Opinion
Docket Nos. 26762 26763.
1951-05-22
GAIUS G. GANNON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.MARY P. GANNON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Paul Port, Esq., for the petitioner. Joseph P. Crowe, Esq., for the respondent.
Paul Port, Esq., for the petitioner. Joseph P. Crowe, Esq., for the respondent.
Petitioner Gaius G. Gannon as a partner to the law firm of Baker, Botts, Andrews and Wharton, owned a 6.2 per cent interest in the firm for which he paid $10,770.42 and which sum represents the adjusted cost basis of his interest. On December 29, 1944, Gannon withdrew from the firm to practice law as an individual and pursuant to the partnership agreement Gannon's investment reverted to the law firm for which he received no consideration. Held, petitioners sustained a loss of $10,770.42 not occasioned by the sale or exchange of a capital asset and this loss is deductible under section 23(e) of the Internal Revenue Code.
These proceedings have been consolidated.
Respondent determined deficiencies in income taxes for the calendar year 1944 as follows:
+------------------------------------------+ ¦Petitioner ¦¦Docket No. ¦Deficiency ¦ +---------------++------------+------------¦ ¦Gaius G. Gannon¦¦26762 ¦$2,862.15 ¦ +---------------++------------+------------¦ ¦Mary P. Gannon ¦¦26763 ¦2,313.89 ¦ +------------------------------------------+
These deficiencies result from several adjustments to petitioner's net incomes; however, the only issue raised in these proceedings relates to respondent's disallowance of a loss claimed by petitioners. This adjustment was explained in the deficiency notice sent to petitioner Gaius G. Gannon as follows:
(b) The community loss of $10,770.42, alleged to have been sustained during the taxable year 1944 at which time you withdrew from the law firm of Baker, Botts, Andrews and Wharton, Houston, Texas, is disallowed as it has not been established that a loss was sustained from the transaction.
A similar explanation was given in the deficiency notice sent to petitioner Mary P. Gannon. By appropriate assignments of error petitioners contest these adjustments.
In an amended answer respondent alleges in the alternative in the event it should be determined that petitioners suffered a loss from the transaction that such loss is a capital loss and not an ordinary loss.
FINDINGS OF FACT.
Some of the facts have been stipulated and they are found accordingly. Other facts are found from the evidence.
Petitioners were married in Dallas, Texas, on October 16, 1923. They have remained husband and wife, and have resided continuously in Texas through the date of the hearing of these proceedings. Petitioner's Federal income tax returns for the year 1944 were filed with the collector for the first district of Texas. The case of petitioner Mary P. Gannon is here solely because of her community property status with her husband and therefore for the sake of convenience petitioner Gaius G. Gannon will hereinafter be referred to as petitioner.
Petitioner was admitted to the bar of Texas in 1919 and practiced law in Dallas, Texas, for that date until 1929. In Dallas he practices as a member of the firm of Robertson, Robertson & Gannon. In 1929 petitioner left the firm in Dallas and became a member of the law firm of Baker, Botts, Parker & Garwood in Houston, Texas. The name of the firm was later changed to Baker, Botts, Andrews and Wharton. The firm has used the names of Baker and Botts continuously since 1874 and is frequently referred to as the ‘Baker-Botts‘ firm.
Petitioner practiced law in Houston, Texas, as a member of the firm of Baker-Botts continuously form 1929 until December 29, 1944, devoting his full time and efforts thereto. On December 29, 1944, he withdrew from the firm and opened up an office as an individual practitioner.
Between the years 1929 and December 29, 1944, Gannon acquired a 6.2 unit (6.2 per cent) interest in the Houston law firm, paying therefor the sum of $10,770.42 out of community funds, and such amount of $10,770.42 is stipulated to be the adjusted cost basis of said interest within the meaning of section 113(a)(13) of the Internal Revenue Code and Regulation thereunder.
During the entire period petitioner was a partner in the firm of Baker-Botts the partnership agreement contained the identical or substantially the same provisions relating to the accounting as to interests in assets and interest in income on the death or withdrawal of a partner. The material provisions thereof are as follows:
ARTICLE VII
DEATH OR WITHDRAWAL OF MEMBERS
As and when a member withdraws form the firm or dies his interest to the firm shall thereupon automatically revert to the firm and settlement for his interest in the assets and income shall be made by the firm with him or with his estate, as the case may be, in accordance with the provisions of this Article VII, as follows:
A. Accounting as to Interest in Assets
(2) In the Event of Withdrawal
In the event a member voluntarily withdraws from the firm at any time and remains in the active practice of law after such withdrawal, or in the event the withdrawal of a member is requested for any cause by a vote of the firm in accordance with the provisions of Article VIII, no compensation shall be paid to such member for his interest in the assets of the firm, but if a member voluntarily withdraws from the firm and from the active practice of law he shall receive the agreed value of his interest in the assets of the firm, to be computed and paid on exactly the same basis as is applicable in the case of the death of a member as provided in subparagraph (1) next above.
B. Accounting as to Interest in Income
(2) In the Event of Withdrawal
In the event a member voluntarily withdraws from the firm at any time and remains in the active practice of law after such withdrawal his interest in the income of the firm shall cease effective as of the end of the month during which he withdraws, but in the event of withdrawal under any other circumstances (irrespective of how such withdrawal shall occur) he shall be entitled to receive from the firm, in lieu of any interest which he otherwise might have in uncollected income of the firm, the same distributions as his estate would have been entitled to receive in the event he had died instead of withdrawn, to be computed and paid on exactly the same basis as provided in subparagraph (1) next above.
It was the well established policy and practice of this firm in so far as possible, to subordinate the importance of any particular lawyer to the firm business, so that the firm would continue on in perpetuity, holding its business and clients, regardless of the death or withdrawal of any particular partner or partners. This was accomplished by having more than one lawyer ordinarily associated with and doing the work of clients, particularly the large corporations. The names of the various lawyers in the firm were not shown on the letterhead. Correspondence was carried on only in the firm name and lawyers writing letters could be identified through a number appearing on the letter, assigned to each attorney. The result has been that the business of the firm has gone on continuously for many years notwithstanding the death or withdrawal of partners.
Petitioner's relationship with his partners in the firm of Baker, Botts, Andrews and Wharton was entirely friendly. His reasons for leaving were primarily that he was not happy in the type of work he was doing or in the heavy volume of work and did not enjoy being in such a large organization. He was not dissatisfied with his income in the firm, which was substantial. He was primarily a trial lawyer and felt he would prefer to represent individuals on a more personal basis rather than doing the work of large corporations, which was the primary business handled by the firm. Furthermore, he wished to work on a part-time basis for a period of time, with extended vacation periods, and this he did for more than a year.
He did not leave his former firm with the thought of making more money, but was resigned to getting along on a lower income. His average income from his law practice for the 5 years prior to leaving the firm was $30,207.78 per year compared with his average net income for the 5 years after leaving of $10,504.44.
At the time he left the partnership petitioner asked the remaining partners that they not apply the forfeiture provision in the contract and reimburse him for his cash investment in the firm assets. However, this request was refused and the forfeiture provision was applied. It was understood and agreed between the petitioner and his partners that he was voluntarily withdrawing from the partnership and would remain in the active practice of law after his withdrawal, and therefore, under the applicable provision of the contract, that he was not entitled to any payment on account of his interest in the partnership assets or any interest in earned but uncollected fees. Petitioner did not in fact received anything for his interest in the firm assets or in earned but uncollected fees. Respondent conceded ‘that Mr. Gannon received absolutely nothing in return for his interest, either in payments at that time or payments at a later date.‘
The firm books were kept on a cash basis. Petitioner received his share of the fees actually received up to the date he left the firm, but received nothing for fees which were earned and uncollected or for his interest in the assets of the firm. Petitioner's withdrawal on December 29, 1944, from the firm of Baker-Botts resulted in the loss of $10,770.42 incurred in his trade or business and which loss did not represent the sale or exchange of a capital asset.
OPINION.
BLACK, Judge:
The issue in these proceedings may be stated as follows: When petitioner Gaius G. Gannon withdrew from a law partnership and pursuant to the partnership agreement his partnership investment was not returned did petitioners sustain a loss within the meaning of either subsection (e) or (g) of section 23 of the Internal Revenue Code?
SEC. 23. DEDUCTIONS FROM GROSS INCOME.(e) LOSSES BY INDIVIDUALS.— In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—(1) if incurred in trade or business; or(2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or(3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft. No loss shall be allowed as a deduction under this paragraph if at the time of the filing of the return such loss has been claimed as a deduction for estate tax purposes in the estate tax return.(g) CAPITAL LOSSES.—(1) Limitation.— Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.(2) Securities becoming worthless.— If any securities (as defined in paragraph (3) of this subsection) become worthless during the taxable year and are capital assets, the loss resulting therefrom shall, for the purposes of this chapter, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
Respondent's primary contention is that petitioner did not sustain any loss upon his withdrawal from the firm of Baker-Botts. In the alternative, respondent contends that if petitioner did sustain a loss, such a loss was a capital loss within the meaning of sections 23(g) and 117 of the Internal Revenue Code.
We shall first consider whether petitioner sustained a loss. There is no dispute herein as to the facts. Petitioner voluntarily withdrew from the firm of Baker-Botts to practice law on his own behalf and pursuant to the partnership agreement no portion of the $10,770.42 which petitioner paid to acquire his 6.2 per cent interest in the firm was returned to him. There is no question raised by respondent as to the date of the loss, if any, as the transaction was finally closed in the taxable year 1944, and petitioner's basis in the property is stipulated to be $10,770.42. In his return for the year 1944, petitioner claimed $10,770.42 as a loss incurred in his trade or business and respondent does not contend that the loss, if any, was not so incurred, except in so far as respondent contends this was a capital loss. When petitioner withdrew from the firm on December 29, 1944, he received no consideration of any kind from the firm of Baker-Botts for the $10,770.42 which he had paid for his 6.2 per cent interest.
Petitioner requested that the remaining partners not enforce the forfeiture provision of the contract and that they reimburse him for his investment; however, the forfeiture provision was applied. If petitioner had continued in the partnership he would have continued to be the owner of this valuable property interest which was forfeited. If the partners had all agreed to a complete dissolution with partition of the assets, Gannon would have received his pro rata share of the assets. If he had died while a partner his interest in the firm would have been paid for by those surviving upon the basis set out in the contract. Instead, for the reasons which we have set out in our findings of fact, he decided to relinquish his interest in the firm of Baker-Botts and establish a law office of his own where he could, so to speak, be his own boss. He thereby lost his investment in the Baker-Botts firm. We, therefore, hold that petitioner sustained a loss of $10,770.42 in 1944. This loss is deductible under the provisions of section 23(e) of the Internal Revenue Code, unless, as respondent contends, the loss was occasioned by the ‘sale or exchange‘ of a capital asset within the meaning of sections 23(g) and 117 of the Internal Revenue Code.
Petitioner's interest in the firm of Baker-Botts represented a capital asset, Allan S. Lehman, 7 T.C. 1088, affd., 165 F.2d 383, certiorari denied, 334 U.S. 819, and if there was a sale or exchange of his interest it would be subject to the limitations of sections 23(g) and 117 of the Internal Revenue Code. It is, therefore, necessary for us to determine whether petitioner's withdrawal from the firm of Baker-Botts represented the sale or exchange of his interest in the partnership. The words ‘sale‘ and ‘exchange‘ as used in the Internal Revenue Code must be given their ordinary meanings. Helvering v. Flaccus Oak Leather Co., 313 U.S. 247; Hale v. Helvering, 32 B.T.A. 356, affd., 85 F.2(d) 819.
Respondent contends that when Gannon separated from the firm he left the $10,770.42 he had paid for his partnership interest in the firm in consideration of the firm's freeing him from the restriction imposed when he signed the partnership agreement, thereby creating an exchange of property rights and bringing the transaction within the provisions of section 117 of the Code. We cannot agree with this contention. Petitioner's interest in the partnership represented a valuable asset and when he withdrew from the firm of Baker-Botts he lost this asset without receiving any consideration. Petitioner's withdrawal resulted in a forfeiture of his $10,770.42. Although a forfeiture in some special instances may result in a capital gain or loss (see section 117(g), I.R.C.) the forfeiture of petitioner's $10,770.42 was not a sale or exchange as those words are ordinarily used and, therefore, petitioner's loss is not limited by section 117 of the Internal Revenue Code.
Reviewed by the Court.
Decisions will be entered under Rule 50.