Farmers Trust Co. v. Commissioner, 29 B.T.A. 190. But the taxpayers point out that there was no showing in any of these cases that the decedent was not entitled to receive his share of the partnership profits at the time of his death.
As a practical matter, there is much merit in the taxpayers' contention. Where the partnership business (if not the partnership) continues beyond the death of a partner, the accounting period of the enterprise should not be lightly ignored, especially where the agreement has legitimate purposes aside from the tax problem, and the artificial splitting of such a period is not required to prevent the avoidance of tax. In such a situation, partnership gains subsequent to a partner's death might result in greater taxes to the Government by taxing all the income to the estate, than by taxing a part of it to the decedent. Further, there may be administrative difficulties incident to the determination of the taxable income of the decedent. However, the recognition of a separate 'taxable year' for the partnership is basically an accounting expedient, and the administrative difficulties occasioned by the adjustments upon a partner's death are insufficient, in my view, to induce an aberration from the basic principle of taxing income. This is not merely an accounting problem. Consequently, the shifting of income by agreement of the parties, even though valid for state law purposes, cannot frustrate the dominant intent of Congress to tax income to those earning it. See Commissioner of Internal Revenue v. Tower, 327 U.S. 280, 288, 66 S. Ct. 532, 90 L. Ed. 670, 164 A.L.R. 1135.
The agreement of the parties here is actually merely a contract that, upon the death of one of them, his earnings will be left in the business, subject to the risk of loss or gain, until the end of the partnership fiscal year. This, in my opinion, does not have the effect of gainsaying that a partner has earnings at his death. It seems to me that a partner has agreed, in effect, that should the business sustain losses after his death, he assigns to his partners that portion of his earnings, as determined by the subsequent accounting, in excess of what would be his distributable share had he lived, in return for the promise of the other partners to assign to his estate, should there be subsequent business gains, the difference between his share at date of death and what would have been his share had he lived. So regarding the agreement, even though it may be entirely legitimate and valid for other purposes, it nevertheless cannot affect the decedent's taxable income. See Lucas v. Earl, 281 U.S. 111, 50 S. Ct. 241, 74 L. Ed. 731; Helvering v. Horst, 311 U.S. 112, 61 S. Ct. 144, 85 L. Ed. 75, 131 A.L.R. 655.
But the case of U.S. v. Wood, 3 Cir., 1935, 79 F.2d 286, 287, is asserted to be controlling on the point that there can be no taxation of partnership income to the decedent, which he had no right, at the time of his death, to demand. The court there did make such a statement, but it does not appear to be the basis of the decision. That case involved a suit brought by the Government to recover an erroneous refund. Since there had been no audit of the partnership accounts as of the date of the deceased partner's death, the Government, bearing the burden of proving the refund erroneous, merely argued that his share of the partnership income at the date of death was a pro-rated amount based upon the final accounting at the end of the partnership fiscal year. The court, however, refused to accept the assumption of the correctness of the proration as being based on fact, and held that the Government had not met its burden of establishing that the profits were earned during the decedent's lifetime. The comment that the decedent had no right, at the date of his death, to demand any share of the partnership profits, was made by way of distinguishing the case of Darcy v. Commissioner, supra. There, with the Government 'aided by a presumption of correctness which is present in every suit for the collection of taxes', it was not apparent whether the deceased partner did or did not have the right to draw upon his profits, a fact which was mentioned as an additional ground for supporting the position. The ratio decidendi, therefore, of the Wood case is that no share of the partnership earnings was taxable to the decedent in the absence of evidence that any part was earned during his lifetime. The implication is that if the Government had established the existence of a drawing account, or if there had been an audit of the partnership accounts showing precisely the amount attributable to the decedent upon the day of his death, that amount would have been taxable to him. In the instant case, there has been such an audit. The Supreme Court has said that 'the 'distributive share' referred to in Sec. 182 does not mean available in cash for payment to the partner,' but merely that 'gains attributable to the partner's interest in the firm were earned.' Helvering v. Enright's Estate, supra, 312 U.S.at page 641, 61 S. Ct.at page 781. And the tax is imposed upon a partner's proportionate share of the income even if 'it may not be currently distributable, whether by agreement of the parties or by operation of law.' Heiner v. Mellon, 304 U.S. 271, 281, 58 S. Ct. 926, 931, 82 L. Ed. 1337.
Supreme Court authority on the precise issue for the Government's position is afforded in Bull v. U.S., 195 U.S. 247, 55 S. Ct. 695, 696, 79 L. Ed. 1421. There, the partnership agreement provided that upon the death of a partner, the survivors should continue the business for one year, the decedent's estate to 'receive the same interests, or participate in the losses to the same extent' as the deceased partner would, if living. Bull died on Feb. 13, 1920, and the firm continued business until the end of the year. His estate received $ 24,124.20 as profits earned before Feb. 13, and $ 200,117.09 as profits earned from Feb. 13 until the end of the year. In issue was the income tax on Bull's partnership interest. The Court held, 295 U.S.at page 254-255, 55 S. Ct.at page 697: 'We concur in the view of the Court of Claims that the amount received from the partnership as profits earned prior to Bull's death was income earned by him in his lifetime and taxable to him as such * * * . We also agree that the sums paid his estate as profits earned after his death were not corpus but income received by his executor, and to be reckoned in computing income tax for the years 1920 and 1921. * * * The portion of the profits paid his estate was therefore income and not corpus; and this is so whether we consider the executor a member of the old firm for the remainder of the year, or hold that the estate became a partner in a new association formed upon the decedent's demise.' In holding that $ 200,117.09 was taxable as income to the estate and that only the $ 24,124.20 was subject to the estate tax, the ruling that the $ 24,124.20 was taxable as income to the decedent was a necessary preliminary, in order to establish that it should not be added to the larger amount found taxable as income to the estate, and also to establish that the smaller amount was the property of the estate at decedent's death and subject to estate tax. It is true, of course, that in the Bull case the decedent's executors voluntarily included in the decedent's return the share of partnership profits earned prior to the date of death, and the question of the tax on such profits was neither directly in issue nor expressly argued. Consequently, the pronouncement of the Court on that issue is not authority compelling in the highest degree. But I cannot agree that it is mere dictum, since it was a determination necessary to the decision of the case. See Degener v. Anderson, 2 Cir., 77 F.2d 859. And the weight of the authorities, I am persuaded, is at variance with the conclusions reached in Estate of Henderson v. Commissioner, 5 Cir., 1946, 155 F.2d 310, 164 A.L.R. 1030, and Estate of Mnookin v. Commissioner, 1949, 12 T.C. 744, which followed the Henderson case.
Taxpayers urge, as an alternative ground for recovery, section 42(a) of the Internal Revenue Code, as amended by section 134(a) of the Revenue Act of 1942, and section 126(a) of the Code added in the same year. For the year 1942, section 42(a), as amended, was made applicable only to those taxpayers who formally consented to have their tax computed under section 126(a). Revenue Act of 1942, section 134(g). The latter section taxes to the estate items of gross income in respect of a decedent 'which * * * are not properly includible in respect of the taxable period in which falls the date of the decedent's death.' However, if, under section 42(a) of the Code, the income is properly includible in the decedent's return, then decedent's executors are not entitled to have the tax computed under section 126(a).
Section 42(a), prior to its amendment by the Revenue Act of 1942, was originally intended to prevent a decedent on a cash basis from escaping income tax on income accrued by uncollected at the time of his death. The Revenue Act of 1934, 26 U.S.C.A.Int.Rev.Acts, page 679, thus made provision for including in a decedent's final return 'amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior method.' But this provision as construed by the courts required the inclusion in the decedent's final return of income which had not been realized under the accounting method of the taxpayer and which might not be received by his executors until several years after his death. See Helvering v. Enright's Estate, supra. It is clear from the legislative history of the amended Section 42(a) that Congress considered the operation of the original section as too harsh and intended to alleviate the hardship occasioned by this interpretation. The amendment prevents the taxing of additional accruals of income to an accrual basis taxpayer which arise solely by reason of his death, but expressly excepts amounts includible in computing a partner's income from the partnership.
Thus it is apparent that Section 42(a) as amended was intended to alleviate no hardship to which this decedent would have been subject under the former Section 42. Entirely apart from that Section as it existed in 1934, decedent as a partner on a cash basis would have been taxable on his share of partnership income. For tax purposes, the decedent partner's share of partnership earnings are not accruals caused by his death but are his actual earnings. Section 42(a) as amended was not intended to affect the distributive share of partnership income.
Furthermore, the amended 42(a) is specifically applicable only to those decedents 'whose net income is computed upon the basis of the accrual method of accounting.' Taxpayer argues that the section eliminated the express requirement that the return of a cash basis decedent include items of income accrued at the time of his death, and includes no exception to the provision dealing with accrual basis decedents, requiring the return of a cash basis decedent to include such income; consequently, the section cannot be confined in its operation to accrual-basis decedents. However, this argument lacks force because, as pointed out above, the taxation of the income of a cash basis decedent partner is not dependent upon Section 42(a).
Finally, even if 42(a) were otherwise applicable, it is expressly inapplicable to 'amounts includible in computing a partner's net income under section 182', a clear indication that for tax purposes a partner's share of partnership earnings are not merely accruals caused by his death, but represent what he has actually earned.
Accordingly, an order will be entered granting the Government summary judgment on its cross-motion, dismissing the taxpayers' complaint and awarding judgment on the counterclaim.