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Tunnell v. United States

decided: October 8, 1958.


Author: Kalodner

Before MARIS, KALODNER and STALEY, Circuit Judges.

KALODNER, Circuit Judge.

The plaintiffs, husband and wife, commenced this action to recover alleged overpayment of their income taxes for the calendar year 1951, when they filed a joint return. Although the district court entered judgment in their favor, 148 F.Supp. 689, the plaintiffs deem the amount inadequate and therefore prosecute this appeal.

The single issue presented is whether the entire proceeds from the sale by husband-plaintiff (hereinafter called the taxpayer) of his interest in a partnership of lawyers is subject to capital gains treatment, or a portion thereof, attributable to earned but uncollected fees, must be taxed as ordinary income.

The facts are as follows:

In 1951, taxpayer owned a fifty percent partnership interest in a law partnership.On June 7, 1951, he withdrew from the partnership. On November 2, 1951, taxpayer and his partners entered into an "Agreement of Dissolution of Partnership" which recited, among other things, that they desired to put in writing the settlement of the partnership rights and obligations. In this document, taxpayer transferred and assigned to the remaining partners all his right, title or interest in the law firm, its good will, furniture, fixtures, bank account, book accounts, and claims for any services which had been rendered prior to June 7, 1951, but which had not progressed far enough to justify billing; in consideration taxpayer was to receive from the remaining partners the sum of $27,500, of which $18,116.07 was acknowledged to have been paid to taxpayer on June 6, 1951, and the balance, $9,383.93, was to be paid following execution of the written agreement.

At the time taxpayer withdrew from the firm, the partnership books showed accounts receivable, charged on the books but uncollected, in the amount of $21,833.51.

Both the taxpayer and the partnership were on the "cash receipts and disbursements", rather than the "accrual", accounting basis. The taxpayer and his wife included in their joint return the proceeds of the sale of taxpayer's partnership interest, treating $24,192.87.*fn1 thereof as ordinary income. Subsequently taxpayer concluded that the entire amount of the proceeds of the sale was gain derived from the sale of a capital asset held for more than six months, and he filed a petition for refund. This petition was denied.

Proceeding to the district court, the taxpayer contended that a partnership interest, under Section 117 of the Internal Revenue Code of 1939, 26 U.S.C. § 117, is a capital asset; that a sale of a partnership interest is not divisible into segments for tax purposes; that there was no net income realized from the receivables and he owned no distributive share on the date of the sale. Accordingly, taxpayer concluded that Section 182 of the Internal Revenue Code of 1939*fn2 is inapplicable, and that he is entitled to capital gain treatment on the entire proceeds of the sale.

The United States did not dispute that a partnership interest is a capital asset.*fn3 But it did contend that to the extent the sale of taxpayer's partnership interest reflected his interest in accounts receivable, computed at 50% of $21,833.51, or $10,916.76, it was a distributive share of partnership earnings and taxable as ordinary income. Consistent with this theory, the government conceded that the difference between that sum and the total price, or $13,276.11, is subject to capital gain treatment, and that the taxpayer should have a refund to that extent.

The district court treated the contentions of the parties at length, and discussed the pertinent authorities. It rejected the distinction between "cash" and "accrual" accounting bases as a reliable guide: compare Swiren v. Commissioner, 7 Cir., 1950, 183 F.2d 656, certiorari denied 340 U.S. 912, 71 S. Ct. 293, 95 L. Ed. 659; Meyer v. United States, 7 Cir., 1954, 213 F.2d 278, and United States v. Snow, 9 Cir., 1955, 223 F.2d 103, 107, footnote 1, certiorari denied 350 U.S. 831, 76 S. Ct. 64, 100 L. Ed. 741. It concluded that while the sale of a partnership is treated as the sale of a capital asset, the sale of a right to receive ordinary income is not. Accordingly, it held that the proceeds of the sale of taxpayer's partnership interest, to the extent that it was attributable to the presence of accounts receivable at the time of the sale, was taxable as ordinary income.*fn4

We agree with these conclusions of the district court.

In Commissioner of Internal Revenue v. P. G. Lake, Inc., 1958, 356 U.S. 260, beginning at page 265, 78 S. Ct. 691, at page 694, 2 L. Ed. 2d 743, the Supreme Court said:

"The purpose of § 117 was 'to relieve the taxpayer from * * * excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions.' See Burnet v. Harmel, 287 U.S. 103, 106, 53 S. Ct. 74, 75, 77 L. Ed. 199. And this exception has always been narrowly construed so as to protect the revenue against artful ...

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