, and without a syllable of evidence or a real fact to the contrary, it erroneously declared and held that the large income in fact earned by the partnership and its members throughout the years was not earned by it but by the petitioner and was, therefore, taxable not to the partnership but to it.

Saying, and thus giving lip service to the settled rule of law, "that a taxpayer may select any form of organization through which to conduct business and is under no compulsion to adopt a type that will yield the greatest amount of tax revenue", and again, "Louis, the architect of the plan, testified, in effect, that taxation was the predominant motive for creation of the partnership. Such a purpose, if the plan for its accomplishment is not unreal or a sham, is of course not fatal. * * *", the majority proceeded by the same kind of unpermissible fiating which has been condemned in the cases, to attribute to petitioner income earned not by it but by the partnership.

Thus, though it is perfectly clear under the undisputed facts that this case is not a family partnership case, indeed the commissioner in his brief "agrees with taxpayer that this is not a typical family partnership case", the organ of the majority by drawing across the trail of the undisputed facts the red herring that Louis Friedlander and Sons, to whom the properties were transferred, is a family partnership, has obscured it for himself and for some, but not all, of his colleagues.

To see clearly that this is so, it is only necessary to read the opinion⁵  in which, with an incisive clarity, precision, and brevity, the dissenting judges at once expose the fallacy of the majority opinion in paramounting and turning this case upon the fact that Louis Friedlander and Sons was a family partnership and establish the fundamental error of the decision.

With the first question, "Whose were the earnings?" thus answered in the petitioner's favor, we turn to the second question, in effect can the court say from a consideration of the record as a whole that the findings of the tax court sustaining the commissioner's salary disallowances are clearly erroneous, to answer it briefly by saying that we do not think we can.

The judgment of the tax court is affirmed in part, reversed in part and the cause is remanded to the tax court with directions to redetermine deficiencies accordingly herewith.