author: MoRRis:

text:
    Appeals of ADDISON MILLER and GEORGE FALTICO.
    Docket Nos. 1596, 1601.
    Submitted August 10, 1925.
    Decided February 13, 1926.
    Tbe composition of and tbe distributive shares' in certain partnerships during tbe years 1918, 1919, and 1920, determined.

      Simon Michelet, Esq., for the taxpayers.

      Willis D. Nance, Esq., for the Commissioner.
    Before Marquette and Moeeis.
    The Commissioner asserted a deficiency in income tax for the years 1918, 1919, and 1920 against the taxpayer Addison Miller in the aggregate sum of $110,044.08, and against the taxpayer George Faltico in the sum of $8,136.04. The controversy is principally an issue of fact as to the composition of and the distributive shares in certain partnerships during the years in question. The appeals of the above taxpayers were consolidated for the purpose of taking testimony in the hearing before the Board.
    FINDINGS OF FACT..
    1. In the year 1916 the taxpayer Addison Miller and others formed a partnership composed of Addison Miller, A. T. Miller, Joseph Colianni, and Paul V. Colianni. A. T. Miller and Paul V. Colianni were the younger brothers, respectively, of Addison Miller and Joseph Colianni. The articles of agreement were as follows:
    St. Paul, Minn., May 1, 1916.

    Effective this date and superseding any and all previous agreements, which we hereby jointly and severally acknowledge to have been satisfactorily accounted and discharged, this agreement is drawn to control the operation and division of monies in the business known as Miller & Colianni, a partnership composed of the signers of this agreement as partners: to wit, Addison Miller, A. T. Miller, Joseph Colianni, and Paul V. Colianni, and to control the operation of any and all business appertaining to such firm.
    The partners are to be as above noted, each with equal standing individually, but the combined financial interest of Colianni brothers is always to be maintained equal to that of Miller brothers so that there shall be no balance of power or influence either way.
    The business to be conducted by the firm to consist, as in the past, of carrying on railway coal dock operations and other railway maintenance operations under contract from railway companies.
    Profits or losses to be adjusted at dates mutually agreeable in the same proportion as of funds supplied which are acknowledged to be equal upon this date for the “ Colianni interests ” and the “ Miller interests ” as above defined.
    Partners engaged in the active conduct of the business to be either allowed reasonable compensation aside from profits or to serve without compensation if all interests agree that the work is handled in equitable proportion and burdens equally distributed.
    The business is entirely solvent as of this date and each of the partners is thoroughly acquainted with its condition.
    This agreement may be terminated by any partner serving notice of reasonable length, either orally or in writing, of his desire for an accounting of a final nature and the satisfactory disposition of all details in connection therewith.
    (Signed) Jos. Colianni
    “ Addison Milleb
    “ A. T. Milleb
    “ Paul V. Colianni
    The partnership carried on its business until December 1, 1919, as “ Miller & Colianni,” and thereafter as “Addison Miller.”

      2. During the years 1917 to 1920, inclusive, there were certain changes in the membership of the partnership and in the distributive shares of income of the partners.
    The members of the partnership and their distributive shares, as determined by the Commissioner and as claimed by the taxpayers for the years in question, are as follows:

    The net income of the partnership of Miller & Colianni for the years in question, as agreed by the taxpayers and the Commissioner, was as follows:
    1918-$ 59,458.42
    1919- 99,154. 32
    1920- 144, 726.02
    The Commissioner has considered the taxpayer Addison Miller a member of the firm with an unvarying 50 per cent ownership during all the taxable years in question and has computed his income tax upon this basis. Pie has considered the taxpayer George Faltico as a partner owning a 50 per cent interest from December 1, 1919, and has computed his income tax upon this basis. The taxpayers claim there were changes in the partnership and percentages of ownership, varying from that determined by the Commissioner, on January 1, 1918, July 17, 1918, January 1, 1919, and December 1,1919.
    8. After the formation of the said partnership of Miller & Coli-anni, there was no change until the year 1917. In September, 1917, A. T. Miller entered the Army, remaining in that service until December 1, 1918. Paul Colianni, brother of Joseph Colianni, withdrew from the firm in the year 1917 to go into business for himself. Both A. T. Miller and Paul Colianni were paid $4,000 each as their share of the profits. These amounts were debited as expenses on the books of the partnership, and the partners, Addison Miller and Joseph Colianni, for the year 1917, apportioned the remaining profits on the basis of 50 per cent each. The partnership filed an income-tax return for the year 1917 showing the members of the partnership to be Addison Miller and Joseph Colianni, each having a 50 per cent interest in the partnership.
    4. During the years in question the parties alleged to have been partners performed services at various times and in varying degrees. The taxpayer Addison Miller continuously devoted a portion of his time to the partnership of Miller & Colianni from the beginning and throughout all the years in question. He was practically in charge of the business. He devoted a part of his time to other partnerships in which he had an interest.
    A. T. Miller was away in the Army practically all of the year 1918, returning to the office about December 23, 1918. He was with the firm during the years 1919 and 1920, except that, during the year 1919, he had some independent contracts which took a portion of his time. He also had some independent business in Duluth which took him away for a portion of the year 1919.
    Joseph Colianni was in ill health during the years 1918 and 1919, and during his absence he paid Addison Miller $500 per month from May, 1918, for the additional burden of work. He also paid George Faltico from July 17, 1918, a stipulated sum for looking after his interests. This arrangement continued until Colianni withdrew from the firm December 1, 1919.
    George Faltico came into the service of Miller & Colianni in July, 1918. During the first part of 1918 he had been employed by the United States Government as a labor agent. Prior to 1918 he had been in the employment agency business and was familiar with the employment of labor. Because of this experience he was induced to enter the service of Miller & Colianni by J oseph Colianni. He was expected to look after the interests of the partnership in Seattle and on the west coast. There was a dispute between J oseph Colianni and George Faltico as to whether the latter had an interest in the firm or was employed by Colianni. Upon the withdrawal from the firm of Joseph Colianni, December 1,1919, and the dissolution of the partnership, Faltico was not required to sign the dissolution agreement as a partner.
    P. M. Faltico, brother of George Faltico, had been employed by the firm of Miller & Colianni as a supervisor of labor since 1917. In the year 1917 he was paid $75 per month and expenses, and this was increased from time to time up to January 1, 1919. In his income-tax return for 1918 he returned $1,200 as salary and $9,633.47 as “income from partnerships.” The participation of P. M. Faltico as a partner was disputed by Joseph Colianni. He took no part in the said dissolution agreement of December 1, 1919.
    5. On or about the first day of December, 1919, Joseph Colianni withdrew from the partnership and sold his interest to the taxpayer George Faltico. The old partnership of Miller & Colianni was dissolved and a new partnership formed under the name of Addison Miller, which continued the same business.
    The dissolution agreement was as follows:
    Joseph Colianni and Addison Miller have this first day of December, 1919, entered into the following agreement:—
    They have heretofore been partners under the name and style of Miller & Colianni. They have this day dissolved said partnership. Said Miller together with one Faltico will continue said business. They have heretofore and hereby release each the other from any and all claims in any manner arising out of the partnership heretofore existing and each agrees to hold the other harmless from any act of his in relation to the conduct of said partnership, heretofore.
    Miller further agrees to hold Colianni harmless from any claim or demand in any manner arising out of the conduct of said business whether existing at the time of this agreement or hereafter in any manner arising in connection with the conduct of said business heretofore or hereafter.
    Colianni acknowledges receipt of Fifty-one thousand, Six Hundred fifteen dollars and twenty-one cents ($51,615.21) in full discharge of all money obligations due or to become due him, unless otherwise specifically provided.
    Addison Miller Joe Colianni
    Witness:
    A. W. Johnson X-I. H. Jensen
    6. The agreement of sale from Joseph Colianni to George Fal-tico was as follows:
    Joseph Colianni and George Faltico have this December 1, 1919, entered into the following agreement:—
    Joseph Colianni has heretofore sold and hereby sells, assigns, and transfers to George Faltico all his right, title and interest of whatsoever name and nature in to or under the partnership agreement and business heretofore conducted by said Colianni with Addison Miller in St. Paul, Minnesota, subject to all debts, liabilities and incumbrances as they exist at the date hereof.
    Joseph Colianni has further agreed with said Faltico that for a period of two years he will not do anything that will 'in any manner interfere with the continued business relations of said Miller and Faltico with the Great Northern Railway Company and the Northern Pacific Railroad Company of the kind and character that said co-partnership has heretofore had with said Railroads.
    In consideration thereof said Faltico agrees; (1) to hold said Colianni free from all debts, liabilities, obligations and incumbrances of said business, former co-partnership or new co-partnership, whether incurred heretofore or hereafter; (2) to pay to said Colianni the sum of Ten Thousand dollars in cash at the time of tlie execution of this agreement; and (3) to pay to said Colianni the sum of One hundred dollars on January 1, 1920, and One hundred Dollars on the first of each and every month thereafter for a period of thirty-six months at such place as said Colianni may from time to time direct in writing. But if the contract heretofore and now existing between said partners and the Great Northern Railway Company and the Northern Pacific Railroad Company are both cancelled then and from that time on said Faltico is relieved and released from the payment of said monthly installments of One Hundred Dollars.
    7. On or about the same day, another agreement was entered into by Joseph Colianni, Addison Miller and George Faltico whereby Joseph Colianni had the privilege of reentering the firm under certain conditions. This agreement reads as follows:
    Joseph Colianni, Addison Miller and George Faltico have' this December 1, 1919, agreed as follows:
    Heretofore Colianni and Miller have been equal partners in a business in St. Paul, Minnesota, under the firm name of Miller and Colianni. This partnership has this day been dissolved by mutual consent. Colianni has sold his interest in said business to George Faltico. Faltico and Miller have entered into a partnership arrangement to continue said business.
    It is mutually agreed that said Colianni may at any time within one year from the date hereof signify his desire to rejoin said business enterprise. Thereupon, it is agreed that said Miller and Faltico will accept said Colianni as a partner on the same terms as he has heretofore had with said Miller, except that the interest of said Colianni in said business shall thereafter be 25% and said Faltico be 25% and said Miller shall be 50%. In order to carry out this agreement it is agreed that said Faltico will execute a proper agreement or bill of sale to said Colianni and all of said parties will enter into such written agreements as may be necessary to carry out the intent of this agreement. Said Colianni shall pay to said Faltico for this interest the sum of $5,000. It is understood, however, that such 25% interest in said business so to be sold and transferred to said Colianni shall be 25% of the contracts as they then exist with the Great Northern Railway Company, and the Northern Pacific Railroad Company but such interest shall in no event be greater than 25% of said contracts as they exist today would be.
    Upon the re-entry of said Colianni into said firm the One hundred Dollar Monthly payments elsewhere provided for from said Faltico to said Colianni shall forthwith cease.
    8. On or about December 1, 1919, after the sale of the interest of Colianni to George Faltico, Addison Miller assumed one-half of Colianni’s interest, leaving George Faltico a 25 per cent interest. Thereupon, a verbal agreement was made whereby the new partnership of “Addison Miller ” should be composed as follows:
    Per cent.
    Addison Miller-37½
    George Faltico-12½
    P. M. Faltico_12½
    A. T. Miller_37⅜⅛

      This arrangement was continued thereafter throughout the calendar year 1920.
    9. The partnership of Miller & Colianni, from its inception, employed one M. J. Schiffer as its accountant and bookkeeper. During the course of his employment he prepared certain audits and reports of the business of the partnership for the following periods: Year 1918; January 1,1919, to June 30, 1919; July 1,1919, to December 31, 1919. The audit for the latter period also contained a statement of conditions on November 30 and December 1, 1919, at the time Joseph Colianni withdrew from the firm.
    In the 1918 audit the pertinent part of the report referring to the partnership interest was as follows:
    The net worth of the partnership interests are:
    Addison Miller_$44, 894. 46
    Joseph Colianni_ 38, 253. 63
    Net worth_ 83,148.09
    Net worth of Miller & Colianni business as at December 31, 1918, $83,148.09. For the period January 1,1919, to June 30,1919, the pertinent part of the audit referring to the partnership interests was as follows:
    STATEMENT OF AFFAIRS.
    The net worth of the partners in the business as at June 30, 1919:
    Addison Miller_$30, 036. 29
    Joseph Colianni- 21, 022. 79
    Total net worth- 51, 059. 08
    Net worth Miller & Colianni business as at June 30, 1919_ 51, 059.08
    NET WORTH ACCOUNT AS AT JUNE 30, 1019.
    Net worth as at Jan. 1, 1919-!-$83,148. 09
    Less withdrawals: Per schedule attached—
    Addison Miller_$22, 902. 00
    Joseph Colianni- 25, 274. 57
    - 48,176.57
    34, 971.42
    Add profit Jan. 1 to June 30, 1919_ 16, 087.66
    Net worth June 30, 1919_ 51,059.08
    The said audit referring to the partners’ interests during the period July 1, 1919, to December 31,1919, is dated February 14, 1920. The pertinent parts of the report and its opening statement are as follows:
    The following is a report disclosing the conditions of the co-partnership of Miller & Colianni as having existed before its termination between the dates .July 1, 1919, and November 30, 1919, and of the new co-partnership for and between Addison Miller and George Faltico, as it came into being December 1, 1919, and as it exists through continuous operations from that date.
    ADDISON MILLER NET WORTH ACCOUNT BEFORE PARTNERSHIP DISSOLUTION
    As at July 1st, 1919_$30,036. 29
    ½ of net profit — July 1st to Oct. 31st, 1919- 26, 592.41
    ⅜ of net profit — November 1919- 4, 000. 00
    Total credits_ 30, 592.41
    $60, 628. 70
    Less withdrawals_ 2, 226.40
    Net worth — November 30th, 1919_$58, 402. 30
    JOSEPH COLIANNI NET WORTH ACCOUNT BEFORE PARTNERSHIP DISSOLUTION
    As at July 1st, 1919_$21, 022. 79
    ¾> of net profit July to October-$26, 592. 42
    ½ of net profit, November- 4, 000.00
    Total credits_ 30, 592.42
    Net worth as at November 30th, 1919_$51,615. 21
    JOSEPH COLIANNI ACCOUNT AFTER PARTNERSHIP DISSOLUTION
    Net worth, as at November 30th, 1919_ $51,615.21
    Charge — Interest absorbed by Addison Miller and George Faltico_$51, 615.21
    00,000.00
    The Addison Miller net worth account as shown on form following is as at December 1, 1919_$105, 994. 00
    The George Faltico net worth account as shown on form is at December 1, 1919_ $18,026.31
    Eeferring back to the disposition of the Joseph Colianni net worth as at November 30, 1919, in the amount of $51,615.21:
    The Joseph Colianni net worth was absorbed by the two credits of $25,-807.60 and $25,807.61 to the Addison Miller net worth account and George Faltico net worth account respectively, those credits indicating absorption of the Joseph Colianni interests by Addison Miller and George Faltico on a basis of fifty per cent.
    The item of $14,782.70, shown as a deduction from the net worth of the George Faltico net worth account is so handled to show the cancellation of a loan to George Faltico (this amount offset by an equal credit to Addison Miller’s net worth as shown in the Addison Miller net worth account) and to malie clear of deductions the George Faltico net worth which now stands at $18,026.31.
    Should Mr. Faltico make remittances to Addison Miller in whole or in part out of funds other than those carried to his credit as shown on the net worth account, he will properly be credited with same.

      GEORGE EALTICO NET WORTH ACCOUNT
    As at December 1st, 1919—
    Salary and expenses___ $7, 001.40
    ⅛ of Jos. Oolianni’s interest, as at November 31st, 1919 - 25, 807. 61
    ⅛ of Good Will_ 5,000.00
    $37, 809. 01
    ⅛ Good will loss to George Báltico- 5, 000. 00
    $32, 809. 01
    Balance due Addison Miller to Addison Miller net worth ac-count_ 14, 782. 70
    George Báltico cash net worth, December 1st, 1919- $18, 026.31
    ADDISON MILLER NET WORTH ACCOUNT

      January 1st, 1920

    As of Dee. 1, 1919_$105, 994.00
    ¾ of December profit_ 4, 655.74
    $110, 649. 74
    Charged with ¾ of $2,118.80, an item generally distributed over the entire year. Labor charge not
    primarily deducted from Profit_ $1, 618. 80
    Geo. Báltico — Expenses_ 500. 00
    $2,118. 80 1, 589.10
    $109, 060. 64
    Addison Miller Charges — December_ 19, 833. 33
    Net worth as at Jan. 1, 1920_'_ $89, 277. 31
    GEORGE EALTICO NET WORTH ACCOUNT

      January 1st, 1920

    As at Dec. 1, 1919_ $18, 026. 31
    ½. of December profits_ 1, 551. 92
    $19, 588.23
    Charged with ⅛ of $2,118.80. An item generally distributed over the entire year. Labor charge not previously deduced from profits_$1, 618.80
    George Báltico — Expenses_ 500.00
    Charge ¾ of this item-$2,118. 80 529. 70
    Net worth as at January 1, 1920_ $19, 048. 53
    In these audits and reports, prepared by the accountant and bookkeeper of the partnership, the names of no persons other than Addison Miller, Joseph Colianni, and George Faltico were set forth as partners. George Faltico’s interest was first shown December 1, 1919, after the withdrawal of Joseph Colianni. According to the audit on December 31, 1919, George Faltico’s interest was 25 per cent and Addison Miller’s interest was 75 per cent, each absorbing one-half of Joseph Colianni’s interest.
    10. There were no written agreements as to the interests of the partners other than the written agreements of May, 1917, and December 1, 1919, nor during this period were funds withdrawn from the firm by anyone as a partner, except Joseph Colianni and Addison Miller.
    11. For the years 1918 and 1919 the original income-tax returns of the Miller & Colianni partnership set forth the partners substantially as herein claimed, except that for the year 1918 the interest of Joseph Colianni was given as two-sixths, or 33% per cent instead of 25 per cent, and the interest of George Faltico as one-sixth, or 16% per cent instead of 25 per cent; and for the year 1919 the interest of Joseph Colianni was returned as one-fourth, or 25 per cent instead of 33% per cent, and the interest of George Faltico and P. M. Faltico as one-eighth, or 12% per cent instead of 8% per cent. For the year 1920 the original return of the partnership of Addison Miller set forth the partners as herein claimed. The individual returns of Addison Miller and A. T. Miller, George Faltico and P. M. Faltico conformed to the partnership returns for these years.
    The ledger of the partnership contained net worth accounts, purporting to represent the net worth of the alleged partners, as follows:
    Dec. 31, 1918:
    A. M. (Addison Miller)- $32,366.15
    J. O. (Joseph Colianni)_ 31,616.16
    A. T. M. (A. T. Miller)_ 10,891.95
    G. F. (George Faltico)- 8,243.83
    Jan. 1, 1920:
    P. M. F. (P. M. Faltico)_ 7,815.55
    G. F. (George Faltico)_ 11,232,97
    A. T. M. (A. T. Miller)_ 47,947.89
    A. M. (Addison Miller)_ 41,279.43
    108,275. 84
    Dec. 31, 1920:
    Addison Miller 69,834.32
    A. T. Miller_ 98, 502.79
    George Faltico 25, 261. 82
    P. M. Faltico— 24,667.18
    12.Since 1913 or 1914, the taxpayer Addison Miller had a contract with the Northern Pacific Railway Co. to run certain of its boarding houses. The headquarters of this business was in Seattle, Wash. On account of the work involved in that city, he took in as a partner one' M. Y. Underwood. In the year 1917, Addison Miller and M. V. Underwood were partners on a 50 per cent basis under the name of W. A. Miller & Sons.
    W. A. Miller, the father of Addison Miller, for years had the contract for supplying labor for the Northern Pacific Railway Co. When the railroads were taken over by the Government during the World War, his income from this source was ended. Thereupon, in January of. 1918, Addison Miller turned over to him his interest in this Northern Pacific Kailway boarding house contract. Addison Miller, however, continued to assist in the supervision of the work. Prior to July 1,1918, the boarding house contracts with the Northern Pacific Kailway Co. were in the name of W. A. Miller & Sons, and the vouchers and checks of the Northern Pacific Kailway were designated accordingly. On July 1, 1918, the old contracts were canceled and a new contract was made in the name of i\ddison Miller. Thereafter, checks were made out by the Kailway Company to Addison Miller and endorsed by him. At the end of January, 1919, M. Y. Underwood withdrew from the firm. Addison Miller continued to supervise the business for a salary of $5,000. In 1921 the interest of W. A. Miller was purchased by the Addison Miller partnership for $35,000. The composition of this partnership for the years in question, and the percentage of ownership, as determined by the Commissioner and as claimed by the taxpayers, are as follows:

    The gross income of the partnership of W. A. Miller & Sons (boarding house business) for the years in question, as agreed upon by the taxpayers and the Commissioner, was as follows:
    3918-$208,862.06
    January, 1919- 22,258. 34
    February 1 to December 31, 1919_ 255, 004. 82
    1920 - 439, 568. 73

      18. The Commissioner, in determining the income of the taxpayer Addison Miller, included items of income from “W. A. Miller & Sons (labor agency) ” as follows :
    1918_$4,857.18
    1919_ 5,548,29
    1920_-_ 9, 813. 97
    The taxpayer owned a labor agency in this name in Minneapolis, but derived no income therefrom during the years 1918, 1919, and 1920, except as shown in his income-tax return. There was also an agency by this name in St. Paul, which was claimed by the Commissioner to be owned by the taxpayer Addison Miller in 1918, by W. A. Miller in 1919, and a 50 per cent interest by Addison Miller in 1920.

      W. A. Miller ran a labor agency in connection with the boarding house business as his individual business,- which included the above-named St. Paul agency, the income of which was included in the return of W. A. Miller.
    14. The Commissioner, in determining the income of the taxpayer George Faltico, included the income from a partnership known as the Northern Pacific Labor Agency or the Faltico Labor Agency, as follows:
    1918_$10,130.24
    1919_ 1, 515. 32
    Prior to 1918 this labor agency was owned by the taxpayer George Faltico. On or before January 1, 1918, the said taxpayer entered the Government service as- a Federal labor agent and left this business in charge of his brothers, P. M. Faltico and M. J. Faltico. On July 17, 1918, the taxpayer entered the service of Miller & Colianni, which employment necessitated his location for a large portion of the time at Seattle, Wash. He did not personally attend to this labor agency business in Minneapolis. He left the bank account of the labor agency in his own name. Deposits and withdrawals were made by his brothers up to June 8, 1919, at which time the account was changed to the name of P. M. Faltico. During this period, January 1, 1918, to June 3, 1919, the said brothers were running this labor agency for the taxpayer George Faltico. Deposits in the name of George Faltico for the year 1918 by said labor agency are shown below. The average monthly balances for the period January 1, 1919, to June 3, 1919, were approximately $500.

    DECISION.
    The deficiency should be computed in accordance with the following opinion. ■ Final determination will be settled on 15 days’ notice, under Rule 50.
   OPINION.

MoRRis:

The question involved in these appeals is: Who composed the various partnerships and what were the respective interests of each? There are a number of partnerships involved, for the most part created by informal, verbal agreements and understandings. The books and records are meager and incomplete, and the evidence is confusing and conflicting. For convenience we shall consider each partnership separately.

The partnership of Miller & Colianni was originally formed in 1916 by a written contract and was.composed of the taxpayers Addison Miller and Joseph Colianni and their younger brothers. The predominating feature of the written agreement was that the Miller and Colianni interests should always be equal. The younger brothers dropped out in 1917 and were paid $4,000 each. In 1917 the partnership, in its income-tax return, set forth the partnership as composed of Addison Miller and Joseph Colianni, 50 per cent each. Up to 1918 the facts seem clear. For the years 1918, 1919, and 1920, the taxpayers claim various changes, both in the partners and percentages of ownership, as set forth in our findings of fact. These changes are flatly denied by the partner Joseph Colianni. In this direct conflict of testimony we must fall back upon the written evidence, documentary and otherwise. The only written instruments in relation to the composition of the partnership are those of December 1, 1919, the time Joseph Colianni withdrew. These seem to bear out the testimony of Joseph Colianni. In the dissolution agreement, the agreement of sale to George Faltico and supplementary agreements, the partners are referred to as Joseph Colianni and Addison Miller, owning equal shares. They are the only partners mentioned and the only ones required to sign the dissolution agreement. The documents were prepared by the lawyer recommended to Colianni by Schiffer, the accountant and bookkeeper of the firm. He probably furnished the lawyer the information and the figures from which to prepare the documents. The alleged partners were there personally or available, but were not in any way considered by any of the parties as necessary parties to the dissolution agreement. It is also significant that the net worth of Joseph Colianni was recited as $51,615.21, which is the exact amount to a penny, as subsequently computed by a written audit of the books prepared by the said Schiffer a month or two later, February 20, 1920, to be exact. This net worth represented one-half of the total net worth. This amount must have been ascertained from some books or source agreeable to all parties. There was no dispute over the amount. The taxpayers attempt to explain away the significance of the written, sworn documents by stating that Colianni was in a hurry to get out and they were in a hurry to get him out. But it appears that the figures were readily obtainable from some source. We do not feel that we should ignore the importance of these documents as relating to the actual situation.

We can not overlook the audits prepared by Schiffer, who acted as bookkeeper and accountant all this time and up to the present time. He prepared an audit for 1918, one for the first six months of 1919, and one for the last six months of 1919. These audits were carried out to the minutest detail. In these audits Addison Miller and Joseph Colianni were recognized as partners until December 1, 1919. Their interests throughout were calculated on a basis of 50 per cent each during this period. Addison Miller attempts to explain these audits as prepared for the purpose of securing credit, but admitted they had not been used for that purpose. A close examination of these audits, however, convinces us that they were made to reflect the actual condition of the firm.

Furthermore, even the taxpayer George Faltico admitted there was a dispute as to his interest. He said:

Q. Now, then this first paragraph, “ Heretofore Colianni and Miller have been equal partners under the firm name of Miller and Colianni ”■ — When you signed that agreement did you think that was true?
A. If you would let me tell you in my own way I would like to tell you something about that, if I may have your permission.
Q. You may start out, anyway.
A. There was always a little bit of doubt in Colianni’s mind whether I was a partner in this business, or whether I was employed by Colianni. He said that I was employed by him and I said I was a partner of his.
Q. Yes, go on.
A. That was in the fall of 1918 after I returned from the west.
In 1919 after I also returned from a trip to the west Oolianni wanted to enter a brother of his as a partner in this business and he made the statement to me at that time that he wanted to pay me off or discharge me, which I refused to do, as I claimed I was an equal partner in that business and was not employed by Colianni.
Q. Is that all you have to say.
A. Yes, on that.

The status of George Faltico was finally determined by the dissolution agreement and the sale of Colianni’s interest to Faltico, in which he was not recognized as a partner, but, on the contrary, signed a document which expressly stated that the partnership was composed equally by Addison Miller and Joseph Colianni. The requisites necessary to create a partnership do not require discussion here. Suffice it to say, however, it is one essential that there be agreement among all the parties of a partnership as to the members of the partnership.

It is true the partnership filed tax returns showing the interests of partners substantially as claimed herein, and also that the individual returns conformed substantially to the partnership returns. But these are the returns that the Commissioner disputes. There is also a discrepancy between the percentages of ownership in the returns and those claimed at the hearing, which would indicate that any such purported arrangement was vague and uncertain in the minds of the alleged partners. Up to December 1, 1919, therefore, there is a clear preponderance of evidence to sustain the contention of the Commissioner as to the composition of the partnership.

For the balance of the year 1919 and the year 1920 the evidence supports the taxpayers’ contention. The parties testified that there was an oral arrangement that the partnership should be continued as “Addison Miller ” and that the interests of the partners were as claimed herein. There is no written or oral evidence to dispute this point as to the year 1920. Joseph Colianni, during this period, was away and not connected with the partnership. We must hold that from December 1, 1919, to December 31, 1920, the partnership was composed of Addison Miller, 37½ per cent; A. T. Miller, 37½ per cent; George Faltico, 12½ per cent, and P. M. Faltico, 12½ per cent.

The partnership of W. A. Miller & Sons, boarding house business, involves the taxpayer Addison Miller and W. A. Miller. All arrangements and agreements were oral and informal. There were strong indications that Addison Miller practically ran this business, particularly after July 1, 1918, when the boarding house contract with the Northern Pacific Railway was changed to and signed by Addison Miller, and all payments were made to him, but the taxpayer Addison Miller testified positively that there was a family arrangement between him and his father and that he merely drew a salary for his work. The father returned income from this source as his individual income. We are inclined to give the taxpayer the benefit of the doubt and sustain his contention in this regard. Thera was also a dispute as to the method of computing income of this partnership, but our holding does not necessitate consideration of that point. We are of the opinion that the taxpayer Addison Miller had no interest in this partnership during the years in question.

The evidence in regard to W. A. Miller & Sons, labor agency, is vague, both on the part of the Commissioner and the taxpayer. The Commissioner ascribes income to Addison Miller from this source as follows:

1918_$4,857.18
1919_1_ 5,448.29
1920_ 9, 813. 97

It appears that the father, W. A. Miller, ran a labor agency as an individual in connection with thé boarding house business. There was an agency at St. Paul and one at Minneapolis. The taxpayer admits ownership of a labor agency in Minneapolis, but any income from that source was returned as income in his individual return. He denies ownership of the St. Paul agency, as that was his father’s, who returned income from that agency in his individual income-tax return. In the light of the testimony, we are of the opinion that the taxpayer Addison Miller received no income from the W. A. Miller & Sons (labor agency) partnership other than that returned by him.

The income from the Northern Pacific Labor Agency (Faltico Labor Agency) was attributed by the Commissioner to be that of George Faltico during the period January 1, 1918, to June 3, 1919. The evidence on this was conflicting, even among the witnesses of the taxpayer. The taxpayer explains that, during the first part of the year 1918, he was a Federal labor agent and had turned this business over to his brothers, P. M. Faltico and M. J. Faltico, and that from July 17, 1918, he was with the firm of Miller & Colianni and was for the most part at Seattle, Wash. However, the evidence discloses that during this time the bank account of this partnership was left in the name of George Faltico, and that substantial deposits from the agency were made throughout the year 1918, amounting to $16,214.98, and that during the year 1919 to June 3, 1919, the average monthly balance was $500. On June 3, 1919, the account was changed from the name of the taxpayer to that of his brother, P. M. Faltico. At the hearing P. M. Faltico testified on direct examination:

Q. Were you interested in tlie labor agency in Minneapolis known as the Faltico Labor Agency, or some other such name?
A. When was that?
Q. 1918.
A. No, sir.
Q. 1919?
A. No, sir.
Q. Did your brother George Faltico turn any labor agency over to you in Minneapolis?
A. Not to me, he did not.
Q. And you had no interest in it?
A. No interest whatsoever in the labor business.
Q. And your brother M. J. had an interest in it?
A. M. J. Faltico in 1919, I think it was.
Q. 1919?
A. Yes, 1919.
On cross examination he testified:
Q. Were you eomiected with this labor agency at 7th and Marquette Avenue at any time?
A. In 1923 I ran it.
Q. In 1918, 1919 and 1920?
A. I had nothing to do with it.
Q. You had nothing to do with it at all?
A. No.
Q. Why did you deposit in it in the name of George Faltico, then?
A. Just looking after his interests while he was away.
Q. Did you deposit any moneys in that bank during 1919, or if you did, it was for George Faltico, wasn’t it?
A. M. J. Faltico.
Q. And also George?
A. No.
Q. You don’t remember ever having a bank account in your name in that bank?
A. No.
Q. During any of these years?
A. No sir.

The taxpayer’s testimony was that P. M. Faltico ran the business during this period, but this brother testified he was merely looking after it for the taxpayer.

It seems clear to us that the brothers were running this business for George Faltico in his absence. We therefore find that during the period January 1, 1918, to June 3, 1919, the taxpayer George Faltico was the owner of this business and the income derived therefrom should be computed accordingly.

On reference to the Board, Smith did not participate.


source: Caselaw Access Project

author: Trussell

license: Public Domain

text:
    Appeal of CONSTANTINE J. TSIVOGLOU.
    Docket No. 3634.
    Submitted July 2, 1925.
    Decided February 15, 1926.
    Valuation of good will asserted by tbe Commissioner overcome by tbe evidence.

      George W. Mathews, Esq., for the taxpayer.

      A. H. Fast, Esq., for the Commissioner.
    Before Littleton, Smith, and TRUssell.
    This appeal involves deficiencies in income and profits taxes for the years 1919 and 1920 of $93,754.84 and $628.56, respectively. The deficiencies result from a computation by the Commissioner showing taxable gain derived by the taxpayer from a reorganization, by incorporation, of his business.
    FINDINGS OF FACT.
    The taxpayer is an individual residing in the State of New Hampshire. His place of business is 131 State Street, Boston, Mass.
    In 1911 he started in business on a small scale as a dealer in confectioners’ supplies in Boston. The business grew steadily, and in 1919 he was operating on a rather large scale. On December 15,1919, C. J. Tsivoglou, Inc., was organized under the laws of Massachusetts, with capital stock of a par value of $149,700, and on December 27, 1919, the taxpayer transferred his going business to that corporation for the entire issue of stock, the par value of the stock being equal to the book value of the assets, less outstanding liabilities. The difference between the book value and market value of the assets, as of the date of exchange, appears as follows:

      The item of foreign exchange, listed among the assets of the taxpayer at $1,197,123.21, represents English pounds sterling and French francs purchased during the year 1919, in the course of business, for use in purchasing supplies abroad, and the market value of assets indicates a deficit of $15,797.69.
    The Commissioner has determined the net income of the taxpayer for 1919 to be $287,303.20. The difference between this amount and the amount previously reported results from the inclusion by the Commissioner in the assets of the taxpayer at the time they were exchanged for stock of an item of good will, upon which he has placed a value of $306,782. This valuation was arrived at by averaging the capital invested and the net earnings for the years 1916 to 1919, inclusive; ascribing 8 per cent as a proper return for the capital, and capitalizing the remaining portion of net earnings at the rate of 15 per cent. On this basis the Commissioner found that the taxpayer realized a profit out of the reorganization in the amount of $141,284.31.
    C. J. Tsivoglou, Inc., continued in business until March 25, 1921, when it was adjudged a bankrupt by the United States District Court for the District of Massachusetts. Subsequently, on the 6th day of July, 1922, James M. Olmstead, receiver in bankruptcy, declared a final and only dividend of one-fifth of 1 per cent on the debts claimed and proved in the bankruptcy case.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days’ notice, in accordance with Rule 50.
   OPINION.

Trussell

: Under section 202 (b) of the Revenue Act of 1918, when property is exchanged for other property the gain or loss resulting, if any, is to be measured by the difference between the cost of the property transferred and the fair market value of the property received in exchange therefor. This taxpayer exchanged his mercantile inventory and business for stock in a corporation organized by him. . The record is entirely silen t as to. whether the stock so received in exchange had any fair market value, or any value whatever, and, so far as can be inferred from the circumstances of this business and its reorganization, we are satisfied that the stock could not have had any market value.

While the taxpayer’s business, during the years 1918 and 1919, had-produced comparatively large profits, an examination of the statement of resources and liabilities of that business, set forth in the findings of fact, shows that, measured by the excess of liabilities over the true value of assets, it was insolvent on the day the corporation was organized.

In view of the record so made, we are forced to the conclusion that the stock of the corporation received by the taxpayer in exchange for his business had no fair market value, and that no gain can be predicated upon the exchange.


author: James:

text:
    Appeal of MASON MACHINE WORKS CO.
    Docket No. 289.
    Submitted November 17, 1924.
    Decided February 15, 1926.
    Taxpayer entered into a contract with a customer for the manufacture of certain engines which proved unsuccessful and the manufacture of which was discontinued in 1917. Although not affiliated, the taxpayer and its customer were closely associated corporations. At the close of 1916 the taxpayer charged off its books a large part of the indebtedness of its customer. During 1918 the possibility of recovering any substantial amounts from the assets of the customer disappeared, but the taxpayer continued to make repairs and supply repair parts to the engines previously manufactured. The taxpayer charged off a further portion but not all of the indebtedness as of the close of 1918. Held, that the debt was ascertained to be worthless in 1918, and that the taxpayer may take, as a deduction for a debt ascertained to be worthless and charged off in the taxable year, all that portion of the debt charged off at the close of 1918, but may not take the remaining portion of the debt not charged oil as at the close of 1918.

      B. G. Shelley, Esq., for the taxpayer.

      W. Franlc Gibbs, Esq., for the Commissioner.
    Before Ivins, KokneR, and Marquette.
    The taxpayer appeals from the determination of a deficiency in income and profits taxes for the year 1918 in the amount of $72,625.94. The sole question at issue is whether the taxpayer should be allowed a deduction of all or any part of an alleged debt, asserted by the taxpayer to have been ascertained to be worthless and to have been charged off within the taxable year 1918.
    FINDINGS OF FACT.
    The taxpayer is a Massachusetts corporation, with its principal office at Taunton.

      In or about the beginning of the year 1914 there was organized a corporation, the Jager Engine Co. by name, with its principal office also at Taunton, which was conducted in close association with the taxpayer.
    During the taxable year 1918 the stock of the taxpayer, in a total amount of 10,000 shares, was held as follows:
    Shares.
    Frederick Mason_ 4, 787
    Harriett Clenson_■_ 4, 781
    William H. Bent_ 422
    A. Bent_ 5
    A. K. Shark_ 5
    Total_10,000
    During the taxable year, until October 15, the stock of the Jager Engine Co. was owned and held, in a total amount of 850 shares, as follows:
    Shares.
    Mason Machine Works Co_ 598
    Charles J. Jager_ 125
    Charles S. Dayl_ 125
    Cleveland & Bent_ 1
    William Davenport_ 1
    Total_ 850
    From October 15 to the close, of the taxable year the stock of the Jager Engine Co. was owned and held as follows:
    Shares.
    Frederick Mason_ 300
    Harriett Clenson_ 298
    Charles J. Jager_ 125
    Charles 8. Day_ 125
    Cleveland & Bent_ 1
    William Davenport_ 1
    Total_ 850
    Prior to May 6, 1914, the taxpayer opened an account upon its books in the name of the Jager Engine Co. and made charges thereto in a total amount of $82,358.02; one on January 1,1914, of $1,761.44, and one on April 30, 1914, of $80,596.58. Credits to this account were made during the year 1914 in the amounts of $25,400 on April 9, and of $1,823.13 and $2,187.50 on April 31 [30]. On April 14 and May 13 the account was credited with $5,000 and $55,000, respectively, on account of capital stock issued to the taxpayer, and thereafter lesser credits were made to the account, so that at the close of the year the total credits amounted to $93,945.21.
    On May 6,1914, the taxpayer entered into a written contract with the Jager Engine Co. whereby the taxpayer agreed to manufacture and sell to the Jager Engine Co. certain types of gasoline engines and parts thereof, in such quantities as the business of the Jager Engine Co. might require. When contractual relations began between these two corporations in 1914, the specifications called for the manufacture of a certain type of engine known as the “Jager Engine.” This type of engine proved to be defective and inefficient. Another pattern was made, and in February, 1915, there commenced the manufacture of the “ Mason Jager Engine,” which manufacture continued up to March, 1917, but this type proved to be as unsatisfactory to the trade as the first type, so that at that time the manufacture of engines ceased altogether.
    In pursuance of the terms of said contract the taxpayer began the manufacture of said engines and delivery thereof to the Jager Engine Co., but, after it had incurred large expenses for labor and material, it was discovered that the product did not prove to be practical, and in due time large numbers of engines were returned from the customers of the Jager Engine Co., due to the faulty and imperfect design. This condition had a twofold demoralizing effect upon the finances of both parties to the contract; first, because it impaired the ability of the Jager Engine Co. to pay for the product already manufactured and delivered, and second, because of the fact that additional sums of money were required to be expended for labor and material by the taxpayer in reconditioning, repairing, and experimenting, thus adding to the Jager Engine Co.’s debt without assisting it in its ability to make the payments stipulated in the contract. By the close of 1916 the open account on the books of the taxpayer with the Jager Engine Co. showed a net balance charged to that company, including the charges above set forth and all charges for work done in conformity to the contract of May 6,1914, in a total amount of $241,673.18. This amount was balanced and carried forward as of January 1, 1917, but after the account was ruled off and forwarded by a journal entry made as of December 30, 1916, the taxpayer charged to profit and loss and credited to the account an amount of $162,843.18, and deducted the said amount as a debt ascertained to be worthless in its income-tax return for the year 1916.
    The taxpayer ceased manufacturing engines under its contract with the Jager Engine Co. in the early part of 1917.
    The Jager Engine Co. still held out the hope that it would be able to sell its drawings, patterns, patents, and whatever inventory it had, en bloc to some other engineering concern, and would thereby realize some funds with which to pay at least part of its indebtedness to the taxpayer. Officers of the Jager Engine Co. began a search for a purchaser of its entire assets, and on April 24, 19Í7, an option was given to one F. K. Lord whereby he was granted an option to purchase the assets of the concern at an agreed price of $44,250. During 1917 Lord paid the sum of $6,000 in cash, of which $4,500 was paid to the taxpayer and credited by it to the account of the Jager Engine Co., but, after many extensions of time had been requested and granted, Lord defaulted under his option on January 10, 1918, and it then became certain that the Jager Engine Co. was hopelessly insolvent and that the taxpayer could never recover the debt then due, or any material part thereof.
    During the taxable year 1917 the taxpayer carried on repair work on machines already made and sold by the Jager Engine Co., and charged that company therefor, and on December 31, 1917, the books of the taxpayer showed a balance due from the Jager Engine Co., after credit for the above amount of $162,843.18 written off, of $92,302.48, which amount was carried forward as the balance on January 1,1918.
    During the taxable year 1918 further minor charges were made to the account and two minor items of debits were made thereto, so that as of December 31, 1918, the account showed a balance of $93,313.46, which amount was forwarded as of January 1, 1919. Against the said amount there was credited by journal entry as of December 31, 1918, but after the account was ruled off and forwarded, an amount of $76,000, and this amount the taxpayer claimed as a deduction in its original return for the year 1918 on account of a debt ascertained to be worthless and written off during the taxable year. On October 15, 1918, Frederick Mason and Harriett Clenson caused to be transferred to themselves the stock of the Jager Engine Co. theretofore owned by the taxpayer. It appears that theretofore the stock of the Jager Engine Co. owned by the taxpayer was charged off the books.
    The balance of $17,313.46 was thereafter increased by minor charges and decreased by minor credits, and was ultimately written off the books in the years 1920, 1921, and 1923. All the contract work for the construction of engines was completed some time in 1917, and, on account of the intimate knowledge of the affairs of the Jager Engine Co. — since the books of account and most of its assets were kept on the premises of the taxpayer and in custody of its employees; from the knowledge of its past experiences in trying to put these engines in satisfactory condition so as to meet the demands of the market; and from its thorough knowledge of the nature, character, and amount of the assets of the Jager Engine Co. — and realizing that nothing of value to the taxpayer could be recovered by legal action, it was ascertained by the taxpayer in 1918 that the account was worthless.
    On December 30, 1921, the stockholders of the Jager Engine Co., in a special meeting, resolved to accept a claim of Charles J. Jager and C. S. Day for services in the sum of $6,300 and to sell to them for that amount the “ inventory ” of the company; to acknowledge the debt of the Jager Engine Co. to the taxpayer and to dissolve the Jager Engine Co. The “inventory” so sold to Jager and Day had no market value, but was turned over in this manner to them in satisfaction of claims which they could not otherwise have collected.
    The Commissioner, in auditing the taxpayer’s income-tax return for 1916, disallowed the deduction of $162,848.18 claimed upon the ground that the debt had not then been ascertained to be worthless. In auditing the taxpayer’s 1918 return he disallowed the deduction of $76,000 written off on account of the debt for the same reason. This disallowance, with other adjustments, resulted,in the determination of a deficiency for 1918 of $72,625.94, from which this appeal was taken.
    DECISION.
    The deficiency should be determined in accordance with the fol-’ lowing opinion. Final determination will be settled on 15 days’ notice, under Rule 50.
   OPINION.

James:

At the end of 1916 the Jager Engine Co. stood charged on the books of the taxpayer with an;open account in the amount of $241,673.18, and as of the close of that year, but after the ruling down of the account, the taxpayer charged off $162,843.18 thereof, leaving a balance of $78,830. In the same manner at the end of 1918 the taxpayer’s balance against the Jager Engine Co., including the above item of $78,830, was $93,313.46, of which $76,000 was charged off as of the close of 1918 but after the books had been ruled off and the balances forwarded. The taxpayer claims that it is entitled to deduct, under section 234 (a) (5) of the Revenue Act of 1918, the total amount of $256,156.64, representing a debt ascertained to be worthless and charged off within the taxable year 1918, within the meaning of that subdivision, and made up of the item of $162,-843.18 charged off in 1917 as of the close of 1916, $76,000 charged off in 1919 as of the close of 1918, and the balance of the account, amounting to $17,313.46. The actual balance of the account on December 31, 1918, was $93,313.46, after deducting the above-mentioned charge-off of $162,843.18.

The Commissioner claims that the entire amount should be written off as of December 31, 1921, and not as of December 31, 1916, when taxpayer charged off $162,843.18, or as of December 31, 1918, when taxpayer charged off $76,000. We are clear that the debt was not deductible in 1916, since in that j^ear it had not been ascertained to be worthless. We are of the opinion that the debt was ascertained to be worthless as of December 31, 1918, and, if the taxpayer has otherwise complied with the requirements of the statute, it is entitled to the deduction in that year. The total account as of the close of that year was, as stated above, $93,313.46, and $162,843.18 had theretofore been charged off, so that the total account as of that date was $256,156.64. In making the book entries thus outlined the taxpayer was following the proper business course, since it was apparent at the close of 1916 that it could not recover all of the account, and it was clear at the close of 1918 that it would never recover any substantial portion of the entire amount.

Not until 1921 did the Income Tax Acts permit deductions for debts ascertained to be worthless in part. The Revenue Act of 1918 allows as deductions “ Debts ascertained to be worthless and charged off within the taxable year.” The language is unambiguous and unmistakably requires compliance with both conditions before a deduction may be allowed for the purpose of computing net income subject to taxation. As to $17,313.46 of the amount claimed by the taxpayer, we are therefore of the opinion that the statute bars the deduction for the simple reason that that amount at least the taxpayer did not “ charge off within the taxable year.” It chose deliberately to carry forward this balance for reasons satisfactory to itself, even though as of the close of 1918 the worthlessness of the account had been ascertained.

But we think the fact that the taxpayer charged off $76,000 after closing the books, putting it as the first entry in 1919, does not affect its right to make the deduction in 1918. The entry dated December 31 was the first entry made after the ruling down of the accounts, and in our opinion substantially complies with the requirement that the amount be charged off within the taxable year. This language must be interpreted in the light of the ordinary course of business practice. It is not the physical act done within the year to which Congress has referred, but to the setting up of evidence of the ascertainment of worthlessness substantially as of the date of such ascertainment 'and in confirmation thereof. The amount of $76,000, we believe, is clearly deductible.

The taxpayer prior to 1918 had charged off $162,843.18, and claimed this amount as a deduction in its return for 1916. The Commissioner very properly disallowed the deduction for that year. For purposes of income-tax accounting, therefore, this amount is to be regarded not as having been charged off by the taxpayer but rather as having been charged to a reserve. In writing the account down to $17,313.46 at the close of 1918 by the entry of $76,000, the taxpayer in effect consolidated with the last-mentioned amount the amount of $162,843.18 theretofore charged out of the account. If the taxpayer had credited surplus and debited the Jager Engine Co.’s account with $162,843.18, and had immediately credited this amount and debited surplus with $238,843.18, it would have complied literally with the requirement that the account be “ charged off within the taxable year ”; yet such an entry would have been wholly meaningless as a matter of bookkeeping and would have been an entry which only could have been put upon the books for purely income-tax purposes, and would have reflected no fact of any significance whatever. The significant fact is that all of the account which then stood upon the books, except $17,313.46, was charged off as of the close of 1918. We are of the opinion that the taxpayer is entitled to a deduction in 1918 of $238,843.18.


author: Marquette:

text:
    Appeal of FIRST NATIONAL BANK OF MANCHESTER, KY.
    Docket No. 941.
    Submitted April 13, 1925.
    Decided February 15, 1926.
    Where bonds were sold on an installment basis, to be delivered upon completion of the subscription payments, the amounts paid by purchasers and retained by taxpayer upon forfeited contracts constitute income to it, and the market value of the bonds at the time the contracts were forfeited is immaterial.

      Attüla Oox, Esq., for the taxpayer.

      W. D. Nance, Esq., for the Commissioner.
    Before Marquette and Morris.
    This appeal is from a determination by the Commissioner of deficiencies in income and profits taxes for the years 1920 and 1921, in the amounts of $714.89 and $291.02, respectively.
    FINDINGS OF FACT.
    The taxpayer is a Kentucky corporation, with principal office in Manchester.
    The United States Government made an allotment of fourth Liberty loan bonds to the taxpayer in the year 1918, and the taxpayer arranged for the sale of the same to the public at par. Each purchaser was obligated to pay with his subscription 10 per cent of the par of the bonds and to pay the balance in installments. The taxpayer was to retain the bonds until the final payment was made therefor. Purchasers defaulted in their payments, and under date of December 8, 1920, the taxpayer made book entries to show the cancellation of the subscriptions and the possession of the bonds by the taxpayer entirely free of any subscription obligations.

      In its return for 1920 the taxpayer included as income the amount of $4,084.65 standing upon its books as the payments made by subscribers who had defaulted on their subscriptions during 1920, and included the same amount as a deduction from income.
    The market quotation for fourth Liberty loan bonds on December 8, 1920, was 85.66 and accrued interest.
    The taxpayer’s net income for 1921 was $7,046.95, instead of $8,046.95, as erroneously stated by the Commissioner.
    The Commissioner determined a deficiency in tax for 1920 of $714.89, and for 1921 of $291.02. The taxpayer duly appealed.
    DECISION.
    The determination of the Commissioner of the deficiency for 1920 is approved. The deficiency, if any, for 1921 should be computed upon a net income of $7,046.95 admitted by the Commissioner. Final determination as to 1921 will be made by the Board upon 7 days’ notice, under Eule 50.
   OPINION.

Marquette:

The only question for decision is whether the payments on the bonds which the taxpayer retained after forfeiture of the contracts constituted income, and the amount thereof. The petition alleged that the sum of $4,084.65 was received from purchasers who failed to comply with their contracts. Depositions were taken by the taxpayer, and upon completion thereof, after leave granted, it filed an amended petition presumably to conform to the testimony offered in the depositions. The amended petition alleged that the aggregate of the amount paid by purchasers of bonds which were forfeited was $2,260, instead of $4,084.65.

To prove the allegations of its amended petition the deposition of the president was taken, who testified as to what the books of the taxpayer showed and who expressed his opinion that the bookkeeper was in error in making the entries. The books were not produced in evidence, nor were they used as memoranda to refresh the recollection of the witness. At the hearing of the appeal the taxpayer was not represented. The Commissioner objected to the testimony of the witness as to the contents of the books as being incompetent and not the best evidence, and further objected to the conclusions and opinions of the witness, which objections were taken under consideration. We think the evidence offered was clearly incompetent, and the Commissioner’s objection thereto was later sustained. There is no evidence to sustain the allegations of the amended petition with respect'to the amount of the forfeited payments, and the Commissioner’s determination of that amount must stand.

We are further of opinion that the amounts retained, by the taxpayer upon the forfeited payments were income to it, and that the market value of the bonds at the time of forfeiture is immaterial. The taxpayer never parted with the title to the bonds, in so far as the record shows, and no sale was contemplated until all of the subscription payments were complete. The determination of the Commissioner with respect to the year 1920 must be approved. See Appeal of Citizens Trust Co., 2 B. T. A. 286.

The Commissioner has admitted error as to 1921, arising from a mathematical error in computing net income. He admits the net income should have been $7,046.95 instead of $8,046.95, and the former amount should be used in determining the amount of tax for the year 1921.

On reference to the Board, Phillips dissents.


author: Smith:

text:
    Appeal of THE NEW OTTAWA COUNTY TELEPHONE CO.
    Docket No. 5558.
    Submitted January 1, 1926.
    Decided February 15, 1926.
    An amount representing appreciation in tbe value of fixed assets, and an amount representing a reserve for depreciation set up out of “earned surplus,” may not be included in invested capital of a corporation for tbe year 1919.

      Alfred L. Geiger, Esq., for the taxpayer.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    Before Smith, Littleton, and Trussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1919 in the amount of $410.57. The deficiency was occasioned by the exclusion from invested capital shown on the return of an amount representing an appreciation in the book value of assets, and an additional amount representing a restoration by the taxpayer to surplus of a reserve for depreciation set up out of earned surplus in the years 1908 and 1916.
    FINDINGS OF FACT.
    The taxpayer is a public utility in the State of Ohio, with its office at Elmore. It was organized in 1902.
    In 1915, at the instance of the Public Utilities Commission of the State of Ohio, it made an inventory of all of its assets, based upon the reproduction cost of its plant and equipment, and determined that the book values thereof were less than market values to the extent of $28,499.50. It therefore increased the book values of its assets by that amount and made a debit to “ inventory surplus v of a like amount.

      From 1902 to 1908 the taxpayer made no provision for depreciation in the keeping of its books of account. In 1908 the board of directors authorized the setting up of a reserve for depreciation in the amount of $25,000. Surplus was credited with a like amount. From 1908 to 1916 depreciation was not regularly charged, and in 1916 the taxpayer added to its reserve for depreciation an additional amount of $18,000. Surplus was reduced by a like amount.
    In its income-tax return for 1919 the taxpayer included in invested capital $28,499.50, representing “ inventory surplus,” and also $43,000, representing the portion of its reserve for depreciation which had been charged against surplus in the years 1908 and 1916.
    The Commissioner has excluded from the invested capital shown upon the return the two amounts in question.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Smith:

The taxpayer claims the right to include in invested capital an amount representing appreciation in the value of its assets, the amount being the difference between the book value of the assets and the value placed upon them as the result of an inventory made by the taxpayer’s employees. The inventory was taken at the instance of the Public Utilities Commission of the State of Ohio, the basis of which was “ reproduction cost in 1915.”

At the hearing it was intimated that the books of account did not accurately reflect the cost of the assets owned by the taxpayer at the date of the inventory. However, this was not proven. So far as the record shows the entire amount of the increase in the inventory over the book value of the assets represented by “ inventory surplus ” was appreciation in the value of those assets. It is significant to note in this connection that the taxpayer, in keeping its books of account, did not carry this amount as a part of its general surplus, which it might properly have done had there been an error in the keeping of its books. It carried the increase simply as “ inventory surplus.” It is a well-established principle of the income tax laws that appreciation in the value of assets may not be included in invested capital. La Belle Iron Works v. United States, 256 U. S. 377.

The argument with respect to the inclusion in invested capital of an amount set up as a reserve for depreciation is that depreciation is a charge against only the earnings of the current year, and that where a corporation has failed to charge depreciation against the current earnings the amount carried to surplus acquires the character of “earned surplus,” and that thereafter it may not be reduced by a charge for depreciation covering a series of years or by an operating deficit for any year; furthermore, that although the earned surplus of a mercantile concern might properly be reduced by an operating deficit, the surplus of a public utility, which derives its income from services rendered to the public under rates-established by governmental authority, occupies a different status and may not be thus reduced.

We think such an argument is unsound. The surplus of a corporation is the equity of the stockholders in the assets of the corporation over and above the par value of the capital stock, and an “ earned surplus ” is simply that portion of the surplus which comes in through earnings. “ Earned surplus ” is not necessarily what a taxpayer’s books of account show as such, for the books of account may be in error. If a corporation which suffers depreciation does not charge it off against operating profits its book earned surplus is not its true earned surplus. Appeal of City National Bank, 2 B. T. A. 623; Appeal of Alexandria Paper Co., 3 B. T. A. 239. In the instant case the taxpayer came to the conclusion in 1908 that its true earned surplus was overstated in the amount of $25,000; hence the reduction of the book surplus by that amount. In 1916 there was a similar reduction of the hook surplus in order to bring its books of account into accord with actual facts. From the record we can not find that the true earned surplus of the corporation was in excess of that shown by the books of account.


author: Morris:

text:
    Appeal of KIRK COAL CO.
    Docket No. 2879.
    Submitted June 15, 1925.
    Decided February 15, 1926.
    1. An amortization deduction on certain assets acquired by the taxpayer between April 6, 1917, and November 11, 1918, disallowed, since no evidence was presented to show the extent to which they were thereafter employed, or the actual or estimated cost of replacing them under normal postwar conditions.
    2. Deduction of certain expenditures allowed as ordinary and necessary business expenses. Other expenditures held to be of a capital nature.
    3. On the facts stated the taxpayer is not entitled to include in invested capital as paid-in surplus any cash value which a certain lease may have had.
    IF. P. Sandidge, Esq., and John A. Wells, G. P. A., for the taxpayer.

      A. H. Fast, Esq., for the Commissioner.

      Before IviNS, Marquette, and MoRris.
    This is an appeal from a deficiency in income and profits taxes for 1918 in the amount of $39,819.99. The taxpayer assigns the following errors: The disallowance of (a) an amortization claim of $18,537.82, (b) structure repairs of $7,373.30, (c) equipment repairs of $3,636.49, (d) cost of labor on structure repairs of $2,133.40, (e) cost of labor on equipment repairs of $1,807.76, (/) exhaustion in the amount of $6,097.83 on a leasehold valued at $152,445.85, (g) the inclusion of the above-mentioned leasehold in invested capital, and (A) the determination by the Commissioner of a profits tax of 61 per cent under section 328 of the Revenue Act of 1918.
    FINDINGS OP PACT.
    The taxpayer is a Kentucky corporation, with its principal office at Beech Creek. Throughout the years of its corporate existence it has been engaged in mining and selling coal. Until 1917 the product of its mines had been marketed in a limited territory south of the Ohio River, in States bordering on Kentucky. After this country became an active participant in the World War, and until about November 11,1918, from 60 to 70 per cent of the coal produced from the taxpayer’s mines was sold to common carriers, munitions plants maintained and operated by the Government, and troop-mobilization cantonments.
    Prior to 1917 the labor market in the vicinity of the company’s mines was such that the taxpayer experienced no difficulty in securing the services of miners. In the fall and winter months, when capacity operations were, being carried on, the supply of labor available for the taxpayer’s needs was swelled by the addition to its ranks of farmers in the adjacent territory. Available facilities in the immediate neighborhood were ample for the housing of its miners, so that the taxpayer had not found it necessary to construct houses for those employees. It did own, however, eight frame houses which had been constructed prior to April 6, 1917, for the purpose of housing its foremen and clerks.
    After this country became involved in the World War the local supply of labor available to the taxpayer began to diminish, and continued to do so because of the drafting of available laborers into the military service and the migration of others to industrial centers until the taxpayer found it necessary to import laborers and construct houses for them. Between April 6, 1917, and November 11, 1918, the taxpayer constructed 35 miners’ houses. These houses were of typical mine construction, being built of soft pine lumber, each having four rooms, and resting on brick or wooden pillars. The total cost of construction, was $27,102.32. These houses are still being used, and the taxpayer tries to avoid employing men who will not occupy them. Of the total deduction claimed on account of amortization of war facilities, $9,537.85 represents amortization of the cost of these 35 houses. The balance of the deduction is made up of the following items, all of which were acquired, constructed, erected, or installed during the period April 6, 1917, to November 11, 1918:
    Cost.
    1 storehouse_$6, 481.91
    1 car shop_ 450. 76
    1 mining machine_ 2, 800. 00
    40 mine cars_;— 3, 980.00
    Copper wire_ 805. 79
    The total deduction. claimed on the return for structure repairs amounts to $9,014.09. The Commissioner allowed the deduction in the sum of $1,640.79, and disallowed the remainder, $7,373.30. The amount disallowed by the Commissioner is made up as follows:
    Steel rails for tracks_$⅜ 901.40
    Iron pipe_r_ 114. 02
    Ties for laying tracks- 531. 70
    Cinders for roadbed- 30. 00
    Spikes- 108. 00
    Iron plates_ 38.18
    Track repairs- 5.23
    Track inspection_ 1. 75
    Track rentals_ 29.18
    Unidentified expenditures_ 1, 613. 84
    7, 373.30
    The steel rails, costing $4,901.40, the ties, costing' $531.70, the cinders, costing $30, and spikes, costing $108, were acquired for the purpose of keeping tracks from main-entry roads in touch with the face of the coal. Their useful life extended over a period of several years.
    The iron pipe was acquired at a cost of $114.02 for the purpose of pumping drainage water from the mines. This water is cop-peras, and iron pipes deteriorate rapidly from contact with it.
    Iron plates, acquired at a cost of $38.18, were used for patching screens. Track repairs, track inspection, and track rentals are all items billed by the Louisville & Nashville Railroad for repairs and inspection to surface tracks owned by the taxpayer, and rental on tracks and switches of the railroad company used by the taxpayer.
    Of the total amount disallowed by the Commissioner the taxpayer failed to identify items representing an aggregate expenditure of $1,613.84.

      The total deduction claimed on the return for equipment repairs amounts to $8,210.60. The Commissioner allowed the deduction in the sum of $4,574.11, and disallowed the remainder, $3,636.49. The amount disallowed by the Commissioner is made up as follows?
    Mule_ $125.00
    Steel rails and frogs_1, 234.65
    Sundry items_ 1, 725. 30
    Unidentified items_ 551. 54
    Total_• 3, 636.49
    The mule was acquired at a cost of $125 to replace one which had become crippled and worn out.
    The steel rails and frogs were acquired by the taxpayer at a cost of $1,234.65 for the purpose of keeping tracks from main-entry roads in touch with the face of the coal. They had a useful life of several years.
    There are approximately 45 items making up the total cost of $1,725 for sundry items. These items are miscellaneous hardware, small tools, repair parts, oils, paints, tar, canvas, etc.
    Of the total amount disallowed by the Commissioner the taxpayer failed to identify items representing an aggregate expenditure of $551.54.
    The mining properties operated by this taxpayer are owned by the Beech Creek Coal Co. In 1910 these properties were leased by the owner to the Hendrie Coal Co. for a term of 25 years on a royalty basis of 4 per cent of the selling price of all coal mined and sold by the lessee. Considerable development work was done by the lessee; approximately one-half mile of track was laid; tipple, blacksmith shop, and other structures were built; an entry of approximately 1,000 feet was driven, and .the mine was producing between 200 and 300 tons of coal per day. The lessee operated the properties until the early part of 1914, when it forfeited the lease. On May 8, 1914, the Beech Creek Coal Co. leased these properties to the taxpayer for a term of 25 years on the same royalty basis as that paid by the former lessee. No consideration was paid by the taxpayer for the lease other than the royalties reserved to the lessor in the lease agreement. At the time this lease was made the capital stock of the taxpayer corporation was owned by L. Z. and H. L. Kirkpatrick, brothers, and C. Kirkpatrick, son of L. Z. Kirkpatrick, while the capital stock of the Beech Creek Coal Co. was owned by L. Z. Kirkpatrick and four of his brothers.
    In its return for 1918 the taxpayer included this lease in invested capital at a value of $152,445.85 in the form of a paid-in surplus, and in the same return claimed a deduction from gross income of $6,097.83, or one twenty-fifth of the claimed value, on account of exhaustion of the lease. The Commissioner disallowed the claimed value of the lease for invested capital purposes, as well as the deduction claimed for exhaustion.
    Taxpayer made application to the Commissioner to have its profits-tax liability for the year 1918 determined under the provisions of section 828 of the Revenue Act of 1918. This application was given favorable consideration by the Commissioner, and the proiits-tax liability was fixed by him at an amount equivalent to 61 per cent of the net income.
    The taxpayer reported a net income of $65,665.34 in its return for 1918, and computed total income and profits taxes thereon of $29,105.75. The Commissioner’s action on the deductions claimed by the taxpayer is summarized in the following table:

    During the hearing of this appeal counsel for the Commissioner admitted error with respect to the disallowance of the cost of labor on structure and equipment repairs, and conceded that such amounts thereof as had been disallowed in computing the deficiency constituted proper deductions from gross income as ordinary and necessary business expenses.
    DECISION.
    The deficiency should be computed in accordance with the admissions made by the Commissioner and the following opinion. Final determination will be settled on 15 days’ notice, under Rule 50.
   OPINION.

Morris:

The taxpayer contends that' the assets with respect to which the amortization allowance is claimed are “ facilities constructed, erected, installed, or acquired on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war” within the purview of section 234 (a) (8) of the Revenue Act of 1918, and that it is entitled to a reasonable deduction for amortization of the cost of these assets in computing its taxable net income. It has computed the allowance for amortization of the cost of miners’ houses by comparison of the actual cost of construction with the estimated cost of replacement under normal postwar conditions, using the ratios in respect of costs of material and labor determined and published in Treasury Decision 8333. By such comparison the actual cost of construction of 35 houses exceeded the estimated postwar cost of replacement by $9,537.85, which is the amount of the amortization claimed with respect to these houses. It claims an amortization allowance with respect to the other assets in an amount equivalent to 50 per cent of their actual cost. The whole deduction claimed has been disallowed by the Commissioner, on the ground that following the termination of the amortization period the taxpayer continued to use all of these assets in the business to their full capacity.

That the assets upon which amortization is claimed were employed in the business subsequent to the termination of the amortization period is clear, but no evidence has been presented to show the extent to which they were so employed, or the actual or estimated cost of the replacement of these assets under normal postwar conditions.

On the second assignment of error the Commissioner contends that the amount he has disallowed is made up entirely of expenditures for items of a capital nature. We find from the evidence before us, however, that of the total amount disallowed by the Commissioner, $188.36, which was expended for iron pipe, iron plates, track repairs, track inspection, and track rentals, was an ordinary and necessary expense. The assets acquired for the purpose of keeping the tracks from the main-entry roads in touch with the face of the coal, including steel rails, ties, cinders for roadbed, and spikes, totaling $5,571.10, were capital items having a useful life of several years, and therefore the cost thereof is not deductible as an ordinary and necessary expense. Appeal of Union Collieries Co., 3 B. T. A. 540. The items making up the balance of the amount of $1,613.84 disallowed by the Commissioner have not been identified by the taxpayer, and we have no knowledge as to their nature.

The Commissioner disallowed certain expenditures made for equipment repairs on the ground that they were of a capital nature. We find from the evidence before us that of the total amount disallowed by the Commissioner $1,725.30 was expended for ordinary and necessary expense. The deduction of $1,234.65 expended for steel rails and frogs is disallowed for the reasons set forth, respecting similar expenditures under structure repairs. The cost of the mule was a capital expenditure, and therefore not deductible. The items making up the balance of the amount disallowed by the Commissioner of $551.54 have not been identified by the taxpayer, and we have no knowledge as to their nature.

The taxpayer acquired a lease subsequent to March 1, 1913, under the circumstances set out in the findings of fact, without capital outlay. Irrespective of whether the lease had any cash value, the law does not authorize the inclusion in invested capital as paid-in surplus of the value of an asset acquired as herein set forth.

The taxpayer failed to prove by any competent evidence its allegation that the Commissioner erred in determining its profits-tax liability under the provisions of section 328 of the Revenue Act of 1918 to be an amount equivalent to 61 per cent of the net income.

Our conclusions, therefore, on the issues raised by the taxpayer are as follows: (a) The amortization claim of $18,537.82 should be disallowed, (5) structure repairs of $188.36 should be allowed and $7,184.94 disallowed, (c) equipment repairs of $1,725.30 should be allowed and $1,911.19 disallowed, (d) (e) cost of labor on structure repairs of $2,133.40 and on equipment repairs of $1,807.76 should be allowed on the admission of error by the Commissioner, (†) (g) exhaustion of $6,097.83 on the leasehold and its inclusion in invested capital should be disallowed, and (A) the Commissioner’s determination of the profits-tax rate is approved.


author: Momas:

text:
    Appeal of H. B. HILL.
    Docket No. 1689.
    Submitted May 21, 1925.
    Decided February 15, 1926.
    1. Salary received by an officer of a corporation and returned thereto under a salary adjustment prior to the close of the taxable year should not be included in his gross income.
    2. Under the circumstances of this appeal, a reasonable annual allowance for the exhaustion of the contract is that proportion of the cost which the income received in each year bears to the total income to be derived from the contract.

      O. B. Irwin, Esq., for the taxpayer.

      J. Arthur Adams, Esq., for the Commissioner.
    Before Maequette and MoeRis.
    This is an appeal from the determination of a deficiency of $1,-402.12 in income tax for the year 1920, arising from the inclusion in gross income of $2,500 as salary received by the taxpayer from the Commercial Health & Accident Co., and $2,205.37 renewal commissions, reduced by $600 depreciation on the cost of the contract under which such commissions were received from the Central Life Insurance Co.
    FINDINGS OF FACT.
    The taxpayer is a resident of Springfield, Ill. During the taxable year in question he was president and a director of the Commercial Health & Accident Co., a corporation organized under the laws of the State of Illinois. In determining salaries at the annual meeting each year the directors took into consideration the fact that the assessment law of the State of Illinois would not permit of an increase in salaries after they had once been fixed by the board of directors, so in anticipating the increase in business they always determined the amount of salary that they would attempt to draw during the year, and set it at the highest possible point, so that if business improved they could draw that salary; on the other hand, if the claims were high and the business would not justify that salary, there was an understanding that they would turn back part of the salary they had drawn. The directors were also officers of the company. The following is an excerpt from the minutes of the regular meeting of the board of directors held January 12, 1920:
    The matter of salaries of officers of the ensuing year was then discussed, and, upon motion made, seconded, and unanimously carried the following yearly salaries were authorized to be paid monthly:
    H. B. Hill, President_$2,400
    H. G. Rockwood, 1st vice-president_ 2, 400
    1?. M. Jeffer, 2nd vice-president_ 2,400
    G. O. Rockwood, Secy.-Treas- 2, 400
    Dr. J. R. Neal, Medical Director- 1, 500
    During the year 1920 the taxpayer received twelve checks for $250 each, which were drawn “ for salary.” Toward the close of the year the directors found that the reserve required by law had been depleted through the payment of claims and that it would have to be increased by $10,000 in order that the annual report would be accepted by the Insurance Department of the State of Illinois. At an informal meeting of the directors it was decided to return that amount to the company, and on December 23 they purchased $10,000 of second Liberty loan bonds and turned them over to the company, each contributing $2,500. This amount was entered on the books of the company as “Advanced by officers,” but on December 31, 1920, the latter account was charged and the general fund, the account to which salaries had been charged, was credited with the same amount. The Insurance Department of the State of Illinois, after the annual report of the company had been filed, required the officers to execute and file a release to the company to the effect that they had no claim whatever on the money returned to it. No part of the taxpayer’s $2,500 has ever been returned to him. In a similar transaction, which took place about two years before, $4,000 was returned to the company.
    By a contract dated October 22, 1910, the taxpayer became a general agent of the Central Life Insurance Co. of Illinois, under the terms of which he was to receive a certain percentage on the first nine renewal premiums paid to the company upon each policy written under said contract. He was actively engaged in writing insurance under this contract until August, 1916. Thereafter he continued to receive his commissions on the renewal premiums until September 16, 1918, at which time he made an assignment of his right to the renewal commissions to L. H. Touche. December 31, 1919, he repurchased the rights of Fouche under the contract for $4,000, and from that time received the commissions upon the renewal premiums paid to the company. The commissions received by the taxpayer during the year 1920 were $2,205.13; 1921, $2,018.21; 1922, $1,250.53; 1923, $740.61; 1924, $391.44. The estimated commission for 1925, based on the amounts received during the first four months, is $150. The last renewal premium under the contract is due in August, 1926.
    In his return for the year 1920 the taxpayer reported a salary oí $500 from the Commercial Health & Accident Co., and did not report any part of the renewal commissions of $2,205.13' received in that year from the Central Life Insurance Co. of Illinois.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, under Fule 50.
   OPINION.

Momas:

The first question involved in this appeal is whether the taxpayer should include in his return for the year 1920, $2,500 which he received from the Commercial Health & Accident Co. and returned to it during that year. The taxpayer contends that his salary for the year was $500, due to a salary adjustment having been made prior to the close of the taxable year, while the Commissioner’s position is that the $2,500 returned to the corporation was a contribution to capital. We are convinced from the evidence that there was an understanding among the officers and directors of the corporation that salaries should be set at the highest possible point in the hope that the business would justify them, but if unexpected claims developed, thereby reducing the income of the corporation, the officers would refund a portion thereof. All of the officers and directors of the corporation were active in the conduct of its business and interested in its success.

Toivard the close of the year 1920 it was found that the reserve-required by law had been depleted through the payment of claims,, and that it would have to be increased to the extent of $10,000. At. an informal meeting the directors decided to return that amount to-the company in accordance with their understanding. On December 23 they purchased $10,000 of second Liberty loan bonds and turned them over to the company, each contributing $2,500. It appears to us that the effect of this action was to modify any prior agreements as to salaries for the year 1920 and to substitute therefor the amounts which were actually retained by the respective officers. We have held in the' Appeal of H. C. Couch, 1 B. T. A. 103, that—

Salary arrangements between corporations and tbeir principal stockholders and managers in cases like this one, where the manager is expected by his associates to protect the interests and the future prospects of the company even at a sacrifice to himself, are and must be at all times subject to such modifications as may be made by agreement from time to time; and it appears to us that the arrangement entered into by this taxpayer and this corporation in the month of December, 1920, clearly shows an intent on the part of both sides to modify the prior existing agreements in regard to this taxpayer’s compensation.

We are of the opinion that the principle therein announced is controlling in this appeal, and that therefore the salary from the Commercial Health & Accident Co. to be reported in the taxpayer’s return for the year 1920 is $500.

No question is raised under the second issue as to the right of the taxpayer to a recovery of the $4,000 paid for the contract with the Central Life Insurance Co. of Illinois, but the basis upon which it shall be recovered is in dispute. The taxpayer contends that he is entitled to a recovery of the $4,000 before any part of the renewal commissions should be reported, while the Commissioner has allocated it ratably over the period during which it is expected such commissions will be received, which is six and two-thirds years. There is one distinctive feature of this contract upon which we believe the solution of the problem rests. Commissions are paid on the first nine renewal premiums on each policy written thereunder. The last policy was written in 1916, so it is apparent that the number of renewal premiums upon which the taxpayer is entitled to commissions is gradually diminishing, although the policies remain in force. The cancellation of policies through death or the nonpayment of premiums also eliminates the possibility of the taxpayer’s receiving further income from them. The net result is that the taxpayer is realizing a diminishing income from the contract, not by reason of fluctuating business conditions, but by reason of the nature of the contract itself. Section 214 (a) (8) provides for a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business. We are of the opinion that the yearly allowance, in order to be reasonable and permit a recovery of the capital investment under the circumstances of this appeal, should be that proportion of $4,000, the cost of the contract, which the income received in each year bears to the total anticipated income under the contract. The commissions for the years 1920, 1921, 1922, 1923, and 1924 are definitely known and constitute substantially all the income that will be received.