The respondent determined deficiencies in income tax for the year 1941 against Leonard W. Greenberg and William Arenson in the respective amounts of $19,533.53 and $19,608.71. The only issue in controversy is whether the income of two businesses carried on in partnership is taxable one-half to each of the petitioners, or one-fourth each to the petitioners and their respective wives.
...Toledo Machinery Exchange Co., hereinafter called Exchange, was organized as a corporation in 1922 for the purpose of engaging in the business of buying and selling new and used machinery. Petitioner Arenson was one of the original stockholders. In 1924 he was employed as manager of the corporation. In 1937 the corporation was dissolved and a certificate of dissolution was issued.
Immediately prior to its dissolution the stockholders of the corporation were Ruth V. Arenson, wife of petitioner Arenson, owning about 195 shares; Sylvia Greenberg, wife of petitioner Greenberg, owning about 5 shares; and Arenson, owning 1 share. Mrs. Arenson was president of the corporation and a director; Mrs. Greenberg secretary; and Arenson was vice president and a director.
Upon the dissolution of the corporation all its assets were distributed to Arenson, who operated Exchange as a sole proprietorship from that time until January 1, 1941, receiving all the net profits arising from its operation.
Petitioner Greenberg is a younger brother of Mrs. Arenson. In 1926 he went to Toledo and became an employee of Exchange. After spending a year familiarizing himself with the business, he became a traveling salesman for the company, buying and selling machinery. He worked as an employee until January 1, 1941. During that time he was paid a salary and commission He did not share in the profits of Exchange.
Some time after Greenberg entered the employ of Exchange he and Arenson discussed the advisability of manufacturing machine tool equipment and marketing it at a price that would be attractive to dealers. Eventually, one of the customers of Exchange, who was unable to meet his obligations for machines purchased, agreed to start manufacturing machine tools for the petitioners in order to pay for his equipment out of profits. Thereafter the petitioners organized L. W. Chuck Co., hereinafter called Chuck, for the purpose of manufacturing these items. Chuck was organized under an oral partnership agreement, providing for an equal distribution of profits between the petitioners.
The operations of Exchange and Chuck were closely interrelated. They occupied the same office space and used the same telephone service. The same personnel was used for both companies. No separate accountings have been kept of funds furnished by each company in the management and operation of the common office. Arenson attended to the financial affairs of both companies.
It was considered essential to maintain separate identities of the two companies, since dealers or competitors in the used machinery business would not purchase the products of Chuck if they knew there was a connection between the two companies.
In 1940 Greenberg was doing practically all the buying and selling of machinery for Exchange. He produced almost all of the machinery business for that company and was also devoting some time to Chuck. Arenson at that time devoted most of his attention to the latter company. Greenberg felt that the salary and commission he received from Exchange were insufficient compared with his efforts on behalf of that company and he told Arenson that he wanted an interest in Exchange.
Arenson agreed that Greenberg was entitled to an interest in the company. However, he stated that he desired his wife also to acquire an interest in the business and proposed the formation of a partnership consisting of himself, his wife, and Greenberg, each owning a one-third interest in Exchange. Greenberg expressed his dissatisfaction with this proposed arrangement, since he felt that he should have more than a one-third interest in the business. Accordingly, a compromise arrangement was arrived at, whereby it was agreed that the petitioners and the respective wives should all become partners, each owning a one-fourth interest in Exchange.
Because of the interrelation in the operations of the two companies, it was decided at the same time that Mrs. Arenson and Mrs. Greenberg should also be allowed to acquire a one-fourth interest each in Chuck.
In accordance with this agreement, on January 27, 1941, the petitioners and their respective wives executed with respect to Exchange, a writing styled "Articles of Partnership," providing in pertinent part as follows:
This AGREEMENT OF PARTNERSHIP made this twenty-seventh day of January, 1941, as of January first, 1941, at Toledo, Ohio, between WILLIAM ARENSON, first party; RUTH ARENSON, second party; L. W. GREENBERG, third party; and SYLVIA GREENBERG, fourth party, witnesseth:
THAT WHEREAS first party has heretofore been the sole proprietor of a certain business known as Toledo Machinery Exchange Co., the net worth of which business, as of the date hereof, it is stipulated and agreed by and between the parties hereto, is the sum of $26,126.13; and
WHEREAS, the parties above named intend by this agreement to form a partnership to carry on said business jointly for the purposes hereinafter stated;
NOW, THEREFORE, in consideration of the premises, the promises and agreements hereinafter stated, and of one dollar to each in hand paid by each other, receipt of which is hereby acknowledged, it is hereby mutually agreed by and among the parties hereto as follows:
ARTICLE I. The second party, third party, and fourth party shall severally, and contemporaneously with the execution hereof, execute and deliver to first party their respective promissory notes, each in the sum of $6,531.53, payable at the time and in the manner therein specified, in payment for their respective partnership interests as set forth in this agreement.
ARTICLE II. The partnership shall be for the carrying on of the business of buying, selling, and dealing in new and used machinery, equipment, and similar products.
ARTICLE III. This partnership shall begin as of the first day of January, 1941, and shall continue until terminated in accordance with the provisions hereinafter set forth...
...The "Articles of Partnership" pertaining to Chuck were in most part identical to those relating to Exchange. It was stated therein that the petitioners had been conducting Chuck as a copartnership; that they had agreed to admit their respective wives in the partnership with them; and that, in consideration of the sum of $6,922.95 (one-fourth of the stated value of the business) paid by each wife to her respective husband, the parties agreed to become copartners in the conduct of the business. ...
From 1926, shortly after her marriage, to 1929 Mrs. Arenson frequently accompanied her husband on trips about the country when he was engaged in buying second-hand machinery, going with him into different shops that had machinery for sale. Through this experience she gradually learned something about the business. Both before and after the execution of the partnership agreements Mrs. Arenson occasionally looked after the office, answering the telephone, waiting on customers, and sometimes making sales. In the years prior to 1941 she received no compensation for these services.
Mrs. Greenberg is a housewife. She knew little about the business. Occasionally she would tend the office when both of the petitioners were out of town. ...
Arenson had great confidence in his wife's judgment. One of the reasons he wanted her in the business was that Greenberg had involved Exchange in some deals which that company was unable to handle and Arenson thought his wife could exercise a restraining influence over Greenberg, since she was his older sister.