Respondent Brief in Opposition — International Ass'n of Machinists v. Central Airlines, Inc.

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INDEX

Opinions below__________- ite beet aha see gk

Jurisdiction. __._.- Os FEDER ee ae eas

Question presented ___- , ete eam

Statutes and regulations involv ed... Pe cane eee

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CITATIONS

Cases:

Berry v. United States, 267 ef Sn

Hulbert v. Commissioner, 227 F. 2d 399_____-

Leff v. Commissioner, 235 F. 2d 439___.____-

Meyer v. United States, 213 F. 2d 278_______-

Suwirin v. Commissioner, 183 F. 2d 656, cer-

tiorari denied, 340 U.S. 912-__-. Aas Sab ema

Tunnell v. United States, 259 F. 2d 916_____-

United States v. Donoho, 275 F. 2d 489__ ~~ _-

United States v. Shapiro, 178 F. 2d 459... _-

United States v. Snow, 223 F. 2d 103, cer-

tiorari denied, 350 U.S. 831_......---..--

Watson v. Commissioner, 345 U.S. 544______-

Statutes:

Internal Revenue Code of 1939 (26 U.S.C.

1952 ed.):

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Internal Revenue Code of 1954 (26 U.S.C.):

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Sec. 1221. _- Laie Aa Son od nid To wi ati ee a hs Se a

628365—62 , @

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Miscellaneous:

H. Rep. No. 1337, 83d Cong., 2d Sess., pp. 65,

70-72 (3 U.S.C. Cong. & Adm. News (1954)

4017, 4091, 4096-4099) _..._.._.________.

Treasury Regulations 118:

Sec. 39.113(a)(13)-2...................

PE ans an wkdau na iweewdbaws ce

Ou the Supreme Court of the Hnited States

OcTOBER TERM, 1961

No. 602 4

LENORA SHERLUCK, INDIVIDUALLY AND AS EXECUTRIX

OF THE EstaTE OF CHRIS J. SHERLOCK, DECEASED,

PETITIONER

es

CoMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW .

The opinion of the Tax Court (R. 21-32) is re-

ported at 34 T.C. 522. The majority and dissenting

opinions of the court of appeals (Pet. Ex. A, pp.

1-11) are reported at 294 F. 2d 863.

JURISDICTION

The judgment of the court of appeals was entered

on September 27, 1961 (Pet. Ex. A, p. 12). Taxpay-

er's petition for rehearing was denied on October 30,

1961 (Pet. Ex. B). The petition for a writ of certio-

rari was filed on December 11, 1961. The jurisdic-

tior. of this Court is invoked under 28 U.S.C. 1254(1).

fl)

2

QUESTION PRESENTED

Whether the two courts below properly decided

that, where taxpayet’ had sold his interest in a paft-

nership for a lump sum, the amount of taxpayer’s

share of the undistributed profits of the partnership,

which profits had accrued prior to the effective date

of the sale, was taxable to him as ordinary income.

STATUTES AND REGULATIONS INVOLVED

The pertinent statutes and regulations involved are

set forth in the Appendix, tnfra.

STATEMENT .

On June 1, 1951, taxpayef and two others organized

a partnership which performed engineering and archi-

tectural services. The partnership agreement pro-

vided that the profits and losses should be borne

equally, that any partner could withdraw from the

firm upon prescribed notice, and that, in the event of

such a withdrawal, the remaihing partners would have

afi option to discontinue the business or to purchase

the interest of the withdrawing partner. The part-

nership kept its books and records on the basis of a

fiscal year ending April 30, ahd on the accrual method

of accounting. (R. 23; Pet. Ex. A, p. 2.)

On February 26, 1954, taxpayer executed a bill of

sale to his partners conveying to them his ote-third

interest in the partnership for $70,000 (R. 23-24;

* Lenora Sherlock is a party to this action as executrix aad

individually as a co-signet of a joint return. Consequently, as

used in this brief, the term “taxpayer” refers to Chris J.

Sherlock.

3

Pet. Ex. A, p. 2). The bill of sale stated (R. 24; Pet.

Ex. A, pp. 2-3):

3. The books of the firm will be closed as of

February 28, 1954, and seller withdraws as

member of the firm and buyers will prepare,

as soon as possible thereafter, returns of the

income reflecting the profit and loss of the part-

nership for the peried beginning June 1, 1953,

and ending February 28, 1954. The profit

between Chris J. Sherlock, Moreland Smith

and Riehard Adams; said returns shall be filed

with the respective Governments and each of

the parties will report their respective income

from the partnership as shown by such returns.

It is agreed that the profit and loss shown by

such partnership to be the profit and loss of

Sherlock has been received by him either

through previous withdrawals or in the pur-

chase price paid or to be paid by buvers.

Pursuant to provision 3 of the bill of sale, the

partnership closed its books of account on February

28, 1954, and filed a return for the period May 1, 1953,

to February 28, 1954. The return reported that the

partnership income for the period was $249,827.38,

that taxpayer's share of the ineome was %X3,275.79,

that the amount of his capital account in the partner-

ship at the beginning of the period was a deficit bal-

ance of $9,641.59 (reflecting overdrafts), and that at

the end of the period he had a credit balance of

$49,303.80. (R. 24-25: Pet. Ex. A, p. 3.)

On the joint return filed by taxpayer and his wife

for 1954, taxpayer reported the entire amount of the

$70,000 paid te him for his partnership interest as a

long-term capital gain computed with a zero basis,

4

but failed to report any amount of his distributive

share of the partnership income for the period May 1,

1953, to February 28, 1954, as ordinary income. (R.

25; Pet. Ex. A, p. 3.) The Commissioner, in his

notice of deficiency, determined that taxpayer should

have included as ordinary income $83,275.78—his

distributive share of the reported partnership profits

for that period. The Commissioner also determined

that the balance of taxpayer’s capital account at

the end of the period (v1z., $49,303.80) constituted

taxpayer’s basis in his partnership interest and should

have been deducted from the $70,000 received by him

for the sale of that interest, thereby reducing the

amount of his reported capital gains (R. 14-17).

Subsequently, at the hearing, the parties stipulated

that the correct amount of the partnership's income

for the period May 1, 1953, to February 28, 1954,

was $147,827.38; that taxpayer withdrew $14,233.95

during that period; and that his capital account at the

beginning of the period had been overdrawn in the

amount of $9,641.59 (R. 25-26; Pet. Ex A, pp. 3-4).

Since the amount of taxpayer's deficiency had been

computed on the basis of the income originally re-

ported by the partnership, taxpayer's liability had to

be recomputed (R. 27-28).

The Tax Court sustained the Commissioner's deter-

mination after making due allowance for the smaller

partnership income stipulated by the parties (R. 21-

32). Accordingly, the court included in taxpayer’s

ordinary gross income $49,275.79—the amount of tax-

payer’s distributive share of the partnership's profits

5

for the period in question, computed on the basis of

the stipulated amount of partnership profit (R. 29).

This resulted in a deficiency for the year 1954 of

$19,372.54 (R. 33). The court of appeals affirmed

(Pet. Ex. A, p. 9).

ARGUMENT

The decisions uf the two courts below are correct;

there is no existing conflict; and the issue here in-

volved is of no future importance. Further review

is unwarranted. |

1. The effective date of the termination of tax-

payer's interest in the partnership was February 28,

1954. Taxpayer was therefore entitled to share in

the partnership’s profits until that date. (R. 24.) —

The parties stipulated that the ordinary income for

the partnership for the fiscal year beginning May 1,

1953, and ending February 28, 1954,° was $147,827.38

(R. 34). Taxpayer was entitled to receive one-third

of that amount—#49,275.79 CR. 23, 28).

Section 182 of the Internal Revenue Code of 1939,

App., infra, provides that a partner must_ in-

clude in the computation of his gross income his

cictributive share of the ordinary et income of the

?The court also imposed penalties totalling $1,513.16 for the

substantial underestimation of estimated tax and for failure to

make timely payment of the amount of tax that was estimated.

Taxpayer does not contest the imposition of those penalties in

his petition.

* Because of taxpayers retirement, the partnership filed a

short-year return (R. 24-25). The income reflected accounts

receivable entered on the partnership's books, which amounts

had accrued to the partnership (which reported its income on

the accrual basis) (R. 23).

6

partnership “whether or not distribution is made to

him.”’ See Treasury Regulations 118, Sec. 39.182-1,

App., infra. Consequently, taxpayer was charged with

his share of the partnership’s profits up to the date of

his withdrawal ($49,275.79), and he could not escape

the tax liability that he had already incurred merely

by selling his partnership interest. See Treasury

Regulations 118, Sec. 39.113(a)(13)-2, App. infra;

Watson v. Commissioner, 345 U.S. 544; United States

v. Snow, 223 F. 2d 103 (C.A. 9th), certivrari denied,

350 U.S. 831; Tunnell v. United States, 259 F. 2d 916

(C.A. 3d); Leff v. Commissioner, 235 F. 2d 439 (C.A.

2d).

2. Contrary to taxpayer’s contention (Pet. 4-5),

there is no conflict among the courts of appeals on

the question here involved. Taxpayer attempts to

characterize the question as whether a lump sum pay-

ment received in consideration for the sale of a partner-

ship interest must be treated as gain from the sale of a

capital asset or whether such amounts of that sum

which are attributable to the assignment of future in-

come of the partnership may be treated as ordinary in-

come. But that is not the issue in this case; the Cu.n-

missioner has never disputed that the sale by taxpayer

of his partnership interest (exclusive of his distributive

share of the partnership income) was a sale of a capi-

tal asset (R. 30-31, 45-46). The Commissioner’s con-

tention, which was sustained by the courts below, is

that the taxpayer’s distributive share of the partner-

ship income for the taxable period May 1, 1953, to

February 28, 1954, was includible in his income for

7

that year under Section 182 of the 1039 Cede, and

the subsequent sale of his interest did aot relieve him

of that liability. See eg. United States v. Snow,

supra; Watedn v. Commissioner, supra. Conse-

quently, with the exception of Meyer v. United States,

213 ¥. 2d 278 (C.A. 7th), the cases cited by taxpayer

(Pet. 4) are inapposite.’ The Meyer case, in turn, is

inconsistent with, and was therefore implicitly over-

ruled by the more recent decision of the Seventh Cireuit

in Hulbert v. Commissioner, 227 F. 2d 399.°

3. In any event, the question here involved is of no

continuing importahce since it has been definitively re-

‘None of the other cases cited by taxpayer involved « situa-

tion where the income had been accrued by the partnership

prior to the sale and was, therefore, distributable to the ere

For example, i tn Siirfn vy. Commissioner, 183 F. 2d 656 (C.A

7th), cettioraHi deed, 840 U.S. 912, and United States v.

Donoho, 2% ¥. 2d 480 (C.A. 6th), the partnerships reported

on the cash basis. The contention of the government in those

cases was that part of the selling price of the partnership in-

terest represénted an assignment of future income which was

already earned.

Similarly in Berry v. United States, 67 ¥. BA 298 (C.A.

6th), the partnership reported on the completed contract basis,

and the sale was made before the contract was completed. In-

deed, the court distinguished the Snow, Leff and Tunnel cases

on that ground (267 F. 2d at 301).

United States v. Shapiro, 178 F. 2d 459 (C.A. 8th), in-

volved the question whether the part of the selling price

of « partnership interest which was attributable to the sale of

noncapital assets should be treated as ordinary income.

Although part of the selling price also reflected accumulated

profits of the business, that amount was not involved in the

litigation. ,

*See the dissenting opinion of Judge Lindley in Hulbert

(227 F. 2d at 402) in which he states that the majority deci-

sion is irreconcilable with the Meyer case.

solved by Section 751 of the Internal Revenue Code

of 1954, which provides that the amount of the selling

price of a partnership interest that is attributable to

either (1) unrealized receivables of the partnership

or (2) inventory items which have appreciated sub-

. Stantially in value is treated as ordinary income.

See also Section 1221(4) of the 1954 Code; H. Rep.

No: 1337, 83d Cong., 2d Sess., pp. 65, 70-72 (3 U.S.C.

Cong. & Adm. News (1954) 4017, 4091, 4096-4099).

CONCLUSION

For the foregoing reasons, it is respectfully sub-

mitted that the petition for a writ of certiorari should

be denied.

ARCHIBALD Cox,

Solicitor General.

Louis F. OBERDORFER,

Assi vs Attorney General.

Harry Baum,

Dovucias A. Kaun,

Attorneys.

FEBRUARY 1962.

APPENDIX

Internal Revenue Code of 1939 (26 U.S.C. 1952 ed.)

Sec. 181. Partnersuip Nor TAXABLE.

Individuals carrying on: business in partner-

ship shall be liable for income tax only in their

_ individual capacity. ;

Spc. 182. Tax oF PARTNERS.

In computing the net invome of each partner,

he shall inelude, whether dr not distribution is

made to him— ;

* ue * 4 * 7

(e) His distributive share of the ordinary net

income ot the ordinary nét;loss of the partner-

ship, computed as provided in section 183(b).

Src. 183. ComPUTATION OF PARTNERSHIP INCOME.

(a) [as amended by Sectiva 9(c)(1) of the

Individual Ineome Tax Act of 1944, c. 210, 58

Stat. 231] General Rule—Thbe net income of

the partnership shall be coznputed in the same

manner afd on the same basis as in the case of

an individual, except as provided in subsections

(b), (e), and (4).

See. 1987. PAktNensnre Rervurns.

Every pattnérship shall make a return for

each taxable year, stating spetifically the items

of its gross income and the de ‘uetions allowed

by this ree ge and snch a Siete tos

e purpose.of catrying the provisions 0

this chanted as ‘te Oontisientonet with the ap-

proval of the Reeteatiy salt by regulations pre-

scribe, and shall includé itt the teturn the names

and addresses of the indifiduals who would be

entitled to share in the net income if distributed

and the amount of the distributive share of each

(9)

10

individual. The return shall be sworn to by

any one of the partners.

Treasury Regulations 118:

See. .39.113(a) (13)-2. Readjustment of part-

nership interests —(a) When a partner retires

from a partnership, or the partnership is dis-

solved, the partner realizes a gain or loss meas-

ured ‘by the difference between the price

received for his interest and the sum of the

adjusted cost or other basis to him of his in-

terest in the partnership plus the amount of his

share in any undistributed partnership net in-

come earned since he became a partner on

which the income tax has been paid. * * *

* _ * * *

Sec. 39.182-1. Distributive shares of part-

ners.—(a) Each partner is required to include

in his return for his taxable year within whieh

or with which the taxable year of the partner-

ship ends, whether or not distributed :

(1) As part of his gains and losses from

sales or exchanges of capital assets held for

not more than six months, his distributive

share of the gains and losses of the part-

nership from sales or exchanges of capital

assets held for not more than six months.

(2) As part cf his gains and losses from

sales or exchanges of capital assets held for

more than six months, his distributive share

of the gains and losses of the partnership

from sales or exchanges of capital assets

held for more than six months.

(3) His distributive share of the ordi-

nary net income or the ordinary net loss of

the partnership, computed as provided in

section 183(b).

2 * * * *

6.8. COVERRWERT PRINTING OFFICE: (ee