| [304 U.S. 271, 272] Messrs.
Homer S. Cummings, Atty. Gen., and Golden W. Bell, Asst.
Sol. Gen., for petitioner.
Mr. John G. Frazer, of
Pittsburgh, Pa., for respondents.
Mr. Justice BRANDEIS
delivered the opinion of the Court.
These cases, tried below in the
federal court for Western Pennsylvania and argued
together here, arise from the same facts and present the
same questions of law.
Each action was brought against D. B. Heiner, as former Collector of Internal
Revenue and individually, to recover an amount paid under
protest by the taxpayer in 1927 upon a deficiency
assessment of his 1920 income tax. The amounts taxed as
additional income were the distributive shares of certain
profits alleged to have been earned by each in 1920 as a
partner in two firms. Due demand for a refund was made.
In No. 144 the taxpayer was A. W. Mellon; in No. 145, R. B. Mellon. Both having died, the suits
are by their executors.
In No. 144, the District Court
entered judgment for $202,502.22 with interest (14
F.Supp. 424); in No. 145 for $187,787.17 with interest.
These judgments were affirmed by
the Circuit Court of Appeals, 3 Cir., 89 F.2d 141.
Certiorari was granted because [304 U.S. 271, 273] of
alleged conflict as to applicable rules of law important
in the administration of the revenue laws. 302 U.S. 672,
58 S.Ct. 21, 82 L.Ed. --.
There is no dispute as to the
relevant facts. Prior to December 12, 1918, A. W. Mellon, R. B. Mellon, and H. C. Frick each owned one-third of the
entire capital stock of two distilling corporations -- A. Overholt &
Company
and West
Overton Distilling Company. On that day those three
individuals formed two partnerships in which each partner
was to have a one-third interest.
In January, 1919, they caused to
be transferred to the partnership called A. Overholt &
Company
all the assets of the corporation of that name; and to
the partnership called West Overton Distilling Company, all the assets of that
corporation. These assets included large whisky
inventories in bonded warehouses.
Neither corporation had
distilled any whisky after 1916. Liquidation of the
businesses of each had been started by the two
corporations in 1918; and the partnerships had been
organized for the purpose of liquidating them. The
business of each partnership in 1920, had, like its
business in 1919, consisted in the sale of whisky
certificates and the storage, bottling, casing, and sale
of the stock of whisky.
It was not until 1925 that the
assets of the partnerships then remaining were sold in
bulk, and the proceeds distributed among those entitled
thereto.
Frick died December 2, 1919; but
throughout 1920 the businesses of A. Overholt &
Company
and of West
Overton Distilling Company were conducted, and their books
were kept, in the same manner as the businesses had been
conducted and books had been kept by the partnerships in
1919, and by the corporations in 1918.
For 1920 the partnership returns
of the two concerns disclosed facts from which it
appeared that substantial gains had been made from the
sale of whisky.
But the amounts were not
reported as income of the partnerships; and neither A. W. Mellon nor R. B. Mellon included in their income [304
U.S. 271, 274] tax returns for 1920 any amount on account
of them.
The Commissioner of Internal
Revenue determined that these sums were distributive
profits; that the returns of taxable income of A. W. Mellon and of R. B. Mellon for the year 1920 should have
included one-third of the profits in that year of each
firm from the sale of whisky; and made a deficiency
assessment on A.
W. Mellon
of $190,419.70 and on R. B. Mellon of $175,259.70.
The Revenue Act of 1918 governs
taxation of 1920 income. Section 218(a) of the Act
provides that individuals carrying on business in
partnership shall be liable in their individual
capacities for the income tax on profits earned therein,
and that in computing the net income of each partner
there shall be included his distributive share, whether
distributed or not, of the net income of the partnership
for the taxable year.
Section 224 provides that the
partnership shall file an informational return setting
forth the items of its gross income, the deductions
allowed and the distributive share of net income to which
each partner is entitled.
The two Mellons filed their individual returns
for 1920, and also the informational partnership returns
for that year. While the Mellons claimed that they were not
taxable on their share of the profits from whisky sold in
1920, they recognized that they were taxable for their
shares of these other profits of the concerns earned in
1920.
The partnership returns in the
case of each concern showed a gain arising from storage,
bottling and casing operations, sales of barrels,
interest and rentals. One-third of each of these profits
was entered by each of the Mellons in his individual return as his
distributive share of the profits of the two
partnerships.
First. The primary
question for decision is whether the net profits made by
the two partnerships in 1920 from the [304 U.S. 271, 275]
sales of whisky were in their nature taxable income.
Throughout 1920, A. Overholt &
Company
and the West
Overton Distilling Company were engaged in business. The
mere fact that the purpose of the partnerships was to
liquidate the assets taken over from the corporations is
not of legal significance.
Profits made in the business of
liquidation are taxable in the same way and to the same
extent as if made in an expanding business. Nor is it of
legal significance that the liquidation was not completed
until 1925 and that until completion of the liquidation
it could not be known whether the business venture, taken
as a whole, had been profitable. The federal income tax
system is based on an annual accounting.
2. Under that
law the question whether taxable profits have been made
is determined annually by the result of the operations of
the year.
Purchasing
real estate, subdividing and selling it in parcels is, in
essence, a liquidating business. The claim has been
repeatedly made that no income was realized until the
investment was recouped; but the Board of Tax Appeals has
uniformly held in accord with Article 43 of Regulations
45 (and later regulations) that the cost of the real
estate must be apportioned among all the lots, and income
returned upon the sales in each year, regardless of the
number of lots remaining undisposed of at the close of
the tax year.
3. A like rule
has been applied where the [304 U.S. 271, 276] taxpayer
had purchased personal property in a block and was
engaged in selling it in parcels.
The claim that there was no
taxable income until the capital had been returned was rejected.
4. The fact that it might
prove that when the business was fully liquidated the
profits of 1920 were offset by heavy loss of later years
is immaterial.
Losses
suffered by a taxpayer in a later year may be deducted
from profits, if any, earned by him in that later year;
but the tax on a year's income may not be withheld
because losses may thereafter occur.
If A. Overholt &
Company
and West
Overton Distilling Company had remained corporations they
would have been obliged to make each year return of the
profits made therein and pay taxes annually throughout
the period of liquidation although it might ultimately
prove that the losses of the later years exceeded the
profits of the earlier ones.
5.
Likewise, if the concerns had each been owned by a single
individual, the fact that his sole business was
liquidating the concern would not have relieved him from
paying annually taxes on the [304 U.S. 271, 277] net
profits
No
good reason is suggested why a different rule should
apply to partnerships.
We conclude that gains
from the sale of whisky in 1920 were income of that year.
The amount of the income was
determinable from the partnership books. Section 212(b)
of the Revenue Act of 1918 provides that the net income
shall be computed 'in accordance with the method of
accounting regularly employed in keeping the books of'
the taxpayer, and it is not shown that the method
employed clearly failed to reflect net income.
Second. The fact that the
partnerships had been dissolved by Frick's death before 1920 does not
affect the liability of the Mellons as surviving partners for
income taxes on their distributive shares of the net
profits made in that year.
Compare
Rossmoore v. Anderson, D.C.S.D.N.Y., 1 F.Supp. 35,
affirmed, 2 Cir., 67 F.2d 1009; Rossmoore v.
Commissioner, 2 Cir., 76 F.2d 520. The business of A. Overholt &
Company
did not terminate on Frick's death. Although dissolved, the
partnerships and the business continued, since, as stated
in the Pennsylvania Uniform Partnership Act: 'On
dissolution the partnership is not terminated, but
continues until the winding up of partnership affairs is
completed.'
6. Throughout
the year 1920, the business of selling stock on hand and
deriving income therefrom was carried on precisely as it
had been theretofore, and for the same purpose.
Article 424 of Regulations 45
recognizes that even in the hands of a receiver a
partnership must file a return.
Third. The Mellons contend, and the court below
held, that the partners' interests in the partnerships
were capitalized upon dissolution, so that until the
liquidation returned to them the cost of their interests,
no taxable income was received; that Article 1570 of
Regulations 45 [304 U.S. 271, 278] so provides; and that
this did not take place before 1925.
But, as already pointed
out, technical dissolution does not affect the liability
of a partner under section 218 for taxes on his
distributive share of the partnership's income; and
Article 1570 does not establish any rule that dissolution
capitalizes the interest of a partner in future
partnership profits.
The
article provides: 'When a partner retires from a
partnership, or it is dissolved, he realizes a gain or
loss measured by the difference between the price
received for his interest and the cost to him or (if
acquired prior thereto) the fair market value as of March
1, 1913, of his interest in the partnership, including in
such cost or value the amount of his share in any
undistributed partnership net income earned since
February 28, 1913, on which income tax has been paid. ...
This article is in no way
inconsistent with the taxation of a partner on his share
of the income of the partnership earned in a single year
after dissolution but before completion of liquidation
and distribution. It deals only with the determination of
a partner's gain or loss on his investment when he
completely severs his connection with the partnership and
its assets. The gain or loss is determined substantially
like that on any other business venture of the
individual, treated as a whole.
On the other hand, the
profits from the sale of whisky in 1920 were current
income of the partnership for that year, not different in
their nature from the profits from storage, bottling,
casing, and similar operations which the Mellons returned as income. Article
1570 does not deal with this situation.
Fourth. The Mellons contend that because the
partnerships were dissolved by the death of Frick in 1919, A. W. Mellon and R. B. Mellon, being surviving partners,
became by operation of law liquidating trustees; that any
income earned in 1920 from operations of the dissolved
partnerships was income to the Mellons only in their [304 U.S. 271,
279] fiduciary capacity as such trustees; that under
section 219 of the Revenue Act of 1918, 40 Stat. 1071,
the trust estate was a separate taxable entity; that if
any income tax was due, it was therefore due from the
trust; and that its assessment is now barred by the
statute of limitations.
We do not find it necessary to
determine whether assessment of the tax on this theory is
now outlawed, or whether, as the Collector urges,
recovery is precluded in any event under the doctrine of
Stone v. White, 301 U.S. 532, 57 S.Ct. 851; for we are
of the opinion that the Mellons are not trustees within the
meaning of section 219. The fact that they may be so
denominated by the law of Pennsylvania, 59 P.S.Pa. 1 et
seq., is not conclusive.
It is well settled that
in the interpretation of the words used in a federal
revenue act, local law is not controlling unless the
federal statute 'by express language or necessary
implication, makes its own operation dependent upon state
law.' 'The state law creates legal interests, but the
federal statute determines when and how they shall be
taxed.' Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74,
77.
7. We think it is clear
that under the circumstances set forth, the income earned
in 1920 was income of a partnership 'carrying on
business' within the meaning of section 218 rather than
of a trust under section 219.
The obligation of the Mellons to pay, under the federal law,
taxes on the profits made in 1920 from sales of [304 U.S.
271, 280] whisky is in no way affected by their fiduciary
obligation under the law of the State to account to the Frick estate for its interest in the
two partnerships being liquidated.
The surviving partners continued
during 1920 to conduct the business from which they
earned profits. On such income the federal law required
that taxes be paid. It did not require that the payments
be made from the partnership assets.
How the assets shall be disposed
of, and what shall be done with the proceeds when
realized, are matters which may be determined by the law
of the State or by agreement of the partners. But however
the assets are required by the law of the State to be
disposed of, or the proceeds applied, the federal law
requires that taxes be paid if, in disposing of them
within the year the business is conducted and profits are
made.
Fifth. The Mellons contend that under the law of
Pennsylvania no distribution of profits could lawfully
have been made by the surviving partners as liquidating
trustees until all debts and liabilities, contingent or
otherwise, had been paid or satisfied, and the partners'
capital returned; and that although the business of the
partnerships had been carried on after dissolution
precisely as before, and the partnership accounts for the
year 1920 showed large profits earned, their respective
shares of them were not distributable and could not be
deemed taxable income of the partners.
Section
218(a) of the Revenue Act of 1918 provides that 'There
shall be included in computing the net income of each
partner his distributive share, whether distributed or
not, of the net income of the partnership for the taxable
year ....'
If
'distributive' meant 'currently distributable under state
law,' the contentions made by the Mellons might have some force. But it
does not. Article 322 of Regulations 45 (and
corresponding articles of subsequent Regulations) defines
'distributive' as meaning 'proportionate.'
Compare Earle v. Commissioner, 1
Cir., [304 U.S. 271, 281] 38 F.2d 965, 967, 968. And
section 220 of the Revenue Act of 1918, 40 Stat. 1072,
taxing to the shareholders the income of a corporation
improperly accumulating its gains and profits for the
purpose of avoiding surtax, assumes that the two words
are synonymous. The tax is thus imposed upon the
partner's proportionate share of the net income of the
partnership, and the fact that it may not be currently
distributable, whether by agreement of the parties or by
operation of law, is not material.
8. No claim is
made that the proportionate interests of the surviving
partners was improperly determined by the Commissioner.
Sixth. Finally, the Mellons contend that in 1928 and 1929
the Commissioner determined that no profit was realized
until final liquidation of the partnerships in 1925, and
that income taxes for that year have been collected on
this theory and not yet refunded.
The Commissioner's alleged
change of position is not here important. It is not shown
that refund of these taxes is now barred. Nor is it
necessary for us to consider the cost to the Mellons of their interests in these
partnerships, or whether the Mellons' 1925 income taxes were
erroneously assessed and collected, or whether the
Commissioner correctly settled the tax liability of the Frick estate.
None of these questions has any
bearing upon the determination of the case before us.
REVERSED.
Mr. Justice CARDOZO and Mr.
Justice REED took no part in the consideration or
decision of this case.
Footnotes
[Footnote 1] Act of February 24,
1919, c. 18, 40 Stat. 1057.
[Footnote 2] Burnet v. Sanford
& Brooks Co., 282 U.S. 359, 365, 51 S.Ct. 150, 152;
Burnet v. Thompson Oil & Gas Co., 283 U.S. 301, 306,
51 S.Ct. 418, 420; Woolford Realty Co. v. Rose, 286 U.S.
319, 326, 52 S.Ct. 568, 569; Brown v. Helvering, 291 U.S.
193, 198, 199 S., 54 S.Ct. 356, 358, 359; Helvering v.
Morgan's Inc., 293 U.S. 121, 126, 127 S., 55 S.Ct. 60,
61, 62; Guaranty Trust Co. v. Commissioner, 303 U.S. 493,
58 S.Ct. 673, decided March 28, 1938.
[Footnote 3] Appeal of J. S.
Cullinan, 5 B.T.A. 996; J. S. Cullinan v. Com'r, 19
B.T.A. 930; Thomas J. Avery v. Com'r, 11 B.T.A. 958;
Brodie C. Nalle v. Com'r, 19 B.T.A. 427; Frederika
Skinner v. Com'r, 20 B.T.A. 491. See, also, B. S. Roberts
v. Com'r, 7 B.T.A. 1162; Hannibal Missouri Land Co. v.
Com'r, 9 B.T.A. 1072; D. C. Clarke v. Com'r, 22 B.T.A.
314, 325; Biscayne Bay Islands Co. v. Com'r, 23 B.T.A.
731; Searles Real Estate Trust v. Com'r, 25 B.T.A. 1115.
Compare Perkins v. Thomas, 5 Cir., 86 F.2d 954, 956,
affirmed on other grounds, 301 U.S. 655, 57 S.Ct. 911;
see, also, Elmhurst Cemetery Co. v. Commissioner, 300
U.S. 37, 57 S.Ct. 324.
[Footnote 4] Santa Maria Gas Co.
v. Com'r, 10 B.T.A. 1412; American Industrial Corp. v.
Com'r, 20 B.T.A. 188; Bancitaly Corp. v. Com'r, 34 B.T.A.
494. Compare Weser Bros., Inc. v. Com'r, 12 B.T.A. 1394;
C. H Swift & Sons, Inc. v. Com'r, 13 B.T.A. 138; Deer
Isle Logging Co. v. Com'r, 14 B.T.A. 1027; O. H. Himelick
v. Com'r, 32 B.T.A. 792.
[Footnote 5] See Regulations 45,
Art. 547; Tazewell Elec. Light & Power Co. v.
Strother, 4 Cir., 84 F.2d 327; Northwest Utilities
Securities Corp. v. Helvering, 8 Cir., 67 F.2d 619; First
Nat. Bank of Greeley v. United States, 10 Cir., 86 F.2d
938. Compare Burnet v. Lexington Ice & Cold Storage
Co., 4 Cir., 62 F.2d 906; Taylor Oil & Gas Co. v.
Commissioner, 5 Cir., 47 F.2d 108; Hellebush v.
Commissioner, 6 Cir., 65 F.2d 902; Whitney Realty Co. v.
Commissioner, 6 Cir., 80 F.2d 429.
[Footnote 6] Pa. Laws 1915, No.
15, 30, Pa. Stat. Ann., Purdon, 1930 tit. 59, 92.
[Footnote 7] See, also,
Burk-Waggoner Oil Association v. Hopkins, 269 U.S. 110,
113, 114 S., 46 S.Ct. 48, 49; Palmer v. Bender, 287 U.S.
551, 555,55 6, 53 S.Ct. 225, 226; Thomas v. Perkins,..301
U.S. 655, 659, 57 S.Ct. 911, 912; Biddle v. Commissioner,
302 U.S. 573, 58 S.Ct. 379. Compare Board of Trade of
City of Chicago v. Johnson, 264 U.S. 1, 8-11, 44 S.Ct.
232, 233, 234; United States v. Robbins, 269 U.S. 315,
327, 328 S., 46 S.Ct. 148, 149; Corliss v. Bowers,....281
U.S. 376, 378, 50 S.Ct. 336; Tyler v. United States, 281
U.S. 497, 503, 50 S.Ct. 356, 359, 69 A.L. R. 758. See,
also, Hart v. Commissioner, 1 Cir., 54 F.2d 848, 851;
Fidelity-Philadelphia Trust Co. v. Commissioner, 3 Cir.,
47 F.2d 36, 38; Rosenberger v. McCaughn, 3 Cir., 25 F.2d
699; Eagan v. Commissioner, 5 Cir ., 43 F.2d 881, 883, 71
A.L.R. 863; Fritz v. Commissioner, 5 Cir., 76 F.2d 460,
461, 462.
[Footnote 8] Compare Earle v.
Commissioner, 1 Cir., 38 F.2d 965; Hill v. Commissioner,
1 Cir., 38 F.2d 165, 168; Pope v. Commissioner, 1 Cir.,
39 F. 2d 420; Ruprecht v. Commissioner, 5 Cir., 39 F.2d
458; Benedict v. Price, D.C.E.D.N.Y., 38 F.2d 309; W.
Frank Carter v. Com'r, 36 B.T.A. 60. See, also, O.D. 187,
1 C.B. 174.
|
First Big
Question:
Exactly when did it come to pass that H. C. Frick owned the West
Overton distillery? If anybody can
clear this up, please write with the details!
Who was D. B. Heiner?
See below what a search of the Full Text online archives
of HistoricPittsburgh has revealed about the
public record of D.
B. Heiner.
The original judgements against
the Mellons:
$202,502.22 + $187,787.17 =
$390,289.39
plus interest
March 28, 1918
See below the R. B. Mellon letter sent
to H. C. Frick. It makes one wonder exactly when the
partnerships began in earnest.
December 12, 1918
Frick and the Mellons formed two distinct partnerships and divided
"the entire capital stock" of each [Overholt]
distilling corporation into three one-third
interests.
January, 1919
All the assets of each corporation were
transferred (by them) to the two partnerships. Assets
included large [Overholt] whiskey inventories in
bonded warehouses.
Distillation ended after 1916;
Liquidation began in 1918.
In 1919 & 1920, sales were in the sale of
whiskey certificates and the storage, bottling, casing,
and sale of the stock of [Overholt] whiskey.
In 1925, the assets then remaining of
the partnerships were sold in bulk.
Frick died Dec. 1, 1919.
But the books were kept in the same manner by
the businesses from year to year -- 1918, 1919, 1920.
For 1920, the partnership returns of A. Overholt & Company and West
Overton Distilling Company
disclosed that substantial gains had been made from the
sale of whiskey, but the amounts were not reported as
income by either Mellon, as partnerships or as individuals.
Total of Deficiency Assessment:
$190,419.70 + $175,259.70 =
$365,679.40
The Revenue Act of
1918 governs taxation of 1920 income.
The Mellons claimed they were
not taxable on their shares of the 1920 profits.
One-third of the 1920 profits from each
concern was entered by each of the Mellons in
his individual tax return.
The Primary Question:
Were the 1920 net profits made by the
partnerships taxable income?
Profits made in the
business of liquidation are taxable in the same way and
to the same extent as if made in an expanding business.
Profits made through the operation of a
concern during a specific year are taxable in that same
specific year.
The Mellon claim was rejected.
It was immaterial that the profits of 1920 were
subsequently subject to a "heavy loss" taken in
later years.
Taxes on net profits must be paid
annually, despite the possiblity that losses of later
years may exceed the profits made in earlier years.
Partnerships must pay annual taxes
annually.
Conclusion:
Gains from the sale of whiskey in 1920 were
income.
The amount of the
income was determinable from the partnership books.
As surviving partners, the Mellons
were liable for income taxes on their distributive shares
of the net profits made in 1920.
The business of selling stock on hand
and deriving income therefrom remained unchanged, and was
engaged in for the same purpose, from one year to the
next.
Technical dissolution
does not affect the liability of a partner for taxes on
his distributive share of the partnership's income.
The profits from the
sale of whiskey in 1920 were current income of the
partnership for that year.
The Mellons claimed that after
Frick's death, they became "liquidating
trustees" and that any 1920 income came to them as
trustees, so any tax due was due from the trust, an
assessment barred by the statute of limitations.
The Mellons are not trustees within the
meaning of section 219. The fact that they may be so
denominated by the law of Pennsylvania, 59 P.S.Pa. 1 et
seq., is not conclusive.
Local law is not
controlling unless the federal statute 'by express
language or necessary implication, makes its own
operation dependent upon state law.'
'The state law creates
legal interests, but the federal statute determines when
and how they shall be taxed.'
Federal law
required that taxes be paid.
It did not require that the payments be made
from the partnership assets.
The Mellons contended that
under PA law, the "large profits" earned and
shared in 1920 were not distributable and could not be
deemed taxable income of the partners.
The word "distributive" is defined as meaning
"proportionate," not "currently
distributable under state law."
No claim is made that
the proportionate interests of the surviving partners was
improperly determined by the Commissioner.
The Mellons contend that in 1928 and 1929
the Commissioner determined that no profit was realized
until final liquidation of the partnerships in
1925, and that income taxes for that year have
been collected on this theory and not yet refunded.
None of these questions
has any bearing upon the determination of the case.
REVERSED.
|
