(2) In the Event of Withdrawal

In the event a member voluntarily withdraws from the firm at any time and remains in the active practice of law after such withdrawal his interest in the income of the firm shall cease effective as of the end of the month during which he withdraws, but in the event of withdrawal under any other circumstances (irrespective of how such withdrawal shall occur) he shall be entitled to receive from the firm, in lieu of any interest which he otherwise might have in uncollected income of the firm, the same distributions as his estate would have been entitled to receive in the event he had died instead of withdrawn, to be computed and paid on exactly the same basis as provided in subparagraph (1) next above.

During the period from 1921 through 1945, Baker-Botts purchased furniture, equipment, etc. which it capitalized. During this period Baker-Botts' annual depreciation was taken on these assets. On December 31, 1945, petitioner's "share" in the assets purchased from 1921 through 1945, minus the depreciation deducted1951 U.S. Tax Ct. LEXIS 128">*137 during these years, was $ 3,058.93. During the same period Baker-Botts made certain donations, some of which petitioners claim were "non-deductible donations" and on December 31, 1945, petitioner's "share" of these nondeductible donations for the entire period was $ 3,479.24.

Since 1930, it was the policy of the Baker-Botts firm that no son or immediate relative of a partner would be employed by the firm out of law school. Because petitioner desired to practice law with his three sons he withdrew from the firm and entered into the practice of law 17 T.C. 14">*18 with two of his sons and his first cousin. Since that time petitioner's third son has joined him in the practice of law.

Petitioner received nothing for his share of fees which were earned and uncollected or for his interest in the assets of the firm. Petitioner's withdrawal on December 31, 1945, from the firm of Baker-Botts resulted in a loss of $ 25,558.93 incurred in his trade or business and which loss did not represent the sale or exchange of a capital asset.

Any part of the facts stipulated not included herein are incorporated by this reference.

OPINION.

The issue in these proceedings may be stated as follows: When petitioner1951 U.S. Tax Ct. LEXIS 128">*138 Palmer Hutcheson withdrew from a law partnership and pursuant to the partnership agreement he received no compensation for his partnership interest, did petitioner sustain a loss (and if so to what extent) within the meaning of either subsections (e) or (g) of section 23 of the Internal Revenue Code. ¹

The parties have agreed that all of the relevant facts in Gaius G. Gannon, supra, may be considered facts in this case. In Gaius G. Gannon, petitioners therein claimed as loss in 19441951 U.S. Tax Ct. LEXIS 128">*139 $ 10,770.42 which Gannon had invested in Baker-Botts to acquire a 6.2 unit (6.2 per cent) interest in the firm. In that case, as in the instant proceedings where petitioner herein paid $ 22,500 for his 7.5 unit (7.5 per cent) interest in the firm, the entire amount of Gannon's investment reverted to Baker-Botts in accordance with the partnership agreement when Gannon withdrew from the firm and continued in the active practice of law. Neither petitioner herein nor Gannon received anything in return for his investment. In Gaius G. Gannon, supra, we held that the loss sustained was a loss incurred in his trade or business and the loss did not represent the sale or exchange of a capital asset. On the authority of Gaius G. Gannon we hold that respondent erred in disallowing the loss of $ 22,500 claimed by petitioners in their tax returns for the year 1945.

An additional problem is raised in these proceedings which was not raised in Gaius G. Gannon, supra. In their petitions the petitioners 17 T.C. 14">*19 claim as a loss, in addition to the $ 22,500 which represented the sum that petitioner had paid for his 7.5 units in the Baker-Botts firm, a deductible community loss of $ 18,7501951 U.S. Tax Ct. LEXIS 128">*140 forfeited by petitioner Palmer Hutcheson at the time of his withdrawal as a liquidated amount to which he alleges he would have been otherwise entitled in lieu of earned and uncollected fees. By amended petitions petitioners also claim as a loss (a) petitioner's share of Baker-Botts' investment in furniture, equipment, etc., less depreciation from 1921 through 1945, or $ 3,058.93; and (b) petitioner's share of the "nondeductible donations" made by Baker-Botts from 1921 through 1945, or $ 3,479.24.

The $ 18,750 claimed by petitioners as a loss represents an amount which petitioner alleges he would have received in lieu of earned but uncollected fees if petitioner had retired from the practice of law or if petitioner's death occurred while he was a member of the firm. See Article VII B (2) of the partnership agreement incorporated in our findings of fact. This amount was never reported as income, and petitioners show no other way of having obtained a basis for this claimed loss. Sections 111 and 113, Internal Revenue Code. To allow petitioners this amount as a loss would be akin to allowing a deduction for a bad debt arising from unpaid wages, salaries, rents, and other similar1951 U.S. Tax Ct. LEXIS 128">*141 items of taxable income which were never reported as income by the taxpayer. Regulations 111, section 29.23 (k)-2. Charles A. Collins, 1 B. T. A. 305; Bush Terminal Buildings Co., 7 T.C. 793. Petitioners are not entitled to deduct as a loss this $ 18,750.

Petitioners also contend that the loss of $ 22,500 claimed on their tax returns for the year 1945 should be increased by petitioner's share in the furniture, equipment, etc. which was purchased and capitalized by Baker-Botts during the years 1921 through 1945, less such amounts as were recovered by depreciation during this period. From 1921 through 1945, petitioners reported their distributive share of the partnership earnings and some of these earnings were invested in furniture, equipment, etc. Although the partnership took depreciation on these assets for each of the years 1921 through 1945, some of these assets had not been fully depreciated at the time petitioner retired from the firm and petitioners have not recovered by way of depreciation or otherwise $ 3,058.93 of the distributive share of partnership income which was invested in these assets. Section 29.1131951 U.S. Tax Ct. LEXIS 128">*142 (a) (13)-2 of Regulations 111 provides in part as follows:

Sec. 29.113 (a) (13)-2. Readjustment of Partnership Interests. -- When a partner retires from a partnership, or the partnership is dissolved, the partner realizes a gain or loss measured by the difference between the price received for his interest and the sum of the adjusted cost or other basis to him of his interest in the partnership plus the amount of his share in any undistributed 17 T.C. 14">*20 partnership net income earned since he became a partner on which the income tax has been paid. * * *

Since the evidence shows that petitioners reported as income his share of the earnings of the partnership unreduced by the investment in furniture, equipment, etc., their basis in the partnership assets is to be increased by $ 3,058.93 and they are, therefore, entitled to an additional loss of the amount which was forfeited by petitioners.

Petitioners also contend that from 1921 through 1945, the firm of Baker-Botts made certain "non-deductible donations" of which Palmer Hutcheson's share for the entire period was $ 3,479.24, and that they are also entitled to increase the loss claimed on their returns by this amount. There is 1951 U.S. Tax Ct. LEXIS 128">*143 no showing as to the nature of the contributions. These contributions by the partnership which were not allowed as deductions did not become capital investments of the partnership as did investments in furniture, equipment, etc., discussed in the paragraph just above. There was nothing of a capital nature about them. We know of no law which would entitle petitioners to deduct any part of these nondeductible contributions as a loss upon petitioner's retirement from the firm and we are not cited to any. This claimed deduction of $ 3,479.24 by petitioners is denied.

Decisions will be entered under Rule 50.