NELSON v. COMMISSIONER

The Commissioner determined a deficiency of $3,060.30 in income tax for the year 1941. The petitioner assails as erroneous the action of the Commissioner in including in his taxable income (1) the net income of $9,403.91 derived from the operation of a hotel, alleged by petitioner to be taxable to his wife, (2) the amount of $160.31 representing an increase in the reported net income derived from petitioner's linen business, and (3) the disallowance of claimed entertainment and automobile expenses in the amount of $1,070.

FINDINGS OF FACT.

The petitioner is a resident of Detroit, Michigan. He was married on November 19, 1933. His wife, Goldye Jean Nelson, for about two and one-half years prior to her marriage was employed as a dental hygienist.

About September 1934 petitioner entered into a wholesale linen business under the name of "A. Nelson Company," to which petitioner contributed about $1,500 and his wife about $1,000. The moneys contributed to the business by the wife consisted of savings out of her salary as dental hygienist and about $400 received upon a matured insurance policy. Petitioner and his wife had an understanding that if she would do the inside work for "some time" so that petitioner was free to go out and solicit business her share would be the same as that of petitioner.

Until the birth of a daughter sometime in the early part of 1938, petitioner's wife assisted petitioner in the linen business. She spent almost every work day and several evenings each week at the place of business taking care of the inside work while petitioner went out soliciting business. After the birth of the daughter she worked only occasionally. In addition to working in the business, she also kept house. A second child was born in 1942.

In June 1936 petitioner commenced the operation of the Aberdeen Hotel, which was held under lease until about October 30, 1939. On that date a land contract was executed by the receiver for the First National Bank of Detroit and Phil Taubman (father of petitioner's wife), under the terms of which the receiver agreed to sell and convey to Taubman land in the city of Detroit (on which the Aberdeen Hotel was located) described as: "Lot Nine (9) Block 47, of Cass Farm, according to the plat recorded in 1836 in Liber 12 of Plats on Page 324 in the City Records; otherwise known as 830-8 Abbott Street, Detroit," in consideration of the payment of $41,000, of which $8,200 was payable upon the execution of the contract and the balance of $32,800, together with interest at 6 percent, in monthly payments of $328 each, to be applied first on interest and the balance on principal. The petitioner received a commission of $1,730 from the receiver for the sale of the property. Under date of November 10, 1939, the land contract was assigned by Phil Taubman to petitioner's wife. Monthly payments were made thereafter, the last one on December 3, 1942, at which time there was a balance due on the contract of $26,159.52, with interest from November 30, 1942. Under date of December 31, 1942, the property as above described, together with all and singular the hereditaments and appurtenances thereunto belonging or in anywise appertaining, was conveyed by `quitclaim deed to petitioner's wife. The balance due on the land contract was paid in part by moneys obtained from the National Bank of Detroit upon a note for $20,000, signed by petitioner and his wife, payment of which was secured by a mortgage on the property. The license for the operation of the hotel was at all times, including the year 1941, issued in the name of petitioner. Prior to the birth of her first child in the early part of September 1938, petitioner's wife devoted a portion of her time to the hotel business, but after the birth of such child she went to the hotel only occasionally.

In addition to the linen and hotel business, the petitioner during 1941 had three houses constructed. The money for that purpose was taken from the A. Nelson Co. bank account. The total amounts received and paid out during 1941 as shown in the "Buildings" column in the receipts and disbursements records were $19,007.60 and $21,603.25, respectively.

From the very outset in 1934 petitioner had charge and control of the moneys derived from his business activities. All moneys received from the linen business and the operation of the Aberdeen Hotel were deposited in an account with the National Bank of Detroit in the name of A. Nelson Co. Petitioner alone had authority to sign checks for the withdrawal of funds therefrom. During all the time from 1934 to 1941, inclusive, no moneys derived from the linen business or the operation of the hotel were paid to petitioner's wife as compensation for her services or as a distribution of profits. During the earlier years whenever she needed money for household expenses petitioner gave it to her; later she was given a regular allowance for household expenses. The down payment of $8,200 on the Aberdeen Hotel property was made by check on the account of A. Nelson Co. The monthly payments of $328 on the land contract were also paid with checks on the account of A. Nelson Co. Petitioner's wife had no bank account until November 1942, when she opened a bank account in the Manufacturers National Bank.

For the year 1941 a record of linens sold was kept on columnar loose-leaf sheets on which in separate columns the place of delivery, date, name of customer, invoice number, sale price, amount of sales tax, amount of invoice, amount of charge sale, and amount of cash sale, respectively, were entered. These columns were totaled monthly. The monthly totals of sales, sales tax, invoice prices, charge sales, and cash sales were entered on a separate sheet and totaled for the year. A record of receipts was kept on similar sheets, on which in separate columns were entered the amounts of bank deposits, discount allowed, date, names of purchasers, amounts received on individual cash and charge sales, and amount received on miscellaneous sales. These sheets also had a column captioned "Aberdeen Hotel" in which total receipts of the hotel for the day were entered. In August a column was added captioned "Buildings." The monthly total of each column was entered on a separate sheet and totaled to show yearly totals of entries under bank deposits, discount, sales, miscellaneous sales, Aberdeen Hotel, and buildings. On similar sheets a record of disbursements was kept. In the first four columns were entered the date, name of payee, check number, and amount of check, respectively. The remaining columns were captioned: "Mdse.," "Rent," "General Expenses," "Light," "Heat & Telephone," "Freight & Cartage," "Commissions Salaries," "Personal," "Sales Tax," "Social Security," "Aberdeen Hotel," "Loans," "Interest," and "Taxes." In the month of April three columns were added covering certain designated lots, which columns were in the following month consolidated into one column captioned "Buildings." At the end of 1941 the total monthly disbursements entered in the "Aberdeen Hotel" column were allocated on a separate yellow sheet to various items, such as principal, interest, payroll, coal, gas and light, water, telephone, laundry, linens and furnishings, office supplies, maintenance and repairs, general, insurance, taxes and painting and decorating. The amounts entered in the principal and interest columns represented the monthly payments of $328 on the land contract covering the Aberdeen Hotel property. Checks issued for personal expenses and withdrawals were entered in the personal column. The record of disbursements shows no check issued to petitioner's wife as salary, distribution of profits, or otherwise. Under date of November 8, 1941, a check of A. Nelson Co. payable to cash in the amount of $5,000 on the National Bank of Detroit was issued and entered in the personal column. The check bears the endorsement of petitioner and his wife.

The above records were kept by a bookkeeper employed and paid by petitioner.

According to an audit report as of June 30, 1939, the net worth of A. Nelson Co. was $18,622.17 as of that date.

The petitioner, upon the advice of a certified public accountant, filed a separate return for 1941. Petitioner's wife, upon the advice of the same accountant, filed for the first time a separate return for 1941 in which she reported the income derived from the operation of the Aberdeen Hotel as her income and paid a tax thereon.

(2) The Commissioner increased the reported income derived from the linen business from $10,467.47 to $10,627.78, or an increase of $160.31. The item of $160.31 does not appear on the records of petitioner. The item represents an adjustment made on the working papers of a certified public accountant, who audited the records of A. Nelson Co. for the year 1941 and prepared petitioner's 1941 return. The records of A. Nelson Co. do not include a general ledger. A detailed list of accounts receivable as of December 31, 1941, was made. The accountant added to the amount of accounts receivable as shown by the balance sheet as of January 1, 1941, the total of the 1941 charge sales, from which was deducted the total cash received during 1941 on charge sales. The remainder represented the so-called accounts receivable control, which amount was $160.31 more than the total of the detailed list of accounts receivable as of December 31, 1941. The accountant, therefore, debited sales and credited accounts receivable control with $160.31 on his working papers to adjust the control to conform to the detailed list of accounts receivable. He did not make an audit for 1940 and was unable to state whether the discrepancy arose in 1941 or some prior year.

(3) In his 1941 return petitioner claimed a deduction for automobile expense of $520 and automobile depreciation of $250, which the Commissioner disallowed. The petitioner bought a 1941 Pontiac automobile, equipped with a heater and radio, in the latter part of 1940 at a cost of approximately $900. The car was sold in December 1941, at which time its speedometer registered about 28,000 miles. Petitioner used the car in 1941 for pleasure and to travel to and from his home and office, a distance of six miles each way. He also used the automobile in 1941 to make deliveries of merchandise, in calling upon customers, in making other business calls, and to travel to and from the locations where he was having buildings constructed, which were about 12 miles from his place of business. Petitioner kept no account, either personal or in the records of A. Nelson Co., of the gasoline used or other expenses incurred in connection with the automobile except that a payment for automobile insurance in the amount of $64.96 was entered under date of November 6, 1941, in the disbursement record as paid with check numbered 4801 and the amount was extended and entered under the column in captioned personal. Since petitioner used the automobile for personal and business purposes, he is entitled to an allowance for depreciation of $162.50 and to the deduction of $155.96 for gasoline and $42.22 for insurance as ordinary and necessary business expenses.

The petitioner claimed a deduction of $300 for entertainment, which the Commissioner disallowed. The petitioner gave candy and whiskey as occasional gifts and as Christmas gifts to customers of his linen business. He also entertained some of his customers at various times at dinner. He kept no record of the cost of such entertainment or gifts. The petitioner is entitled to a deduction of $150 for entertainment as an ordinary and necessary business expense.

OPINION.

HILL, Judge:

The Commissioner determined that the entire 1941 net income of $9,403.91 from the operation of the Aberdeen Hotel was taxable to petitioner under the provisions of section 22 (a) of the Internal Revenue Code. He contends that petitioner, for tax purposes, was the owner of the property, that the operation of the hotel in 1941 was the business of petitioner and hence any income derived therefrom was taxable to him.

The petitioner states that the pertinent question to be determined is "Who is the owner of the property, Albert Nelson or his wife, Goldye Jean Nelson?" and he contends that, since the wife was the owner of the property in 1941, the income was taxable to her as income from "dealings in property, whether real or personal, growing out of the ownership" of such property. Sec. 22 (a).

The petitioner at all times from 1934 through 1941 had control over all moneys received in the linen business, the hotel business, and his other business activities. All such funds were commingled in one bank account in the name of A. Nelson Co. and petitioner alone had authority to withdraw such funds. The petitioner became the licensed operator of the Aberdeen Hotel in 1936 under lease, which lease is not in evidence. He continued to operate the hotel as licensed operator and manager of the hotel after the purchase of the property on land contract in 1939 through 1941. The payment of $8,200 on the land contract was made from petitioner's bank account and all subsequent monthly payments up to and including the last one on December 3, 1942, were also from such bank account.

It is true the wife testified categorically that the hotel business and income therefrom was hers, but there is no clear and convincing evidence to sustain her statements. The petitioner did not definitely so testify. Although petitioner's wife was quite positive in claiming the hotel property as her own and as paid for with her own money, she was unable to recall whether or not she signed the application for the mortgage, the note of $20,000, or the mortgage, none of which are in evidence. Petitioner testified that his wife worked in the linen business until the early part of 1938, when the first baby came and she had to stop work, that thereafter she did not work every day, but just occasionally, and that this was true in both the hotel business and the linen business. The wife admitted that her husband was operator and manager of the hotel and that she did not alone manage it, that there were three clerks there most of the time and also maids who did the work. The testimony of both petitioner and his wife was rather indefinite and vague as to the nature of the services rendered by her during 1941, but both testified that she would come to the hotel to look at or check on the accounts. However, the accounts or records were not kept by her, but by the bookkeeper employed by petitioner.

At no time did petitioner's wife have control of the hotel receipts or disbursements. As heretofore stated, all such receipts were deposited in the A. Nelson Co. bank account and all withdrawals were made by checks signed by petitioner. During 1941 no check was issued to the wife. All she received was an allowance for household expenses, and this allowance was given to her by petitioner. Five checks were presented in evidence which petitioner testified were checks made out to his wife to "settle off some of the account of the Aberdeen Hotel." All the checks were checks of A. Nelson Co. signed by petitioner and drawn on the National Bank of Detroit. The first check, dated September 18, 1939, for the sum of $500 payable to B. C. Schram, Receiver, First National Bank of Detroit, was the first down payment made to the receiver by Phil Taubman on the purchase of the hotel property. It was a part of the initial payment of $8,200 on the land contract. The second check for $5,000, dated November 8, 1941, was payable to "Cash." It was endorsed by both petitioner and his wife and bears the stamp of the National Bank of Detroit dated December 10, 1941. This check was entered in the record of disbursements as paid to cash in the personal column in which the personal expenditures of petitioner were entered. There is nothing in such record to indicate that the check represented a distribution of profits of the hotel business to petitioner's wife. The remaining checks, one dated November 9, 1942, and the other two dated December 31, 1942, for the amounts of $4,000, $3,000, and $406.29, respectively, were made payable to G. J. Nelson, petitioner's wife, and are endorsed by her. The $3,000 check bears a stamp reading "Mortgage Teller, Dec. 31, 1942, National Bank of Detroit." The check for $4,000 and the check for $406.29 bear a stamp of Manufacturers National Bank of Detroit, one dated October 9, 1942, and the other January 6, 1943. It is rather significant that these three checks were issued at or about the time the land contract, on which there was a balance due of $26,159.52, plus 6 percent interest from November 30, 1942, was paid up. The evidence shows that $20,000 was obtained for such purpose on a mortgage note from the National Bank of Detroit, but the source of the remainder of the balance due of $6,159.52 and interest, plus any expense of refinancing, is not disclosed by the evidence. The checks, and the vague and indefinite evidence concerning them, do not, in our opinion, establish, as claimed by petitioner, that the checks represented balances due the wife from the Aberdeen Hotel operations. Section 22 (a), in so far as pertinent, is as follows:

(a) GENERAL DEFINITION.—"Gross income" includes gains, profits, and income derived from * * * businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; * * * [Emphasis supplied.]

Income may be derived from dealings in property growing out of the "ownership" or the "use" of such property. Ownership may be in one person and the right to the use of the same property may be in another, with income flowing to each. To one it would be income growing out of the ownership of such property and to the other income growing out of the use of such property. Although legal title to the hotel property was in petitioner's wife, it does not follow that she was entitled in 1941 to the income growing out of the use thereof. The petitioner acquired the right to the use of the property in 1936 for the purpose of operating a hotel and he continued such use after the execution of the land contract. There is no evidence that petitioner intended to or did turn over to his wife the hotel business itself, or that he acted as her agent in the management thereof. There is no evidence that petitioner agreed to or did pay his wife any sum whatever as rental for the use of the property in his business.

Even if it be conceded that petitioner's wife had an equitable interest in A. Nelson Co. which she withdrew by payment by petitioner of the $8,200 on the land contract, as suggested by counsel of petitioner, it would not of itself prove that the hotel business and the income derived from such business belonged to her. If the hotel business had been run by a stranger instead of by petitioner, his wife, by reason of the purchase of the realty, could not legally lay claim to the hotel business operated by the stranger on the property and the entire income therefrom as well, but would be entitled only to the rental theretofore paid by the stranger as required by his lease.

The case of Herman Gessner, 32 B. T. A. 1258, cited by the petitioner in support of his contention that the income was taxable to his wife as owner of the property, is distinguishable on the facts. In that case the husband and wife owned as tenants by the entireties certain real estate in Michigan from which they received a gross rental in 1931 of $21,600. The husband and wife filed separate returns in which each reported one-half of the income. The Commissioner contended that the entire income from the realty was taxable to the husband. It was held that under the laws of Michigan the income from property held as tenants by the entireties was taxable equally to the husband and wife. The income in that case was clearly income growing out of the ownership of property and not out of the use thereof. The case of H. D. Webster, 4 T.C. 1169, cited by petitioner, is also distinguishable on the facts.

We do not believe that the Michigan courts have held that the owner of realty is entitled, by reason of his ownership thereof, to the entire income growing out of the use of such property, where the right to such use is held by one other than the owner and the other's use thereof produced the income. What the Supreme Court stated in Commissioner v. Tower, 327 U.S. 280, although it has reference to a husband and wife partnership, is equally applicable here, as follows:

* * * Thus, Michigan could and might decide that the stock-transfer here was sufficient under state law to pass title to the wife, so that in the event of her death it would pass to whatever members of her family would be entitled to receive it under Michigan's law of descent and distribution. But Michigan cannot by its decisions and laws governing questions over which it has final say, also decide issues of federal tax law and thus hamper the effective enforcement of a valid federal tax levied against earned income. * * *

It is our conclusion that the income in question was earned by petitioner in the operation of his own business and hence it is taxable to him.

(2) The evidence shows that the reduction of 1941 sales by $160.31 was the result of an accounting adjustment made by petitioner's accountant on his work sheets to adjust accounts receivable control as set up by him to conform to the detailed list of accounts receivable as of December 31, 1941. Neither the accountant nor the petitioner was able to state when the discrepancy arose and to what error of commission or omission it might be attributable. Net income must be computed upon the basis of an annual accounting period. Net income in one year may not be reduced to correct errors or discrepancies which arose in a prior year. Since the petitioner has failed to show that 1941 sales were properly reduced by reason of some error in sales or the omission of some item of expense in connection therewith, the determination of the Commissioner in increasing 1941 net income by $160.31 must be approved.

(3) The claimed deduction of automobile expense and depreciation and entertainment expense totaling $1,070 was based upon a mere estimate of petitioner. The evidence shows that he did use the automobile in his business and that he did entertain some of his customers for business reasons. After a careful consideration of the indefinite and unsatisfactory testimony of petitioner and bearing heavily upon him "whose inexactitude of his own making," we have concluded and have so found that he is entitled to an allowance for depreciation on the automobile of $162.50 and to a deduction of $155.96 for gasoline, $42.22 for automobile insurance, and $150 for entertainment, as ordinary and necessary business expenses. Cohan v. Commissioner, 39 Fed. (2d) 540.

Decision will be entered under Rule 50.