26 CFR 1.61-1: Gross income.

Partnership contract assigned to partner-owners. An accrual-method partnership performed services under a contract providing a lumpsum payment on termination by the contracting corporation. The contracting corporation was

quired by another corporation and the partnership assigned the contract to its cash-method partners who agreed to termination of the contract for 10 unconditional annual installment payments. The continuing partnership must accrue the total of the unconditional minimum installments, and each partner must report his share of that amount, in the contract termination year.

Rev. Rul. 75-113

Advice has been requested regarding the inclusion in gross income of certain contract termination payments under the circumstances described below.

AB partnership, which uses the accrual method of accounting, performed leasing and management services for M, a corporation that owns shopping centers, under an agreement executed in 1958. The agreement gave AB sole and exclusive leasing and management authority with respect to all original leases granted in certain of M's shopping centers. In payment for its services AB received 5 percent of the gross rents on all leases covered under the agreement. Under the terms of the agreement, M had the right to terminate the agreement, upon 30 days notice, in connection with the management of any or all shopping centers and upon such termination AB was entitled to receive a lumpsum amount equal to 2.5 percent of the gross rentals due or to become due for the then remaining balance of the leases involved.

In 1973, X, a corporation unrelated to M, approached the management of M with a proposal to acquire the as

sets of M and to assume its liabilities in exchange for stock of X. X's activities included real property management, so it wanted termination of the management agreement between M and AB to be a condition of the acquisition. Accordingly, it was agreed among X, M, and AB that if the shareholders of M approved the acquisition by X, the management contract between M and AB would be assigned to the individual partners of AB who, after the transfer of assets and liabilities from M to X, would enter into an agreement with X terminating the management contract.

On February 15, 1974, the shareholders of M approved a plan of reorganization with X, in which substantially all of M's assets subject to its liabilities would be transferred to X.

On February 20, 1974, AB distributed, by an instrument of assignment, to each of its partners, A and B, in their individual capacities as tenants in common, an undivided onehalf interest in all rights, title and interest, subject to its obligations, under the management agreement. A and B, both of whom use the cash receipts and disbursements method of accounting, are the partners of AB, and each owns a 50 percent interest in the capital and in the profits and losses of the partnership.

On February 21, 1974, M transferred to X substantially all of its assets subject to its liabilities, pursuant to the plan of reorganization which qualified as a tax-free transaction.

On February 21, 1974, A and B entered into a new agreement with X whereby the above-described management agreement (assumed by X under the plan of reorganization) was cancelled. The new agreement reflects the terms previously negotiated and provides for the unconditional payment of ten annual installments beginning in 1974 in lieu of the lumpsum payment provided for in the cancelled agreement. The ten annual payments are to be based on a percentage

of certain rents collected by X. The agreement provides for a minimum. payment of 200x dollars annually and a maximum annual payment of 250x dollars.

AB actively continued in business. after the assignment of the agreement to A and B as it had other leasing arrangements not connected with M.

The question presented is whether the ten installment termination payments are includible in the income of AB on the accrual basis in the year of termination, or in the gross income of A and B, when received, under the cash receipts and disbursements method of accounting.

Under Subchapter K of the Internal Revenue Code of 1954, a partnership is considered, for various purposes, to be both an aggregate of its partners and an entity independent of its partners. The aggregate theory, for example, results in the imposition. of Federal income tax on the partners and not on the partnership. The entity theory is employed, among other purposes, to allow the partnership to choose its own method of accounting for purposes of computing the partners' respective distributive shares of partnership income. This conclusion is supported by the Supreme Court of the United States decision in United States v. Basye, 410 U.S. 441 (1973), 1973-1 C.B. 325, wherein the Court stated:

The legislative history indicates, and the commentators agree, that partnerships are entities for purposes of calculating and filing informational returns but that they are conduits through which the taxpaying obligation passes to the individual partners in accord with their distributive shares.

For purposes of Federal income taxation, a partnership is thus viewed in two different manners depending on the nature of the inquiry presented. In the instant case the inquiry presented is whether A and B negotiated the termination of the management contract on behalf of AB or in their individual capacities.

In Commissioner v. Court Holding

Co., 324 U.S. 331 (1945), 1945 C.B. 58, the Supreme Court held that a sale of property by the shareholders of a corporation after receipt of the property as a liquidating distribution was taxable to the corporation when the corporation had, in fact, conducted all negotiations and the terms of the sale had been agreed upon prior to the distribution of the property. Even though section 337 of the Code was enacted to eliminate inquiry as to whether a sale of corporate property in accordance with a plan of liquidation was made by the corporation or by the shareholders, the basic holding of the case that "the incidence of taxation depends upon the substance of a transaction" regardless of "mere formalisms" remains applicable in other areas of taxation. See, Hines v. United States, 477 F. 2d 1063 (5th Cir. 1973) with respect to distributions other than complete liquidations governed by section 337 and Rev. Rul. 69-172, 1969-1 C.B. 99 with respect to liquidations governed by section. 332. Similarly, the principle of Court Holding Co. would be applicable in noncorporate distributions such as the assignment of the management contract in the instant case.

It is evident from the decision in the Basye case that a partnership is considered to be primarily an entity, rather than an aggregate of its partners, for purposes of computing the income, and hence the tax, owed by the partners. It follows therefore, that partners, when dealing with partnership property in an ongoing partnership, are acting for, and on behalf of, the partnership and not in their individual capacities.

Thus, in the instant case, A and B renegotiated the management agreement in their capacities as partners of AB, not in their individual capacities, and the termination payments under the circumstances described above are the income of AB. See: General Guaranty Mortgage Co., Inc. v. Tomlinson, 335 F. 2d 518 (5th Cir. 1964).

The management contract in fact represented no more than a right to income when it was assigned and income is taxed to the one who earns it, not to his assignee. Lucas v. Earl, 281 U.S. 111, 115 (1930). In Commissioner v. First State Bank of Stratford, 168 F. 2d 1004 (5th Cir. 1948), cert. denied, 335 U.S. 867 (1948), taxpayer-bank distributed to its shareholders as a dividend in kind certain notes that had been deducted as bad debts in prior years. The individual shareholders, acting through one individual, made collections on these notes. The court held that such collections were taxable to the bank on the theory that the dividend in kind merely represented an assignment of

income.

In the instant case, under the new agreement between X and the individual partners A and B, X is obligated to make ten unconditional paygated to make ten unconditional payments of at least 200x dollars each. Thus, a minimum of 2000x dollars will be paid to A and B for the termination of the management agreement.

As a general rule, an assignment of income by a partnership to a partner does not result in the avoidance or deferral of any income taxes inasmuch as the partner would have been required to include the amount assigned in his income under section 702 of the Code had there been no assignment. However, as in the instant case, where the assignment was for the purpose of avoidance of the accrual by the partnership of the income resulting from the deferred payments, thereby in effect converting the partnership's accounting method election under section 703 (b) into an option, the general rule stated above is not justified. See section 451 (a).

Accordingly, AB must accrue the entire minimum amount of the ten annual installments (2000x dollars) payable under the new termination agreement as of February 21, 1974. Further, under section 702 of the Further, under section 702 of the Code, such amount is taxable one

half each to A and B in 1974, the year the management contract was terminated.

26 CFR 1.61-1: Gross income.
(Also Section 7805; 301.7805-1.)

Husband and wife; jointly held property; Michigan. Income arising from property held by a husband and wife as tenants by the entirety in Michigan belongs to the husband and he must include the entire amount of such income in his separate return if they do not file jointly; the contrary decision in Hart will no longer be followed. However, if the property is sold, each is entitled to one-half of the proceeds which should be reported in their separate returns if they do not file jointly. This ruling, as it relates to income from the property, is not applicable for taxable years ended before 1975 where detrimental to either the husband or wife.

Rev. Rul. 75-132

Advice has been requested whether a husband and wife holding real property in the State of Michigan as tenants by the entirety and disposing of this property during the year may each report one-half of the rents received and one-half of the profits from the sale in separate Federal income tax returns.

In Morrill v. Morrill, 138 Mich. 112, 101 N.W. 209 (1904), a wife brought suit against her husband. (from whom she was separated, but not divorced) on the grounds that she was entitled to an equal share of crops grown on land that, although purchased with her funds, was held by her and her husband as tenants by the entirety. The Supreme Court of Michigan rejected her claim, holding that a wife has no right to a share of the crops growing on lands held by a husband and wife as tenants by the entirety in Michigan.

In Commissioner v. Hart, 76 F. 2d

864 (6th Cir. 1935), aff'g 27 B.T.A. 528 (1933), acq., 1937-2 C.B. 13, withdrawing nonacq., XII-1 C.B. 17 (1933), the question was whether the income from entireties property in Michigan was taxable solely to the husband or whether each spouse was taxable on one-half of such income. The court noted that in Morrill it was held that in Michigan the husband has the control of property held by the entire ties and the right to receive and dispose of the income therefrom. The court further noted, however, that a series of Michigan cases arising subsequent to the Morrill case had held that the creditors of the husband could not garnish the income from entireties property and concluded that these cases had, in effect, repudiated the Morrill decision. On the basis of this conclusion, the court held that the income from entireties property in Michigan was not taxable to the husband alone.

The decisions of the Michigan courts subsequent to Hart consider the rule announced in Morrill to be in effect and have consistently held that the husband is entitled to the full use of and all income from property held by him and his wife as tenants by the entirety notwithstanding the Hart decision. See, for example, Maynard v. Hawley, 331 Mich. 123, 49 N.W. 2d 92 (1951); Arrand v. Graham, 297 Mich. 559, 298 N.W. 281 (1941); and Dombrowski v. Gorecki, 291 Mich. 678, 289 N.W. 293 (1939). Therefore, the Internal Revenue Service will no longer follow the Hart decision.

Accordingly, for Federal income tax purposes, the husband and wife may not divide the income arising from the ownership of property held by them as tenants by the entirety in the State of Michigan. The entire. amount received from such property should be reported in their joint return or in the separate return of the husband.

The same rule does not apply to

income derived from the sale of the property. Each is entitled to one-half of the proceeds of the sale, and the wife should, therefore, report her share of the profit or loss in a separate return if a joint return is not filed. Compare Mich. Stat. Ann. section 25.132 (1957), and Muskegon Lumber & Fuel Co. v. Johnson, 338 Mich. 655, 62 N.W. 2d 619 (1954).

See Rev. Rul. 75-142, page 256 of this Bulletin for an application of the principles of this Revenue Ruling to the acquisition of property by a wife. as a surviving tenant by the entirety.

In view of the foregoing, the acquiescences in John H. Hart, 27 B.T.A. 528 (1933), 1937-2 C.B. 13; Herman Gessner, 32 B.T.A. 1258 (1935), 1937-2 C.B. 11; Anna S. Whitcomb, 37 B.T.A. 806 (1938), 1938-2 C.B. 34; H. D. Webster, 4 T.C. 1169 (1945), 1945 C.B. 7; and Paul G. Greene, 7 T.C. 142 (1946), 1946-2 C.B. 2; are withdrawn and nonacquiescences are substituted therefor. See page 3 of this Bulletin.

Pursuant to the authority contained in section 7805(b) of the Code, the

conclusion reached in this Revenue Ruling as it relates to income arising from the ownership of property (as distinguished from the sale of property) will not be applied for the taxable years ending on or before December 31, 1974, if the application of the conclusion would be detrimental to the taxpayer, husband or wife.

26 CFR 1.61-1: Gross income. (Also Sections 111, 164, 316, 6042, 6049; 1.111-1, 1.164-7, 1.316-1, 1.6042-2, 1.6049-1.)

Refund of Illinois personal property tax on bank shares. Examples illustrate the income tax treatment of a refund of Illinois personal property tax on bank shares paid by the bank on behalf of its shareholders, and the requirements for filing information returns Forms 1099INT and 1099DIV, in situations where the personal property tax was paid

(1) from the bank's own funds and (2) from declared dividends belonging to the shareholders.

Rev. Rul. 75-133

Advice has been requested with respect to the Federal income tax consequences of a recovery of Illinois personal property tax paid on bank stock by an Illinois bank on behalf of its shareholders, under the circumstances described below.

Situation 1. The personal property tax was paid out of the bank's funds apart from declared dividends belonging to the shareholders. The bank deducted the amount paid pursuant to section 164(e) of the Internal Revenue Code of 1954.

Situation 2. The personal property tax was paid out of declared dividends belonging to the shareholders. The shareholders included that portion of the declared dividends used to pay the tax in their gross income as a constructive dividend since the payment extinguished their tax liability. The shareholders deducted the tax

paid by the bank under section 164(a)

of the Code.

In 1973, following the decision of the Supreme Court of the United States in Lehnhausen v. Lake Shore Auto Parts Co., 410 U.S. 356 (1973), upholding the right of Illinois to abolish the personal property tax with respect to individuals but retain it for corporations, Illinois refunded the personal property tax assessed and collected after 1970 on outstanding bank capital stock held by individuals.

The refund checks, including interest, received by the banks in each of the situations were sent to the bank

by the local county tax authority and were issued to each individual shareholder and the bank jointly. Upon receipt of the check, the bank endorsed each check and forwarded it to the shareholder whose name appeared on the check for his unqualified use.

In each of the above situations the

specific issues are (1) whether the refund of the state personal property tax, which was paid by a bank on behalf of its shareholders with respect to their bank stock, is includible in gross income by the bank, (2) whether the refund check, which was issued to the bank and each shareholder as joint payees and then endorsed by the bank, is includible in gross income by the shareholders, (3) whether the county treasurer who issued the refund check must file Form 1099INT for interest paid on the refunded taxes, and (4) whether the bank must file Form 1099DIV for a dividend when it endorses and forwards a refund check to a shareholder.

Ill. Rev. Stat. ch. 120, section 557 (1970), provides that the stockholders of every incorporated bank shall be assessed and taxed upon the value of their shares of stock therein, in the taxing district where such bank is located. This tax has been interpreted as one imposed upon the shareholders, not the bank. People v. First Natl' Bank of Marissa, 33 Ill. 2d 457, 211 N.E. 2d 713 (1965). However, Ill. Rev. Stat. ch. 120, section, 558 (1970), provides, in part, as follows:

For the purpose of collecting such taxes, it shall be the duty of every such bank, or the managing officer or officers thereof, to retain so much of any dividend or dividends belonging to such stockholders as shall be necessary to pay any taxes levied upon their shares of stock, respectively, until it shall be made to appear to such bank or its officers that such taxes have been paid ***.

The provision for collection of the taxes by the bank has been interpreted to mean that the tax may be collected from the bank if it declares or pays a dividend and fails to withhold taxes therefrom. People v. First Nat'l Bank of Marissa, People v. Oak Park Trust & Savings Bank, 351 Ill. 334, 184 N.E. 643 (1933).

Section 164(a) of the Code provides, in part, that in computing taxable income there shall be allowed as deductions state and local personal

property taxes paid or accrued within the taxable year.

Section 164(e) of the Code allows a corporation to take the deduction where the corporation pays a tax imposed on a shareholder on his interest as a shareholder and the corporation is not reimbursed by the shareholder. In such case, no deduction is allowed to the shareholder.

Section 1.164-7 of the Income Tax Regulations provides that in such a case, the amount paid by the corporation should not be included in the gross income of the shareholder.

Section 111(a) of the Code provides the general rule that gross income does not include income attributable to the recovery during the taxable year of bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax,

or amount.

Section 1.111-1 of the regulations provides, in part, that the term "recovery exclusion" means an amount equal to the portion of prior taxes (or other items subject to the rule of the exclusion) which, when deducted or credited for a prior taxable year, did not result in a reduction of any Federal income tax of the taxpayer.

Section 111(b) (2) of the Code defines the term "prior tax" as a tax on account of which a deduction or credit was allowed for a prior taxable year.

The converse of the above recovery exclusion rule in section 111 of the Code is that where amounts previously deducted from gross income, which thereby effected a tax benefit, are recovered in subsequent years, such recoveries are includible in gross income for the year of recovery under section 61.

Section 316 of the Code provides, in part, that the term "dividend" means any distribution of property made by a corporation to its shareholders (1) out of earnings and profits accumulated after February 28,

1913, or (2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.

Section 6049 of the Code provides, in general, for the filing of information returns by every person who makes payments of interest of $10 or more to any person during any calendar year. However, section 1.6049-1 (a) (2) of the regulations provides, in part, that the term person when used in that section does not include the United States, a State, the District of Columbia, a foreign government, a political subdivision of a State or of a foreign government, or an international organization.

Section 6042 of the Code provides, in general, for the filing of information returns by every person who makes payments of dividends of $10 or more to any person during any calendar year.

In situation 1, of the instant case, the bank deducted, under section 164 (e) of the Code, the voluntary payment of a tax imposed on the shareholders from its own funds. Based upon its payment out of corporate funds, the bank is entitled to the entire refund of the tax.

Accordingly, in situation 1 the entire amount of the refund checks is includible in the bank's gross income, pursuant to the provisions of section 61 of the Code, to the extent not excluded by the provisions of section 111. The amount of any interest on the refunded taxes included in the checks is includible in the bank's gross income without regard to section 111. It is further held that the amount of such refund checks, which were endorsed by the bank and forwarded to the shareholders, are dividends to the shareholders from the bank to the extent such payments satisfy the definition of a dividend under section 316,