7 T.C. 125">*126 The Commissioner determined 1946 U.S. Tax Ct. LEXIS 152">*153 deficiencies in income tax against the following taxpayers in the amounts and for the periods indicated:

The issue is whether respondent erred by including in the taxable income of the surviving members of an accounting partnership that portion of the partnership income which was paid to the estates of deceased partners pursuant to the terms of the partnership agreement.

FINDINGS OF FACT.

The individual petitioners are members of a partnership engaged in the practice of public accounting in Connecticut. Frank E. Soule, who died July 6, 1943, and whose estate is petitioner in Docket Nos. 8631 and 8632, was a member of the firm which since 1927 has been known as Hadfield, Rothwell, Soule & Coates. Seth Hadfield, who died December 7, 1941, was also a member of the firm, as was Percy Rothwell, who died November 8, 1945, after these proceedings were commenced, 1946 U.S. Tax Ct. LEXIS 152">*154 and his estate is presently a petitioner in Docket No. 8617. All of the petitioners filed their income and victory tax returns on a cash basis. The partnership also filed its partnership return on a cash basis. All were filed with the collector of internal revenue at Hartford, Connecticut.

The then members of the partnership of Hadfield, Rothwell, Soule & Coates, including all the individual petitioners and the decedents whose estates are petitioners, entered into a partnership agreement as of January 1, 1936, which continued in effect through the tax year involved here. The pertinent provisions of this agreement are set out below:

* * * In the event of either the withdrawal or death of any co-partner, it shall not operate to dissolve the co-partnership. * * * The estate of a deceased partner shall continue as a member of the co-partnership for a period of five years as hereinafter provided, but such estate shall have no voice in the administration or management of the affairs of the co-partnership, except through the trustee, the Phoenix State Bank and Trust Company, and only to the extent provided in Paragraph 10 (b) hereof. * * * Nothing herein shall prevent the other co-partners1946 U.S. Tax Ct. LEXIS 152">*155 (that is, in the case of withdrawal or death of any one or more co-partners) from admitting one or more additional co-partners to the firm, provided that the participation percentage in net earnings of the estate of a deceased co-partner as hereinafter stated shall continue unaltered 7 T.C. 125">*127 until five years have elapsed from first of month after date of death as hereinafter provided. * * *

The net profits and/or net losses shall be determined at least annually, and oftener if mutually agreed to, * * *

From and after January 1, 1941 such profits and/or losses shall be divided among said parties in the following proportions:

* * * All losses that shall happen in said co-partnership business appearing upon settlement of accounts at the stated times, however caused, except by the gross negligence or wrong doing of one or more co-partners, shall be borne by said co-partners in the same proportion as the profits are divided1946 U.S. Tax Ct. LEXIS 152">*156 at the time of the loss.

* * * *

The said co-partnership shall once each year (or oftener if necessary, or if mutually agreed to) cause to be made and rendered to each co-partner a true, just and perfect inventory and account of all property, earnings, profits, expenses, losses and disbursements, and all other dealings by them made or incurred, and at the end of every calendar year the net profits and/or net losses shall be set out and credited or debited to each co-partner in the proportions aforesaid. The reference to net losses shall not apply to the estate of a deceased co-partner.

* * * each co-partner, except the estate of a deceased co-partner, may draw against his anticipated earnings such sums as may be reasonable, but which aggregate sums shall not exceed eighty-five (85) per cent. of his earnings as credited to him in the preceding year, and in no event shall such withdrawals exceed his interest in the business as shown on the books of the co-partnership.

The share of net earnings of the co-partnership to which the estate of a deceased co-partner is entitled shall be paid to the estate in equal quarterly installments based on eighty-five (85) per cent. of the estate's 1946 U.S. Tax Ct. LEXIS 152">*157 percentage of participation in earnings applied to the net earnings of the previous year. Adjustment to participation in actual earnings for any year shall be made as soon as determined upon closing the books but not later than the last day of February of such succeeding year. For the purpose of this paragraph, the payments to be made to the estate shall be based on calendar year quarterly periods, the first payment to cover to the end of the next calendar year quarter and the last payment in the five year period herein provided to be the date of such five year period end.

* * * *

In the case of death of any co-partner, the co-partnership shall not be terminated thereby, but shall continue as an existing co-partnership, among the surviving co-partners and the estate of the deceased co-partner, in the proportions of the respective interests of the surviving partners as specified in Paragraph 5 hereof increased to absorb the reduction in the deceased partner's proportionate interest at date of death to the lessened participation percentage of the estate of the deceased co-partner as hereinafter stated. The estate of a deceased co-partner shall participate in the net earnings but not1946 U.S. Tax Ct. LEXIS 152">*158 the net losses of the co-partnership 7 T.C. 125">*128 starting at the first day of month following the month of death and continuing for a period of five years in the following proportions:

In addition to the foregoing, the capital interest of a deceased co-partner shall be determined and settled as soon as possible but in not more than five years from date of death payable in equal quarterly installments without interest as follows, to wit:

(a) His capital interest in the co-partnership shall be determined from the books as shown by the next monthly closing date after his death. The value of the then work in process shall be increased to an amount which shall be twice the cost thereof as then stated on the co-partnership ledger. * * *

(b) For the purpose of effectuating more surely the performance of this agreement and for the protection of the estate of any co-partner who may die, the parties hereto make and constitute the Phoenix State Bank and 1946 U.S. Tax Ct. LEXIS 152">*159 Trust Company, a Connecticut corporation located in Hartford, to be trustee for the several parties and their respective estates to the extent and with the powers hereinafter enumerated, viz: In the event of the death of any co-partner then and thereafter until the co-partnership interest of the estate of the deceased co-partner has been paid in full as hereinbefore specified, the surviving co-partners will furnish every month to said trustee monthly balance sheets and profit and loss statements which together shall fully disclose the condition of the affairs of said co-partnership, each co-partner's interest (including the interest of the estate of the deceased co-partner) the amounts paid and unpaid under this agreement, and an analysis of the capital account of each co-partner. Said trustee is hereby given power to examine the books of the co-partnership and to investigate on its own account the condition of said co-partnership for the protection of the interest of the estate of the deceased co-partner. A reasonable charge of the Phoenix State Bank and Trust Company for its services as trustee hereunder, including any necessary expenses incurred, shall be a charge against the 1946 U.S. Tax Ct. LEXIS 152">*160 then existing co-partnership. Said trustee in its discretion shall have power to require an immediate liquidation of the co-partnership and an immediate settlement in full of the earnings and capital interest of the estate of the deceased co-partner (notwithstanding anything herein contained to the contrary) provided that said trustee shall not be satisfied in its own judgment that the letter and spirit of this agreement is being faithfully performed, and the interest of the estate of the deceased co-partner being or becoming impaired by the continuance of the business by the surviving co-partners; and said trustee is hereby authorized and empowered to enforce this agreement by any action at law or in equity including the right to apply as trustee for the appointment of a receiver to liquidate its affairs.

If the surviving co-partner shall not carry on the co-partnership business and fully perform this agreement as to the payments as herein provided during the period of five years after the death of the deceased co-partner, the earnings and capital interest of the estate of the deceased co-partner as above stated shall be paid in full out of the liquidation proceeds of the co-partnership1946 U.S. Tax Ct. LEXIS 152">*161 before any sums whatever shall be paid to the surviving co-partners on account of their interest in the co-partnership. For this purpose the balance of the earnings interest of the estate of the deceased co-partner, which remains unpaid of the five year 7 T.C. 125">*129 period shall be computed on the basis of the average annual net earnings of the two preceding calendar years.

At the termination of the five year period as aforesaid and the completion of all payments to the estate of a deceased co-partner, all interest of the estate of the deceased co-partner shall cease and terminate.

In consideration of the foregoing, the surviving co-partners shall have the right to continue the use of the name of the deceased co-partner in the style or title of the firm as the same was used therein immediately prior to his death.

The undrawn earnings of the deceased partners have been and are being paid to their respective estates in quarterly installments over a period of five years, as the agreement provides. No question is involved here with respect to these earnings.

Hadfield's estate has been regularly credited with 20 1/2 per cent of the partnership income earned after his death, in accordance1946 U.S. Tax Ct. LEXIS 152">*162 with the terms of the agreement, and Soule's estate has been credited with 12 per cent as therein provided. Both estates are treated on the partnership books as participants in the partnership earnings, in the same manner as the surviving partners.

The partnership has never sustained an annual net loss, and the agreement provides that any loss which might arise from the gross negligence or wrongdoing of a partner shall be charged to him. The parties to the partnership agreement did not consider it possible that a net loss would ever be suffered.

The partnership is a personal service organization, in which capital plays a negligible role. Each client of the firm dealt principally with the partner who handled his account, although it is the practice to have at least one other partner become well acquainted with the client. The firm employs an average of twenty to thirty staff accountants, and has an excellent reputation as an accounting firm. It has enjoyed increasingly substantial prosperity. Each partner's withdrawal or earnings during any year is limited to 85 per cent of his share of partnership income for the previous year. The balance is withdrawable after the close of 1946 U.S. Tax Ct. LEXIS 152">*163 the year. No partner has ever contributed any capital to the firm, the pool of undrawn earnings being available for use as capital. The office equipment owned by the partnership was carried as fully depreciated on its books, and its fair market value was nominal. At the time the partnership agreement was executed it was agreed that the value of the equipment was such that it should not be given any consideration in delineating the rights of the partners. The library consisted largely of tax services and similar publications which were renewable each year. The partnership held short term leases on its office space. It kept no records of any value to anyone else. The good will and trade name upon dissolution of the partnership had nominal value only.

7 T.C. 125">*130 Phoenix State Bank & Trust Co., designated in the partnership agreement as the agency through which the decedents' estates participated, to the extent authorized therein, in the affairs of the partnership, was also executor of the estates. It examined reports of the partnership to determine whether the agreement with respect to the deceased partners' estates was being complied with. It also discussed with the surviving1946 U.S. Tax Ct. LEXIS 152">*164 partners questions of partnership policy, including partnership investments and the admission of new partners. It treated the income which it received as trustee for the estates as income, not as corpus, and this treatment was accepted by the probate court having jurisdiction over the decedents' estates in approving its accountings.

OPINION.

The only question before us is whether the income of the partnership which is payable to the estates of deceased partners pursuant to the terms of the partnership agreement is taxable to the individual surviving partners.

Section 182 of the Internal Revenue Code provides that:

In computing the net income of each partner, he shall include, whether or not distribution is made to him * * *

(c) His distributive share of the ordinary net income * * * of the partnership * * *.

Respondent has included the shares of the partnership income payable to the estates of the deceased partners in the taxable income of the surviving partners, arguing that the estates were not partners and were not, therefore, entitled to participate in the partnership earnings; that the surviving partners earned the income by their personal service and are therefore taxable on1946 U.S. Tax Ct. LEXIS 152">*165 it; and that the payments of income after the death of the deceased partners constituted consideration for the purchase by the survivors of the decedents' shares in the partnership.

Petitioners argue that the estates were partners by the very terms of the partnership agreement and were entitled to participate directly in the earnings to the extent provided therein; that, although the services of the survivors produced the income, they were never at any time entitled to receive and retain it, since by the terms of the preexisting contract the estates became entitled to their share of it immediately upon its receipt; and, finally, that there was here no purchase and sale arrangement and none was intended, since the decedents had contributed no capital to the firm and in the contract under which the partners provided for the ultimate disposition of their partnership interests they recognized no valuable rights in the office equipment, which constituted the only physical asset of the partnership, or in any intangible assets.

7 T.C. 125">*131 It should be pointed out that none of the partners made a contribution to the capital of the partnership. The so-called capital account of each of the 1946 U.S. Tax Ct. LEXIS 152">*166 deceased partners consisted of his earnings undrawn to the date of death, plus his proportionate share of the value of the work then in progress. The amount of the payments to be made to the estates of deceased partners on account thereof, and the method of payment, were fixed by the partnership agreement. There is no dispute here as to the taxability of these payments of the so-called capital accounts. The dispute concerns only the taxability of the payments made to the estates of the deceased partners from the income earned during the five years after their deaths.

If this income constituted the distributive share of the net income of the partnership belonging to the surviving partners and paid by them to the estates of the deceased partners as consideration for the acquisition of that part of the assets of partnership owned by the deceased partners at the time of their deaths, then the whole of the net partnership income is taxable to the surviving partners. If, on the other hand, the income in question is owned when earned by the surviving partners and the estates of the deceased partners in the proportions set out in the partnership agreement, it is taxable to all of them 1946 U.S. Tax Ct. LEXIS 152">*167 in those proportions.

Much has been said by the parties on brief about the exact status which the estates occupied in the partnership after the death of their respective decedents -- whether they were or were not partners, either general or limited, under state law or the definition of the Internal Revenue Code. The discussion seems to us to be inconclusive of the question before us. That question is whether, under the contract involved, they are entitled to receive the income of the partnership apportioned to them, not as the proceeds of a sale or liquidation, but as income, so as to be taxable on it. If they are so entitled to the income, it does not matter whether in law they are general or limited partners. It is sufficient that they have the contractual right quoad the surviving partners to share in the partnership income as if they were partners.

Partnership agreements of the same general class as the one now before us are not unusual, and their tax effects have been considered in a number of cases, always in the light of the particular agreement involved.

Perhaps the leading case in the field is Bull v. United States, 295 U.S. 247">295 U.S. 247, 1946 U.S. Tax Ct. LEXIS 152">*168 in which there was a partnership agreement which provided that in the event a partner died the survivors should continue the business for one year thereafter and his estate should "receive the same interests, or participate in the losses to the same extent" as the deceased partner would, if living. The enterprise required no capital, and none was contributed by the partners. The Court held the payments 7 T.C. 125">*132 of partnership income earned after the death of the deceased partner were income to the estate. On the question whether the payments of income earned after the death of the partner were consideration for the purchase by the survivors of the decedent's interest in the partnership, the Court said:

* * * Where the effect of the contract is that the deceased partner's estate shall leave his interest in the business and the surviving partners shall acquire it by payments to the estate, the transaction is a sale, and payments made to the estate are for the account of the survivors. It results that the surviving partners are taxable upon firm profits and the estate is not. Here, however, the survivors have purchased nothing belonging to the decedent, who had made no investment1946 U.S. Tax Ct. LEXIS 152">*169 in the business and owned no tangible property connected with it. The portion of the profits paid his estate was therefore income and not corpus; and this is so whether we consider the executor a member of the old firm for the remainder of the year, or hold that the estate became a partner in a new association formed upon the decedent's demise.

* * * *

Since the firm was a personal service concern and no tangible property was involved in its transactions, if it had not been for the terms of the agreement, no accounting would have ever been made upon Bull's death for anything other than his share of profits accrued to the date of his death * * * and this would have been the only amount to be included in his estate in connection with his membership in the firm. * * *

In Gussie K. Barth, 35 B. T. A. 546, the petitioner was the widow of a lawyer who had been a member of a law partnership prior to his death, under a partnership agreement which provided that the partnership should not be immediately dissolved upon the death of a partner, but his interest therein should be determined by payment to his widow or estate over a period of three years of certain1946 U.S. Tax Ct. LEXIS 152">*170 stipulated percentages of the profits to which the deceased partner would have been entitled if he were living. It also provided for continued individual ownership of capital assets. The surviving partner continued the practice of law, under the old firm name, and made the payments provided for in the agreement. Taxpayer reported these amounts as income and later claimed overpayment on the ground that the payments were capital items, received by her as consideration for the sale of her husband's interest in the firm pursuant to his contract with his surviving partner. We held the amounts received by the taxpayer did not represent capital payments, but that they were properly treated as income. There was, in that case, no attempt to hold the surviving partner liable for tax on the entire partnership income. The more recent case of Richard P. Hallowell, 2nd, 39 B. T. A. 50, involved a partnership engaged in marketing wool. Capital was essential to the business, and each partner made substantial contributions.

The partnership agreement provided that in the event of the death of a partner the partnership should terminate after six months, or 7 T.C. 125">*133 1946 U.S. Tax Ct. LEXIS 152">*171 earlier by notice of a majority of survivors, but that all of the survivors might elect to continue the partnership as to themselves until the end of the period prescribed for the life of the partnership in the articles, or until the interest of the deceased partner terminated, whichever was longer. It was provided that during the continued existence of the partnership the estate of the deceased partner should continue to have the same interest in the profits and be responsible for the same share of losses as the deceased partner would have had or borne, had he lived, but that the estate should have no voice in the management of the business. The agreement further provided for the method of determination and settlement of the capital interests of the partners. The controversy involved the Commissioner's treatment of all partnership profits after the partner's death as income of the surviving partners. We felt it was unnecessary to decide whether the estate was or was not a partner during the period in question, since, in any event, it was clear that the estate had a direct right, by virtue of the partnership agreements, to a share of the partnership income, as such.

The facts 1946 U.S. Tax Ct. LEXIS 152">*172 before us are not decisively different from those involved in the cited cases. In each case it was felt that whether there was a sale or not depended largely on the intention of the parties, as expressed in the particular contract involved.

The agreement in the instant case provided for the use of undrawn earnings of the partners as the capital of the firm, each partner to be credited on the books with the amount left by him in the business. This is the only "capital" account the members of the firm had. The office equipment was fully depreciated, the library consisted largely of material renewed each year, and the leases were for short terms. All of these assets were of only nominal value and were not even considered by the partners in the negotiations leading to the execution of the partnership agreement. This agreement provided further for liquidation of the "capital" account by payment to the estate of a deceased partner after his death of this "capital" interest in the firm, computed as therein authorized. These payments have been or are being made, and are not the subject of this dispute. It was not the intention of the parties that any interest of a deceased partner be1946 U.S. Tax Ct. LEXIS 152">*173 left in the firm, and none has been or will be left in the firm after the expiration of the time allowed for the orderly liquidation of the capital accounts. Having provided for the return to the estates of any valuable capital interest the decedent had in the firm, it is difficult to find any evidence of an intention to sell that interest to the surviving members. Certainly, no language of bargain and sale is used in the agreement. Although respondent feels that the deceased partners had a valuable interest in the good will and partnership name, it is apparent from the entire record that the parties to the agreement 7 T.C. 125">*134 placed no value upon these items. Ordinarily no value, or nominal value, will be given to good will attaching to a personal service partnership such as one composed of physicians, attorneys, or accountants. See 38 C. J. S., p. 952; Rowley, Modern Law of Partnership, sec. 331. See also D. K. MacDonald, 3 T.C. 720. There is no evidence in the instant case which would justify a conclusion that the parties to the partnership agreement involved herein intended to make a sale of good will, upon dissolution of the partnership by1946 U.S. Tax Ct. LEXIS 152">*174 death, in return for payments to the deceased partner's estate out of income earned after his death. Since the instrument in question does not purport to make a sale of good will upon liquidation, and since, according to general standards of value, the good will of this particular partnership would not be sufficiently valuable to be the subject matter of, or consideration for, a sale, we de not feel justified in assuming or reading into the agreement language from which we could spell out an intention to make a sale upon dissolution.

In addition to the provisions for the return of the "capital interests" to the estates are the provisions with which we are here concerned for participation by the estate of a deceased partner in the earnings of the partnership for five years after the partner's death. These payments have no relation to the other type of payments provided for the liquidation of the capital account. They provide simply that the estate of any deceased partner shall participate to the extent there provided in the net earnings of the partnership for a period of five years. The evidence establishes that this provision was intended by the parties not to be the consideration1946 U.S. Tax Ct. LEXIS 152">*175 paid by the surviving partners for the capital interest of a deceased partner upon the dissolution and liquidation of the partnership, but was intended to be a present consideration given by each partner upon the formation of the partnership. It was intended to be in the nature of a mutual insurance plan, the disadvantage of which each partner was willing to accept in consideration of a similar commitment for his benefit on the part of all other partners, and, in part, as further compensation for the past services of the deceased partner payable after his death.

These payments were not made in liquidation of any capital interest of the deceased partner in the firm's assets. The only payments of this nature required upon the death of a partner were the payments on account of past earnings and work in process, here designated as the "capital account." In addition to these payments, the estate of a deceased partner was entitled to the payment of a share of post death earnings, not in consideration of a sale of partnership assets on liquidation, but in consideration of mutual promises contained in the original partnership agreement having no relationship to such a sale. These payments1946 U.S. Tax Ct. LEXIS 152">*176 arose out of and depended upon the contract and their character must be determined by its terms. The estate acquired, 7 T.C. 125">*135 upon the death of the partner, a vested contractual right to a share of the earnings, as earnings, and this right was fortified by a power lodged in the trustee to require a liquidation of the business if its rights were not fully respected by the surviving partners. When and as the income was earned, it became immediately subject to the preexisting rights of the estates to their share of it. The amounts so distributable to the estates were not distributable to any surviving partner, with the result that here, as in Richard P. Hallowell, 2nd, supra, the disputed amount attributed by the respondent to each surviving partner may not be regarded as "his distributive share, whether distributed or not, of the net income of the partnership."

The case upon which respondent chiefly relies and which has been decided since 295 U.S. 247">Bull v. United States, supra, is Estate of George R. Nutter, 46 B. T. A. 35; affirmed sub nom. McClennen v. Commissioner, 131 Fed. (2d) 165.1946 U.S. Tax Ct. LEXIS 152">*177 Its facts are clearly distinguishable. In that case there was an "investment of capital in, and tangible property owned by, the partnership"; there was a clear recognition that each partner had a valuable capital interest in the partnership assets; and the effect and intent of the contract was clearly to make a sale of such an interest to the surviving partners. It is precisely because there is no such intent to make a sale of a capital asset in the instant case that we are impelled to a contrary conclusion.

We are of the opinion that the respondent erred in including in the income of the surviving partners those portions of the income distributable under the terms of the partnership agreement to the estates of the deceased partners.

Decision will be entered for the petitioners.