Before MARIS, MCLAUGHLIN, and KALODNER, Circuit Judges.
This appeal is from the entry of a judgment by the District Court on a jury verdict in favor of a taxpayer who sued to recover taxes paid as the result of an allegedly erroneous determination by the Commissioner of Internal Revenue that 90 per cent of the income of a limited partnership (made up of a family group) was to be attributed to the taxpayer.
The basic facts are not in dispute and may be summarized as follows:
In 1910 William A. Lamb ("taxpayer")*fn1 formed a partnership with his brother for the conduct of a commercial stationery business under the firm name of Lamb Brothers. In 1934 he purchased his brother's interest and operated the business as sole proprietor until 1942 when he decided he would like to have the business continued as a family partnership. He discussed the matter with his attorney and the latter prepared a draft of a limited partnership agreement under which the taxpayer and his son William M. were to be general partners and his wife and two married daughters, Virginia and Doris, were to be limited partners. The taxpayer's motives, according to his son, seem to have been to give the business stability by its continuance before and after his death as a family partnership (taxpayer was then 65 years old); to permit his children to enjoy benefits from the business while he yet lived and could derive paternal gratification from that fact and to reward with partnership the industry of his son (who had been engaged in the business as an employe since 1934) without discriminating against his other loved ones. Saving in income taxes was only an "incidental reason."
The draft of the partnership agreement was reviewed at a family conference in mid-September. On September 25th taxpayer gave his wife $12,500, his daughters $4,500 each and his son $4,000. The money came from the taxpayer's personal funds,*fn2 and was deposited in each instance in the recipient's checking account. In making the gifts taxpayer told his wife and children that they could do as they wished with the money but that they would be "foolish" not to put some of it back in the business as partners.
Subsequently, on October 1, 1942, the articles of partnership were formally executed by the taxpayer, his wife and their children. The value of the business having been fixed at $40,000, the wife contributed $12,000 for a 30 per cent interest, and the three children $4,000 each for respective 10 per cent interests. The remaining 40 per cent interest went to the taxpayer in consideration of his contribution of $16,000 in net book value of assets in the old business.*fn3
The partnership agreement contained the standard provisions appropriate for organization under the Uniform Partnership Act of Pennsylvania, 59 P.S. § 1 et seq. The taxpayer and his son reserved the right to decide whether profits should be distributed or left in the business.
Profits and losses were to be shared in proportion to capital contributions, except that limited partners were not to become liable beyond the amounts of their respective capital contributions. The limited partners were to have no right to participate in the conduct of the business nor to bind the partnership in any way. The right of general or limited partners to substitute new partners was limited. Only the general partners were authorized to draw checks on the accounts of the firm. A salary in the sum of $3,000 was fixed for the taxpayer and a minimum salary of like amount for his son. The agreement further provided that it could be amended by majority vote in interest but not so as to effect vested rights.
The wife and daughters never rendered any services to the business nor did they in any way participate in its management or control. The taxpayer's personal services to the business were not much different from those of other ordinary employes. Capital was the most important item in the business.
Profits were drawn regularly from the business and deposited in the personal bank accounts of each of the partners. At the end of the year, the capital account of each partner was increased by the gain attributable to that partner less the drawings.
Taxpayer's wife and daughters spent their shares of the distributed profits on the ordinary expenses of their households and families.Virginia and Doris, the daughters, had been living apart from the taxpayer's household since their respective marriages in 1934 and 1940.
Under the circumstances above set forth, the Commissioner determined, on February 25, 1947, that there was no genuine partnership for tax purposes between the taxpayer and his wife and daughters, and that 90 percent of the partnership income was accordingly taxable to him. The Commissioner conceded that the son was a partner to the extent of his 10 per cent interest in the business.
Prior to the Commissioner's ruling the taxpayer and his wife had filed separate returns for the tax years here involved. During 1946 both taxpayer and his wife had separately made the required payments on estimated income. Subsequent to the ruling and as a consequence of it, they filed a joint return for the year 1946 on March 7, 1947 and took credit thereon for the payments made by the wife during 1946 on estimated income. The District Court, in accordance with the jury's finding that there was a "real" partnership, concluded that the taxpayer was entitled to revoke the election to file the joint return for 1946; the tax actually owing, as determined by the District Court, was calculated as if the taxpayer had filed a separate return for 1946. It may be noted, parenthetically, that the Collector here attacks the propriety of the District Court's ...