HERMAN FELDMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 18837. Promulgated January 11, 1950.

Trust created by petitioner for his minor son held on all facts

not a true partner in partnership composed of petitioner and his
brothers.

Simon E. Sobeloff, Esq., and Eugene M. Feinblatt, Esq., for the petitioner.

E.M. Woolf, Esq., for the respondent.

Petitioner challenges respondent's determination of deficiencies in income tax for the years 1944, 1945, and 1946 in the respective amounts of $17,085.07, $49,566.69, and $28,727.64. Respondent has conceded error in attempting to tax to petitioner all the income of a certain trust for benefit of Samuel Feldman, petitioner's son. The only issue in contest is whether respondent was correct in refusing to recognize the trust as a partner in the firm of Brooks Clothes and taxing to petitioner that portion of the firm income credited to the trust.

FINDINGS OF FACT.

Petitioner resides in Baltimore, Maryland, and he filed his income tax returns for 1944, 1945, and 1946 with the collector for the district of Maryland.

In 1934 petitioner opened a business in Norfolk, Virginia. Later in that year the business was incorporated, and petitioner's brothers, Jack, Al, Edward, and Julius Feldman, became corporate officers. The original business consisted of several retail clothing stores. Within two years factories were acquired and subsequently the retail business expanded. On December 1, 1941, the five brothers executed a written partnership agreement, continuing the business under the name of Brooks Clothes. At that date the capital of the partnership was $250,000, to which contributions were made in the following proportions: Petitioner, 35 per cent; Jack, 20 per cent; Al, Edward, and Julius, 15 per cent each. The agreement provided, among other matters, that profits were to be shared and losses borne in proportions equal to the capital contributed. Each of the partners was to be delegated certain duties. Only Jack had authority to sign checks or contracts. The agreement provided that the concurring vote of four partners was necessary to determine whether the profits of the business should be withdrawn or credited to capital. The agreement further provided that upon the death of any one of the partners the legal representatives of the deceased partner should sell to the partnership, and the partnership should purchase, the interest of the deceased

partner in the partnership; each of the surviving partners to be obligated to purchase and pay for such portion of the interest of the deceased partner as the value of his interest might bear to the total value of the interest of all the surviving partners. In addition, the instrument provided that, notwithstanding any other provisions of the agreement, upon the death of petitioner and Jack Feldman the partnership business should be liquidated as promptly as possible.

Petitioner's son, Samuel Feldman, was born on May 30, 1929. In 1938 or 1939 Samuel started to work at the Baltimore store, engaging in tasks such as wrapping packages, delivering clothes to customers, and running errands. From that time Samuel worked regularly in the Baltimore store on Saturdays, in the evenings after school hours and before the store closing time of 9 p. m., and during the summer vacation months. In 1942 Samuel began to take on the duties of a salesman and cashier. Samuel was encouraged by all the partners to take an active part in the business. His education and activities were directed towards that end. In 1942 petitioner proposed that he give to Samuel part of his interest in the business. At that time the only other male child of the Feldman brothers was one infant. The brothers were interested in taking in members of the younger male generation. However, they would not have accepted as a partner an individual outside of the family. Petitioner was aware of the tax advantages which he might gain.

On July 1, 1942, petitioner executed a declaration purporting to assign an interest in the partnership to Maurice Feldman, as trustee, for the benefit of petitioner's son, Samuel. Maurice Feldman, petitioner's brother, was a physician and had not previously been associated with the business. He agreed to serve as trustee. The following are the provisions of the trust instrument:

WHEREAS, I, the undersigned HERMAN FELDMAN, of Baltimore City, State of Maryland, have this day caused the transfer of a certain portion of my interest in the partnership business known as Brooks Clothes, to my brother, MAURICE FELDMAN, as Trustee, for the benefit of my son, Samuel Feldman, as hereinafter provided, I do by these presents make known and declare the terms of the said transfer and trust.

1. Together with my brothers, Jack Feldman, Al Feldman, Julius Feldman, and Edward Feldman, I am a member of a partnership engaged in the clothing business in Baltimore City under the firm name of Brooks Clothes. My share in the said partnership has until this date been a thirty-five per cent (35%) interest in its capital and net profits. In order to provide an independent estate for my son, Samuel Feldman, I have this day, with the consent of my partners, caused to be assigned on the books of the partnership thirteen per cent (13%) interest in the capital of the said business (and the same has been charged to my thirtyfive per cent (35%) interest) to my brother, MAURICE FELDMAN, in special trust and confidence. nevertheless, to hold the said interest for the use and benefit of my son. Samuel Feldman, until he shall have attained the age of twenty-one (21) years.

2 (a) The said Trustee is hereby specifically authorized to engage in the clothing business as a partner in Brooks Clothes; or in the event of the termination of the said partnership or his withdrawal therefrom, in his sole discretion to invest, and from time to time to reinvest, the proceeds in any other business, or to purchase stocks, bonds or other securities of any form, or real or personal property, and he is hereby authorized to mortgage, lease, sell or otherwise deal in such property to the fullest extent.

(b) The said Trustee shall pay all necessary expenses of the trust, including taxes, and shall retain and add to the corpus of the estate any net income or profits from his investment in the said partnership, or from any reinvestment of the trust property, and shall make no distribution to my said son during the period of his minority for any cause whatsoever. Any share of the profits of the business that may, under the partnership agreement, be credited to the said Trustee in excess of the necessary expenses, including taxes, may in his discretion and with the consent of the other partners be permitted to remain with the partnership as an account payable to the Trustee, or may be reinvested by him in the said partnership business, or may be otherwise invested. Any deficiency which may be charged against the Trustee by reason of losses of the partnership shall be considered as an account receivable, or may be charged to the Trustee's capital account, as he and the other partners may agree. The Trustee may repay any such deficiency out of any funds in his possession, and he is authorized for this purpose to raise cash by the sale of any investments or assets in his hands. In selling assets of the trust estate, the Trustee is hereby given full power and authority, and persons dealing with him shall not be required to look to the application of the purchase money. After the said beneficiary shall have attained the age of twenty-one (21) years, the trust shall terminate and the Trustee shall turn over and deliver all of the trust property, both principal and income then remaining in his hands, unto my said son, free, clear, and discharged of all trusts.

(c) In the event of my death before my son has attained the age of twenty-one years, the Trustee may, in his sole discretion, expand for the use and benefit of my son any income or profits which may have accrued, or may thereafter accrue, upon the trust property.

3. Any payment made by the Trustee to the beneficiary shall be made into the hands of the said beneficiary personally and not unto any other person whatsoever, whether claiming by his authority or otherwise, so that the said property may not be liable for the debts, contracts, or engagements of such beneficiary, or be taken in execution, attachment or garnishment or other legal or equitable proceedings while in the hands of the Trustee; nor shall any payments of principal or interest be subject to anticipation during the minority of my said son. 4. In the event of the resignation or inability of the said Trustee to serve, my wife, FANNIE FELDMAN, shall become trustee in his stead, and if for any reason she is unavailable then such other person as the said Trustee may designate in writing shall succeed him as Trustee. In the event of the death of the above named Trustee, my wife, Fannie Feldman, shall succeed him in the trust, and if she is unavailable the new trustee shall be such other person as the above named trustee, Maurice Feldman, may appoint in his last will and testament. Any successor trustee shall be clothed with the same power, authority and discretion as the original trustee, and both the original trustee and any successor shall be excused from the necessity of furnishing bond and shall not be liable for mistake of judgment or negligence but only for wilful breach of trust committed mala fide.

5. If my said son, Samuel Feldman, should die before the entire trust property, including principal and income, shall have been distributed to him in

accordance with the terms of this Declaration of Trust, then the trust property shall pass to such person as he may appoint in his will; and if he leaves no will or fails to make such designation the trust property shall pass free, clear and discharged of the trust to his mother, if living, otherwise to his sister, Shirley Ann Katz.

6. The Trustee above named and any successor trustee shall serve without compensation.

7. I hereby declare that I have retained and shall have no beneficial interest whatsoever in the said trust property, the said transfer being made in consideration of natural love and affection, and I hereby relinquish all power to revoke or modify this trust or to exercise any control over its administration.

On July 1, 1942, the six Feldman brothers, petitioner, Jack, Al, Julius, Edward, and Maurice as trustee, executed an agreement stated to be supplemental to the original partnership agreement. That supplemental agreement provided as follows:

Jack Feldman, Al Feldman, Julius Feldman and Edward Feldman, co-partners with Herman Feldman in the partnership business conducted in Baltimore City under the firm name of BROOKS CLOTHES, do hereby agree with Maurice Feldman, Trustee for Samuel Feldman, as follows:

1. The said co-partners consent to the transfer by Herman Feldman to Maurice Feldman, as trustee under the Declaration of Trust of this date, of thirteen per cent (13%) of the capital of the said partnership, and hereby accept the said trustee as an additional partner in Brooks Clothes; and they agree that thirteen per cent (13%) of the net profits thereof shall be payable to Maurice Feldman, Trustee, as distribution of profits may from time to time be made to the partners, as hereinafter provided in paragraph 5 of the original partnership agreement of December 1, 1941, as amended; and it is understood and agreed that neither the said Trustee nor the beneficiary named in the trust shall receive any salary or drawing account from the said partnership independent of services rendered merely on account of the fact that the Trustee is a partner hereunder.

2. The Trustee shall not participate in the purchase of any deceased or withdrawing partner's interest, but Herman Feldman shall participate in such purchase to the extent provided in the original partnership agreement of December 1, 1941, as though no trust had been created.

3. Paragraph 5 of the partnership agreement of December 1, 1941, is hereby amended to read as follows:

5. The partners shall be entitled to share in the profits of the business, and shall bear all losses happening in the course thereof, in the following proportions:

Out of the first $20,800.00 of net profits in each of the periods, January 1 to June 30 and July 1 to December 31, in each year, the partners shall receive as their respective shares the following:

The remaining profits for the half year shall be shared as follows:

In the event that the net profits for the half year are less than $20,800.00, the profits are to be shared as follows:

In the event that there is a net loss for the half year, the loss is to be shared as follows:

4. In all other respects the said Trustee shall be entitled to the same rights as the other partners.

5. The Trustee's interest shall be computed from the statement as furnished by Leonard B. Rowles, C. P. A. as at June 30, 1942. The interest as so computed is $49,815.52, as evidenced by the attached memorandum.

Petitioner paid a gift tax on the assignment, evaluating a 13 per cent interest in the partnership at $49,815.52. Subsequently revenue agents asserted a greater value for that interest on the basis of the business good will, and petitioner paid an additional gift tax.

The change was made public to the business world. The banks, the firm suppliers, Dun & Bradstreet, and the National Credit Office were notified of the change. Thereafter all papers signed by the partners bore the signature of the trustee as partner.

Maurice Feldman served as trustee until May 26, 1944, when he resigned. Fannie Feldman declined to act as trustee. Maurice then appointed Jack Feldman, who has continued to serve in that capacity and to act as a partner in his own behalf.

After July 1, 1942, Samuel Feldman continued to work in the business. During the three years here involved, 1944, 1945, and 1946, Samuel was aged 15, 16, and 17. During 1944, in the evenings and week ends, and during the Christmas and Easter holidays and the summer months, he worked in the Baltimore store as salesman and cashier. In 1945 he continued to work at the Baltimore store in evenings, on week ends, and during holidays. During the summer of 1945 Samuel worked in the office, learning the general accounting pro