ESTATE OF LOWENSTEIN v. COMMISSIONER

The respondent has determined deficiencies in income tax for 1942 and 1943 in the amounts of $17,496.89 and $2,832.53, respectively. The issues are (1) whether the one-third share of the distributable income of a partnership which was payable to the decedent's estate should be reduced by the difference between the partnership inventory value used in determining the distributable partnership income and the inventory value used in determining the value of the estate in the decedent's estate tax return; (2) whether the loss on the sale by the decedent's estate of its one-third interest in the partnership to the surviving partners was a capital loss, as determined by the respondent, or an ordinary loss, as claimed by the petitioner; (3) whether charitable gifts made by the partnership in 1942 and 1943, and deducted in the partnership returns as business expenses, are deductible in computing the estate's share of the distributable income of the partnership; and (4) whether an advance payment made by decedent's estate in December 1942 of the estimated state income taxes due the State of Alabama for that year is deductible in the estate's 1942 Federal income tax return.

FINDINGS OF FACT.

The stipulated facts are incorporated herein by reference.

The decedent died July 8, 1941, and the First National Bank of Mobile, the petitioner herein, was appointed executor of his estate. The returns involved in this proceeding were filed with the collector for the district of Alabama.

At the time of his death the decedent was an active member of a partnership doing business under the name of Taylor, Lowenstein & Co. The partnership for many years had been engaged in the mercantile and naval stores business, with its principal office located at Mobile, Alabama. The decedent was one of three equal partners in the business.

The partnership agreement under which the business was conducted provided, in so far as here material, that the partners would share equally the expenses, gains, or losses of the partnership; that upon the death of any partner the partnership would not be dissolved, but would be continued by the surviving partners for one year from January 1 next following the deceased partner's death, on certain terms and conditions; and that at the expiration of such period the surviving partners would purchase the deceased partner's interest at a price based either on his "stock account," plus or minus any credit or debit in his "personal account," or at a price to be agreed upon by arbitration. It was specifically provided that the deceased partner's representative would receive:

* * * all payments and credits, to which such deceased partner would have been entitled, if living, and likewise the general estate and assets of such deceased partner shall be bound and liable for all the firm's debts, liabilities and losses, incurred or created during said period, in the same manner that such deceased partner would have been liable, had said debts, liabilities and losses, been created and incurred while deceased was living and was a member of said firm.

It was further provided that:

* * * The personal representative of any deceased partner shall have no right of any actual control or interference in said business, but shall, however, have all other rights, including the right of access to the books of account of said firm, which would have belonged to said deceased partner.

None of the partners was to receive a salary except that for the specified period of operation following a partner's death the remaining partners were to receive a salary of $5,000 per year.

On the death of the decedent, July 8, 1941, the books of the partnership were closed and the partnership filed a Federal income tax return for the period July 1 to July 8, 1941. Its next return covered the period July 9, 1941, to June 30, 1942. The partnership kept its books and made its returns on an accrual basis and, normally, for a fiscal year ending June 30. It consistently valued its inventories for income tax purposes at cost or market, whichever was lower. The closing inventory at July 8, 1941, as shown in the partnership return, was $665,771.78. The return showed $8,227 of income distributable to the decedent's estate, and that amount was reported by the estate in its income tax return for 1941. No change was made by the respondent in the inventory figure or the tax shown in that return.

The partnership's inventory had a fair market value on July 8, 1941, the date of decedent's death, of $721,191.40. In the decedent's estate tax return, in which the assets were valued as of the date of the decedent's death, one-third of that amount, $240,397.13, was reported as decedent's share of such inventory. That inventory value was used in determining the value of decedent's entire interest, $376,624.02, in the partnership for estate tax purposes.

The partnership's closing inventory of $665,771.78 as of July 8, 1941, based on cost or market, whichever was lower, was used as the opening inventory in the income tax return which the partnership filed for the period July 9, 1941, to June 30, 1942. The returns showed partnership income distributable to the decedent's estate of $95,107.15, and that amount was reported as ordinary income in the fiduciary return filed by decedent's executor for the year 1942. There was deducted in that return an item of $24,039.71, representing one-third of the difference between the inventory as reported in the partnership returns and that reported in the estate tax return. It is now agreed that the correct amount of such one-third portion of the difference between the inventories is $18,473.21 instead of $24,039.71. The respondent disallowed the deduction so claimed in the income tax return of the estate, and the decedent's executor then filed a claim for refund of Federal estate taxes in the amount of $5,387.28, on the ground that the inventory was overstated in the estate tax return. This claim was disallowed on September 16, 1947.

Pursuant to the provisions of the partnership agreement, the surviving partners on March 31, 1943, purchased the deceased partner's interest in the partnership for $442,209.76. The sale was approved by the local court having jurisdiction over the administration of decedent's estate.

In its income tax return for 1943 the petitioner claimed long term capital losses of $11,478.36 on the sale of the partnership interest and $1,376.56 on the sale of securities. It reported no other long term capital losses or gains. The respondent determined that the petitioner sustained a long term capital loss on the sale of its partnership interest in the amount of $21,252.26, which, with the loss on the sale of securities, made a total capital loss of $22,628.82, but that, since there were no capital gains, the amount of the deduction was limited under section 117 (d), Internal Revenue Code, to $1,000.

It is stipulated that, if the deduction claimed in the petitioner's 1942 income tax return on account of the difference in the inventories (the amount as corrected being $18,473.21) is allowed, the loss to the estate on the sale of the partnership interest in 1943 is $2,779.93; and that, if this deduction is disallowed, the loss is $21,253.14.

The partnership during 1942 and 1943 made charitable contributions in the respective amounts of $1,796.50 and $2,537.50. These amounts were deducted in the partnership returns as ordinary and necessary business expenses. The petitioner's share of the charitable gifts was disallowed by the respondent for the reason that the gifts were not made pursuant to the provisions of the decedent's will, within the meaning of section 162 (a), Internal Revenue Code.

In December 1942 a certified public accountant employed by Taylor, Lowenstein & Co., who was handling tax matters for decedent's estate, made an estimate of the partnership's 1942 income tax liability to the State of Alabama and found that petitioner's portion thereof would be approximately $2,000. On behalf of the estate, he made an advanced payment of that amount to the State of Alabama on December 31, 1942, and the amount so paid was claimed as a deduction in the Federal income tax return filed by the petitioner for 1942. The respondent disallowed the deduction on the ground that no liability for the payment of the tax existed in that year.

A state income tax return which showed no tax due and a claim for refund of the $2,000 payment previously made were filed by the petitioner April 14, 1943. The claim for refund was allowed in 1945.

OPINION.

LEMIRE, Judge.

The petitioner's first contention is that its distributable share of partnership income for 1942 should be reduced, for income tax purposes, by $18,473.20 representing the excess of the fair market value of the partnership inventory at the date of decedent's death, which was used in computing the value of the estate for estate tax returns, over the book value of the inventory on that date, which was used in computing the partners' 1942 distributable income.

Petitioner's theory is that after the decedent's death his estate owned a one-third interest in each and every item of the partnership's inventory and that in computing the gain or loss on the sale of this inventory in 1942, from which the partnership income was derived, the estate is entitled to use the basis at which the inventory was valued in the estate tax return. As statutory authority for this contention, the petitioner relies upon section 113, Internal Revenue Code, which is quoted in material part in the margin.1

We do not think that this provision of the statute was intended to apply to a situation such as we have here. It deals generally with the "adjusted basis for determining gain or loss" of property acquired "by the decedent's estate from the decedent." It applies to property which has passed to the decedent's estate. See Robert E. Ford, 6 T.C. 499. There was no distribution in kind to the decedent's estate of any part of the partnership inventory. The partnership agreement clearly shows that the parties intended to prevent any such distribution and to permit the continuance of the business for the period specified, with the deceased partner's estate sharing in the profits as though the partner were still an active member. What the estate acquired under the partnership agreement was not specific items of inventory, but a contractual right to a share of the partnership income for a limited period. That this income was not intended to constitute consideration for the decedent's capital interest in the assets of the business is conclusively shown, as petitioner recognizes in its brief, by the later provision in the same agreement for purchase by the surviving partners of a deceased partner's capital interest in the business at its book value. Cf. Estate of George R. Nutter, 46 B. T. A. 35.

The operation of the partnership agreement here does not conflict with, nor is it in any way affected by, the laws of the State of Alabama relating generally to the ownership of partnership property. See Robert E. Ford, supra.

The question of the character of distributions, whether income or capital, received by the estate of a deceased partner from the earnings of a partnership which had been continued, by agreement of the partners, for a period of one year following his death was under consideration by the Supreme Court in Bull v. United States, 295 U.S. 247. It was held that such distributions retained their character as income to the deceased partner's estate. See also Charles F. Coates, 7 T.C. 125, and Richard P. Hallowell, 2nd, 39 B. T. A. 50. We think that the income distributed to the decedent's estate by the partnership in 1942 is taxable to the estate in its entirety as partnership earnings.

Petitioner contends next that its loss on the sale of decedent's one-third interest in the partnership is deductible in full as an ordinary loss. The respondent has treated it as a capital loss, with respect to which the deduction is limited under section 117 (d) (2), Internal Revenue Code, to $1,000. The parties have stipulated that the amount of the loss, computed by using as a cost basis the value of the partner's interest as reported in the estate tax return, plus the profits left in the partnership by the petitioner, plus the expenses of the sale, was $21,253.14.

The petitioner concedes in its brief that this contention is contrary to recent decisions of this Court which hold that a partnership interest is a capital asset, and that the gain or loss on its sale is subject to the provisions of section 117, Internal Revenue Code. See H. R. Smith, 10 T.C. 398; affd., Commissioner v. Smith, 173 Fed. (2d) 470, and cases therein cited.

There can be no question but that the sale here was a sale of an undivided interest in the partner's business, rather than a sale of specific assets belonging to the decedent's estate. We find nothing in the laws of the State of Alabama which requires the treatment of the sale of an interest in a partnership existing under the laws of that state other than as a capital transaction.

There was no error in the respondent's treatment of the loss on the sale of the decedent's interest in the partnership as a capital loss.

As to the deductibility of the charitable gifts made by the partnership, the respondent takes the position that, since charitable gifts are deductible by an estate only where made pursuant "to the terms of the will or deed creating the trust," as provided in section 162, Internal Revenue Code, and since the decedent's will contained no provisions for charitable gifts, the deduction cannot be allowed to the decedent's estate.

The charitable gifts were made not by the decedent's estate, but by the partnership as a business unit. They were deducted in the partnership returns as ordinary business expenses and were allowed to the other two partners. It is not stipulated or otherwise shown whether the respondent allowed the deduction to the active partners as ordinary and necessary business expenses, as claimed in the partnership returns, or as charitable gifts by the individual partners, under section 23 (o), Internal Revenue Code. In any event, we think that the deduction should have been allowed to the decedent's estate, as well as to the active partners. The fact is that the estate never received the amount representing its portion of the charitable gifts. They were deducted from partnership income before its share of the earnings was ever determined. Under the partnership agreement the estate was entitled to receive only its one-third share of the distributable earnings; and, since the active partners were charged with the management of the business, it might be said that the charitable gifts they made were actually made pursuant to the partnership agreement. What the respondent has done, in effect, is to add to the petitioner's distributable partnership income one-third of the charitable gifts, which it never received. We think that the entire amount of the gifts should have been allowed as a deduction in computing the distributable income.

The remaining question is whether the estate is entitled to deduct its portion of the estimated income tax due the State of Alabama for 1942, which it paid in December of that year, before the due date thereof.

The evidence is that in making this estimate of state income tax the accountant for the estate gave no consideration to the Federal estate tax because at that time the state authorities were treating it as payable out of the assets of the decedent's estate, and as not deductible in computing the income tax liability of the estate. The refund of $2,000 which the estate received in 1945 resulted from a reversal of the policy. No claim is made that the accountant did not act in good faith, and there is evidence that he did.

Under the statutes of the State of Alabama, income tax returns made on the basis of a calendar year are required to be filed not later than March 15 of the following year (see Title 51, ch. 17, sec. 394, Code of Alabama, 1940) and the tax thereon is payable in full at that time, or in equal quarterly installments thereafter. Sec. 409, Code of Alabama. However, there is a specific provision authorizing advanced payments as follows:

§ 409. Time and Methods of Payment.— * * * (d) Voluntary advance payment. The tax imposed by this chapter or any installment thereof, may be paid, at the election of the taxpayer, prior to the date prescribed for its payment.

Since the petitioner was authorized to make and did make the advanced payment of the 1942 income taxes in that year in good faith, we think that the respondent erred in disallowing the deduction. See Lillian Bacon Glassell, 12 T.C. 232.

Reviewed by the Court.

Decision will be entered under Rule 50.