SCOTUS Reports

Tag: Johnson v. Commissioner

  • Johnson v. Commissioner, 32 T.C. 257 (1959): Reimbursements Not “Properly Includible” in Gross Income Under Section 275(c) if “Washout”

    32 T.C. 257 (1959)

    Amounts received as reimbursement for expenses, that result in a “washout” are not considered to be “properly includible” in gross income, and, therefore, not subject to the extended statute of limitations under Section 275(c) of the 1939 Internal Revenue Code.

    Summary

    The Commissioner determined deficiencies in Abbott L. Johnson’s income tax for 1951 and 1952, arguing that reimbursements Johnson received from his employer for business expenses should have been included in his gross income, thereby triggering an extended statute of limitations. Johnson argued that the reimbursements essentially “washed out” the expenses, so they were not “properly includible” in his gross income as per the IRS’s own instructions. The Tax Court sided with Johnson, holding that because the reimbursements offset the expenses, only the net amount (if any) was required to be reported as gross income. The court ruled that the extended statute of limitations did not apply because the omitted amounts were not “properly includible” in gross income, thus, there was no omission under section 275(c).

    Facts

    Abbott L. Johnson, a corporate executive, received reimbursements from his employer for travel, entertainment, and sales promotion expenses in 1951 and 1952. Johnson did not include these reimbursement amounts in his gross income reported on his tax returns, nor did he claim any expense deductions. The Commissioner included the total reimbursement amounts in Johnson’s income, which exceeded 25% of the reported gross income. The Commissioner also allowed certain expense deductions to arrive at adjusted gross income. The Commissioner asserted that the excess was “other income” and thus triggered the extended statute of limitations under Section 275(c) of the 1939 Internal Revenue Code.

    Procedural History

    Johnson filed joint individual tax returns for 1951 and 1952. The IRS issued a notice of deficiency, asserting an extended statute of limitations under section 275(c) of the 1939 Internal Revenue Code. Johnson challenged the deficiency in the U.S. Tax Court.

    Issue(s)

    1. Whether the amounts received by Johnson from his employer as reimbursement for expenses were “properly includible” in his gross income for the purpose of extending the statute of limitations under section 275(c).

    Holding

    1. No, because the reimbursement amounts were essentially offset by the related expenses and were therefore not “properly includible” in gross income to the extent of the “washout” under the IRS’s own instructions.

    Court’s Reasoning

    The court focused on the phrase “omits from gross income an amount properly includible therein” from section 275(c). The court found the IRS’s own instructions, issued to taxpayers, instructive. The instructions stated that reimbursed expenses should be added to wages, then the actual expenses should be subtracted. Only the balance was to be entered on the tax return. Therefore, the court concluded that the amount “properly includible” in gross income was only the net amount, after expenses were deducted from reimbursements. The court stated, “We may say, at the outset, that we think it apparent that an amount is not to be deemed omitted from gross income under section 275(c) unless the taxpayer is required to include such amount in gross income on his return.” Because Johnson was not required to report the gross reimbursement but only the net, the extended statute of limitations did not apply.

    Practical Implications

    This case provides guidance on when an extended statute of limitations applies in tax cases involving reimbursements. It highlights the importance of adhering to the IRS’s published instructions. The ruling in Johnson, while it pertains to the 1939 Internal Revenue Code, informs on modern tax law with regard to employee expense reimbursements. It underscores that if reimbursements equal or are less than the expenses, then the employee may not have to include the gross reimbursement in income. This case illustrates that taxpayers should carefully review the applicable instructions for reporting income and deductions. The Court’s emphasis on the instructions highlights the need for the IRS to be clear and consistent in its guidance to taxpayers.

  • Herbert C. Johnson v. Commissioner, 30 T.C. 974 (1958): Patent Transfer and Capital Gains Treatment

    30 T.C. 974 (1958)

    The transfer of a patent by an inventor to a controlled corporation, where the inventor retains no proprietary interest and receives payments based on the corporation’s sales, is a sale entitling the inventor to capital gains treatment, not ordinary income, provided the transaction serves a legitimate business purpose.

    Summary

    Herbert C. Johnson, an inventor and sole owner of the common stock of National Die Casting Company, Inc. (National), transferred patents to the corporation in exchange for a percentage of the corporation’s sales of products using the patents. The IRS contended that these payments were royalties, taxable as ordinary income. The Tax Court held that the transfer constituted a sale of a capital asset, entitling Johnson to long-term capital gains treatment. The court emphasized that the transaction was bona fide, served a valid business purpose, and was fair and reasonable, despite the fact that the transferor owned the corporation.

    Facts

    Herbert C. Johnson, a tool and die casting designer, owned several patents for a fruit juice extractor. In 1941, he formed National, transferring most of his manufacturing assets to the corporation but initially retaining the patents and certain real estate. He did so to shield these assets from the potential liabilities arising from the corporation’s war work. National manufactured and sold fruit juice extractors covered by the patents. Johnson allowed National to use his patents without compensation during that time. After the war and contract renegotiation, Johnson decided to transfer the patents to National. On November 17, 1947, Johnson entered into a written agreement with National to sell the patents, receiving 6% of the selling price of products using the patents and 80% of any royalties from licensing. Johnson owned all the common stock of National, while his wife and sons owned all the preferred stock. The payments received under this agreement became the subject of the tax dispute.

    Procedural History

    The Commissioner of Internal Revenue determined income tax deficiencies against Johnson, arguing that the payments received from National should be taxed as ordinary income. The Johnsons petitioned the Tax Court, challenging the IRS’s determination and claiming long-term capital gains treatment was appropriate. The Tax Court heard the case and ruled in favor of the Johnsons.

    Issue(s)

    1. Whether payments received by Johnson from National, representing a percentage of sales of products covered by the patents, constitute ordinary income or long-term capital gains.

    2. Whether the transfer of the patents to National was a bona fide sale or a transaction lacking a valid business purpose, given Johnson’s control of the corporation.

    Holding

    1. Yes, the payments are considered long-term capital gains because the transfer of the patent was deemed a sale and not a license agreement.

    2. Yes, the transfer was a bona fide sale made for a valid business purpose, despite Johnson’s control over the corporation.

    Court’s Reasoning

    The court began by establishing that the transfer of a patent can result in capital gain or loss if the patent is a capital asset in the transferor’s hands and if the transaction constitutes a sale or assignment, not merely a license. It rejected the IRS’s argument that payments contingent on sales are automatically royalties, classifying them as capital gains. The court cited precedent supporting the treatment of such payments as capital gains. It found the transaction to be a sale and emphasized that the agreement was fair and reasonable. The court refuted the IRS’s claim that the transaction was a sham, finding a legitimate business purpose behind Johnson’s actions. The court noted Johnson’s initial reluctance to transfer the patents, due to concerns about liabilities during the war effort, and concluded that the arrangement was not merely an attempt to avoid taxes but a practical business decision. The court emphasized that National operated as a separate entity and the sale of the patents was an arm’s-length transaction, even though between Johnson and his wholly-owned corporation.

    Practical Implications

    This case is critical for business owners and inventors as it allows for capital gains treatment in the sale of patents to their controlled corporations, under specific conditions. The ruling reinforces the importance of documenting a valid business purpose for the transaction, even in closely held corporations. It confirms that payments tied to production or sales do not automatically preclude capital gains treatment. This decision is crucial for tax planning. Lawyers should advise clients about the necessity of structuring transactions carefully to reflect a genuine sale of the asset. They also must document the business reasons for the arrangement, and ensure the terms are fair and reasonable.

  • Johnson v. Commissioner, 18 T.C. 510 (1952): Constructive Receipt of Income and Substantial Limitations on Payment

    Johnson v. Commissioner, 18 T.C. 510 (1952)

    Income is not constructively received if there are substantial limitations or restrictions on the taxpayer’s ability to access the funds, even if the funds are credited to their account.

    Summary

    The case concerns the doctrine of constructive receipt and whether salary credited to an employee’s account but not paid in the tax year was taxable income. The court determined that the salary was not constructively received because there was an oral agreement among the company’s officers that the salary checks would not be cashed until the company president authorized it, due to the company’s financial situation. The court focused on whether the taxpayer had unrestricted control over the funds and found that the restriction constituted a substantial limitation, thus preventing the application of the constructive receipt doctrine. The decision emphasizes that the ability to access funds, rather than the mere availability, is key.

    Facts

    The taxpayer, Johnson, was an officer and shareholder of Dartmont Coal Company. In 1949, Dartmont credited $2,951.10 to Johnson’s salary account but did not pay it in cash that year. The company had insufficient cash to pay all salaries. The company’s president agreed with the other officers that the salary checks would not be presented for payment until the president authorized it. The IRS argued that the salary was constructively received by Johnson because the corporation had enough assets to pay it.

    Procedural History

    The Commissioner of Internal Revenue determined that the credited salary was constructively received income for the 1949 tax year. The taxpayer challenged this determination in the Tax Court.

    Issue(s)

    1. Whether the credited salary of $2,951.10 was constructively received income in 1949, despite not being paid.

    Holding

    1. No, because there was a substantial limitation on the taxpayer’s ability to access the funds.

    Court’s Reasoning

    The court applied the doctrine of constructive receipt, which holds that income is taxable when it is unconditionally subject to the taxpayer’s demand, even if not actually received. The court cited Section 29.42-2 of Regulations 111, which states that the income must be credited or set apart without substantial limitation or restriction as to the time, manner of payment, or conditions upon which payment is made. The court emphasized that the taxpayer must have the ability to draw the money at any time and bring its receipt within their control and disposition.

    The court found that there was a substantial limitation because of the agreement among the officers that the checks would not be cashed until the president authorized it. The court found that the amount was not unequivocally subject to his demand and disposition. The court stated, “it is essential for us to determine whether the amount credited to petitioner’s account was unequivocally made subject to his demand and disposition without any substantial limitation thereon during the taxable year.”

    The court rejected the Commissioner’s argument that the corporation’s available funds on certain days meant the salary was constructively received. The court considered the corporation’s overall financial position, including its liabilities and other outstanding obligations, concluding that the restriction on payment was valid. The court considered the corporation’s cash on hand, and the fact that there was not enough cash to pay the full amount of accrued salaries, as well as other outstanding obligations. The court also considered the financial difficulties of Dartmont at the time, as demonstrated by the fact that the salary checks were restricted and large loans had to be taken out.

    The court distinguished the case from situations where a corporation has the ability to pay but chooses not to. In this case, the condition restricting payment was mutually agreed upon by all the involved parties.

    Practical Implications

    This case provides clear guidance on the application of the constructive receipt doctrine. It is crucial to assess whether there were substantial limitations on the taxpayer’s access to the funds. Even if the funds are available in a technical sense, restrictions based on financial needs or agreements among parties can prevent constructive receipt. This case emphasizes the importance of understanding the taxpayer’s control over the income. In situations involving closely held corporations, it is crucial to document any limitations on the distribution of income. Tax professionals need to examine the entire financial picture, including the company’s cash flow and liabilities to determine if the taxpayer had the ability to draw upon the credited funds. This case is frequently cited in constructive receipt cases.

  • Johnson v. Commissioner, 21 T.C. 733 (1954): Tax Implications of Partnership Income Upon Sale of Interest

    21 T.C. 733 (1954)

    A partner is taxed on their share of partnership income until the date their partnership interest is actually sold, even if the sale agreement relinquishes their right to some of that income.

    Summary

    In 1944, George Johnson and Leonard Japp were partners in Special Foods Company, sharing profits equally. Johnson and Japp decided to dissolve the partnership and Johnson agreed to sell his interest to Japp. The agreement, finalized on June 20, 1944, stated the partnership dissolved on May 20, 1944 and that Johnson would relinquish rights to all profits earned after that date. However, Johnson reported only the amount he withdrew from the partnership as income for the period January 1 to May 20, 1944. The Commissioner of Internal Revenue argued that Johnson was taxable on his full share of the partnership income up to the date of sale, which the court agreed with.

    Facts

    George F. Johnson and Leonard M. Japp formed Special Foods Company in 1938, with each owning a 50% interest. Profits and losses were shared equally. In 1944, they decided to dissolve the partnership and Johnson agreed to sell his interest to Japp. On May 20, 1944, they executed “Articles of Dissolution,” and on June 20, 1944, they executed a sales contract, which included Johnson relinquishing any claims to profits earned after May 20, 1944. Johnson reported only the amount he withdrew from the partnership during the period from January 1, 1944, through May 20, 1944, as his share of the partnership income on his 1944 tax return. The Commissioner determined that Johnson should have included his full 50% share of the partnership income for the period up to the date of sale. The partnership’s ordinary net income for the period January 1, 1944, through May 20, 1944, was $112,085.80.

    Procedural History

    The Commissioner of Internal Revenue issued a notice of deficiency to George F. Johnson, asserting that Johnson had underreported his income. Johnson disputed the deficiency in the U.S. Tax Court, arguing that he was only liable for income received, and that his share ceased on May 20, 1944. The Tax Court sided with the Commissioner.

    Issue(s)

    Whether the taxpayer, George F. Johnson, was required to include in his income his full distributive share of the partnership’s earnings, as determined under the original partnership agreement, up to the date of sale of his partnership interest, or whether his income was limited to only the amount he withdrew from the partnership during the period in question.

    Holding

    Yes, because a partner’s distributive share of partnership income is taxable to them until the date their partnership interest is actually sold, irrespective of any agreement that attempts to alter this after the fact.

    Court’s Reasoning

    The court relied on established tax law, particularly the principle that a withdrawing partner is taxable on their share of partnership profits up to the time of their withdrawal, regardless of current distribution or sale of the partnership interest. The court found that there was no change in the profit-sharing agreement until the sale of the interest. The “Articles of Dissolution” and the sale contract executed June 20, 1944, were not relevant to income earned before that date. Therefore, Johnson was taxable on one-half of the partnership income from January 1, 1944, to the date of the sale.

    The court referenced the cases of LeSage v. Commissioner and Louis as precedent. The court also noted that limiting withdrawals was not the same as changing the profit-sharing ratio. The court found that the agreement to sell his interest did not change his tax liability for the period prior to the sale, because the sales agreement and the relinquishing of right to profits was not effective until the actual sale date.

    Practical Implications

    This case underscores the importance of determining the exact date of the sale when calculating a partner’s taxable income. The decision clarifies that the date of sale, and not the date of the dissolution agreement, determines the income allocation. Legal practitioners should be mindful of the timing of sales, dissolutions, and profit-sharing agreements in partnership arrangements to accurately advise clients on their tax obligations.

    Attorneys should advise clients of the tax implications of withdrawing from a partnership and the importance of accurately reporting their share of income up to the date their interest is transferred. The court’s emphasis on the date of sale has important implications for drafting partnership agreements, especially in terms of how income will be allocated upon a partner’s departure.

    This case also reinforces the IRS’s position that the substance of the transaction, not the form, determines the tax consequences. While the agreement tried to assign profits differently, it was not effective for the period prior to the sale. This case is distinguishable from situations where partners are not selling their interests, but are merely agreeing to shift how income is allocated during the ongoing life of the partnership. The date of the sale is key.

  • Johnson v. Commissioner, 21 T.C. 371 (1953): Taxability of Payments Under a Separation Agreement

    21 T.C. 371 (1953)

    Payments made under a separation agreement are not taxable as alimony if the agreement was not “incident to” a subsequent divorce, meaning the divorce was not contemplated at the time of the agreement.

    Summary

    The U.S. Tax Court addressed whether payments received by a wife under a separation agreement were taxable as income, even though a divorce later occurred. The court held that since the parties did not intend to divorce when the separation agreement was signed, the payments were not “incident to” the divorce. The court emphasized the importance of determining whether a divorce was planned at the time of the agreement, influencing whether the payments should be considered taxable income as alimony under the Internal Revenue Code. This case provides guidance on when a separation agreement is considered tied to a divorce for tax purposes.

    Facts

    Frances Hamer Johnson and Bedford Forrest Johnson married in 1919. Due to marital difficulties, they entered into a separation agreement on December 8, 1941. The agreement provided for monthly payments to Mrs. Johnson until her death or remarriage, and required Mr. Johnson to maintain a life insurance policy for her benefit. At the time of the agreement, Mrs. Johnson did not contemplate divorce; the separation was prompted by her husband’s alcoholism, and she hoped for reconciliation. Mr. Johnson filed for divorce on December 20, 1943, and the divorce was granted on April 4, 1944. He remarried shortly thereafter. The separation agreement was not incorporated into the divorce decree, but the court was aware of its existence.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in Mrs. Johnson’s income taxes for 1947, 1948, and 1949, arguing that the payments she received from her former husband under the separation agreement were taxable as alimony because the agreement was “incident to” their divorce. Mrs. Johnson challenged this determination in the U.S. Tax Court.

    Issue(s)

    Whether the separation agreement between Mrs. Johnson and her former husband was “incident to” their divorce within the meaning of Section 22(k) of the Internal Revenue Code.

    Holding

    No, because the court found the agreement was not incident to the divorce, as the parties did not initially intend to divorce when the separation agreement was created.

    Court’s Reasoning

    The court relied on Section 22(k) of the Internal Revenue Code, which deals with the taxability of alimony. It stated that the key question was whether a clear connection existed between the separation agreement and the divorce. The court differentiated situations where a divorce was not contemplated, as in this case, from those where the separation agreement explicitly contemplated an immediate divorce. “The connection is obvious when there is an express understanding or promise that one spouse is to sue promptly for a divorce after signing the settlement agreement, and the action is brought and followed through quickly.” The court looked at the facts: Mrs. Johnson’s testimony, the testimony of witnesses to the agreement, and the attorney who drafted the agreement all indicated no intent to divorce at the time of the agreement. The court found no evidence that the parties intended to divorce when the agreement was signed, even though divorce occurred later. The court found that the absence of an explicit link between the separation agreement and the divorce, and the lack of intent to divorce at the time of the separation agreement, meant that the payments were not taxable under Section 22(k).

    Practical Implications

    This case underscores that for payments under a separation agreement to be considered taxable as alimony, there must be a demonstrated connection between the agreement and the divorce. Crucially, there must have been an intent or contemplation of divorce at the time the separation agreement was created. Legal practitioners must closely examine the intent of the parties at the time of the separation agreement and gather evidence (testimony, documents) to support or refute the argument that divorce was anticipated. A lack of explicit reference to divorce in the agreement or evidence that divorce was not contemplated will favor the position that payments under the agreement are not taxable. Subsequent cases and IRS guidance have continued to emphasize the importance of intent and the circumstances surrounding the agreement.

  • Johnson v. Commissioner, 17 T.C. 1261 (1952): Determining “Home” for Travel Expense Deductions

    17 T.C. 1261 (1952)

    For tax purposes, a taxpayer’s “home,” when determining deductible travel expenses, is typically their principal place of business or employment, not necessarily their family residence.

    Summary

    Harold Johnson, a master mechanic, sought to deduct travel expenses for meals and lodging. His employer’s temporary garage in Memphis was the location of approximately half of his work. He spent the other half at various job sites. The Tax Court had to determine whether Johnson’s “home,” for tax purposes, was in Memphis (his principal place of employment) or Statesville (where his family resided). The Court held that Johnson’s tax home was Memphis; therefore, he could only deduct expenses incurred while working away from Memphis.

    Facts

    Harold Johnson was employed as a master mechanic by Foster and Creighton. He maintained construction equipment, spending approximately 50% of his time working in his employer’s temporary garage in Memphis, Tennessee. The remaining 50% of his time was spent at various construction sites within 125-150 miles of Memphis. Johnson received orders from his employer’s Nashville office and returned to the Memphis garage after each assignment. He spent weekends with his family in Statesville, Tennessee, where they lived in a rented house. Johnson also rented a room in Memphis.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Johnson’s 1946 income tax. Johnson contested the determination, arguing that the Commissioner erred in disallowing a deduction for traveling expenses. The Tax Court reviewed the Commissioner’s determination.

    Issue(s)

    Whether the Tax Court erred in determining that the location of the Petitioner’s “home”, for purposes of deducting travel expenses under sections 22(n)(2) and 23(a)(1)(A) of the Internal Revenue Code, was Memphis, Tennessee where his principal place of employment was located, rather than Statesville, Tennessee where his family resided?

    Holding

    No, because for the purposes of deducting travel expenses, a taxpayer’s “home” is defined as their principal place of business or employment.

    Court’s Reasoning

    The Tax Court relied on the Supreme Court’s decision in Commissioner v. Flowers, 326 U.S. 465 (1946), which addressed the meaning of “home” in the context of travel expense deductions. The Court stated that the Tax Court and administrative rulings consistently defined it as the equivalent of the taxpayer’s place of business. Because Johnson spent approximately half his working time in Memphis, and it was the location to which he returned after temporary assignments, the Tax Court determined that Memphis was Johnson’s “home” for tax purposes. The Court then allowed Johnson to deduct expenses incurred while working away from Memphis, using the Cohan rule (Cohan v. Commissioner, 39 F.2d 540) to estimate the amount of deductible expenses due to a lack of detailed records.

    Practical Implications

    This case clarifies the definition of “home” for travel expense deductions under the Internal Revenue Code. It establishes that a taxpayer’s principal place of business or employment generally determines their tax home, regardless of where their family resides. This ruling has significant implications for individuals who work in one location but maintain a residence elsewhere, limiting their ability to deduct expenses incurred in their principal place of employment. Later cases applying this ruling must focus on whether the location was truly the ‘principal’ place of business, not merely a temporary work site.

  • Johnson v. Commissioner, 8 T.C. 303 (1947): Deduction of Living Expenses While Away From Home

    8 T.C. 303 (1947)

    Expenses for meals and lodging incurred at a taxpayer’s principal place of business are not deductible as traveling expenses when the taxpayer chooses to maintain a residence elsewhere for personal reasons, not due to the employer’s requirements.

    Summary

    John D. Johnson, an employee of Johns-Manville Sales Corporation, sought to deduct expenses for meals and lodging incurred in New York City. He maintained a home in Cleveland with his wife and daughter while temporarily assigned to the New York office. The Tax Court disallowed the deduction, holding that the expenses were personal and not related to his employer’s business. The court relied on the Supreme Court’s decision in Commissioner v. Flowers, emphasizing that the expenses were incurred due to Johnson’s personal choice to maintain a home in Cleveland, not due to a business necessity dictated by his employer.

    Facts

    Johnson was a long-time employee of Johns-Manville Sales Corporation. He lived in Cleveland, Ohio, with his family. In January 1943, he was temporarily assigned to the New York City office as acting sales manager, replacing an employee on leave for naval service. His family remained in Cleveland. Johnson lived in hotels in New York City throughout 1943. His employer paid his travel to New York and initial lodging for 16 days. Thereafter, Johnson paid his own New York living expenses. Johnson considered the New York assignment to be temporary and indefinite. He later received a permanent assignment in New York.

    Procedural History

    Johnson deducted $1,638.60 for “New York Living Expenses” on his 1943 tax return. The Commissioner of Internal Revenue disallowed the deduction, resulting in a deficiency assessment. Johnson petitioned the Tax Court for a redetermination. The Tax Court upheld the Commissioner’s determination.

    Issue(s)

    Whether expenditures for meals and lodging incurred by a taxpayer in his principal place of business are deductible as traveling expenses while away from home in the pursuit of a trade or business, or whether they constitute non-deductible personal, living, or family expenses.

    Holding

    No, because the expenses were incurred as a result of the taxpayer’s personal choice to maintain a home in a different city from his principal place of business, and were not required by the employer’s business.

    Court’s Reasoning

    The court relied heavily on the Supreme Court’s decision in Commissioner v. Flowers, which established three requirements for deducting traveling expenses under Section 23(a)(1)(A) of the Internal Revenue Code: (1) the expenses must be reasonable and necessary traveling expenses; (2) they must be incurred “while away from home;” and (3) they must be incurred in the pursuit of a business. The Supreme Court in Flowers emphasized a direct connection between the expenditures and the carrying on of the employer’s business, and that the expenses must be necessary to the employer’s trade or business. The Tax Court found that Johnson’s expenses failed the third requirement because they were incurred due to his personal choice to maintain a home in Cleveland, not due to any requirement or benefit to his employer. The court rejected Johnson’s argument that his New York assignment was temporary, noting that employment of indefinite duration is not the same as temporary employment. The court stated, “The added costs in issue, moreover were as unnecessary and inappropriate to the development of the railroad’s business as were his personal and living costs in Jackson. They were incurred solely as the result of the taxpayer’s desire to maintain a home in Jackson while working in Mobile, a factor irrelevant to the maintenance and prosecution of the railroad’s legal business.”

    Practical Implications

    This case, following Commissioner v. Flowers, clarifies that taxpayers cannot deduct living expenses incurred at their principal place of business if they choose to maintain a residence elsewhere for personal reasons. This decision reinforces the principle that deductible business expenses must be directly related to the employer’s business and not merely for the employee’s convenience or personal preference. Attorneys should advise clients that maintaining a residence separate from their place of work will likely result in non-deductible personal expenses unless the employer requires the separation as a condition of employment. Later cases continue to apply the Flowers test, focusing on whether the expenses are truly business-related or primarily for personal convenience.

  • Johnson v. Commissioner, 86 F.2d 710 (7th Cir. 1936): Gift Tax and Dominion of Control

    Johnson v. Commissioner, 86 F.2d 710 (7th Cir. 1936)

    A gift is not complete for tax purposes if the donor retains dominion and control over the gifted property, even if formal legal transfers have occurred.

    Summary

    The Johnsons transferred stock to family members shortly before dividend declarations but then borrowed the dividends back. Despite formal transfers, the Tax Court found the Johnsons retained dominion and control over the stock and its proceeds. The key issue was whether the Johnsons truly relinquished control despite their actions. The court held that the gifts were incomplete for tax purposes because the Johnsons maintained control, evidenced by the timing of transfers, borrowing back dividends, and controlling the stock and notes. This case highlights that substance, not mere form, governs gift tax analysis.

    Facts

    Mr. and Mrs. Johnson transferred shares of stock in their company to their wives and children.
    The transfers occurred shortly before substantial dividends were declared.
    Almost immediately after the dividends were paid, the Johnsons borrowed back the dividend amounts from the transferees.
    All stock certificates and notes representing the borrowed dividends were kept in the company’s office, accessible and controlled by the Johnsons.
    The Johnsons freely endorsed dividend checks made payable to the transferees and used the funds.
    Instructions were given to destroy the notes representing the borrowed dividends and issue new ones.
    There was a collateral agreement with the children that the notes would not be presented for payment until they reached certain ages, and even then, the boys would receive interests in the business rather than cash.
    The Johnsons paid the income taxes due on the dividend income for all transferees.

    Procedural History

    The Commissioner of Internal Revenue determined that the stock transfers were not valid gifts for tax purposes.
    The Johnsons appealed to the Board of Tax Appeals (now the Tax Court), which upheld the Commissioner’s determination.
    The Johnsons then appealed to the Seventh Circuit Court of Appeals.

    Issue(s)

    Whether the transfers of stock to family members constituted completed gifts for federal tax purposes, considering the donors’ continued control and benefit from the transferred property.

    Holding

    No, because the donors retained dominion and control over the stock and dividends, indicating a lack of intent to make a completed gift. The court emphasized the substance of the transactions over their form.

    Court’s Reasoning

    The court focused on the practical effect of the transfers. Despite the legal formalities, the Johnsons continued to exercise exclusive management and control over the corporation and enjoy the dividends as if they still owned the stock. The court noted several factors indicating a lack of intent to relinquish control, including:
    “Many things point to a lack of intent on the part of petitioners to relinquish dominion and control. Among these are the fact that in each year the transfers were made from four to fourteen days before the declaration of the substantia] dividends, which were in each case immediately borrowed back and used by the petitioners; the fact that all the stock and all the notes, those of the adult transferees as well as of the children, were kept in the corporate office, where they were under the control of the petitioners.”
    The court found that the Johnsons’ actions, such as borrowing back the dividends, keeping the stock and notes under their control, and paying the transferees’ income taxes, demonstrated that they never truly relinquished control over the gifted property.
    Because the donors maintained significant control over the assets, the transfers did not qualify as completed gifts for tax purposes.

    Practical Implications

    This case underscores the importance of demonstrating a clear and unequivocal relinquishment of control when making gifts, particularly within family settings. Taxpayers must ensure that the donee has genuine control and benefit from the gifted property.
    Subsequent cases have cited Johnson to emphasize the substance-over-form doctrine in gift tax cases. When analyzing similar situations, legal practitioners must look beyond the formal transfer and scrutinize the donor’s actual behavior to determine whether they have truly surrendered control. This case serves as a cautionary tale for taxpayers seeking to reduce their tax liability through gifts while maintaining control over the assets.

  • W.D. Johnson v. Commissioner, 1 T.C. 1041 (1943): Res Judicata and Community Property Income

    1 T.C. 1041 (1943)

    A prior tax court decision for different tax years is not res judicata if the core issues concerning the characterization of income as community or separate property were not definitively decided in the prior case.

    Summary

    W.D. Johnson challenged a tax deficiency, arguing that income from Texas and New Mexico lands and cattle was community property, taxable equally to him and his wife. The IRS argued res judicata based on prior tax years and characterized all income as Johnson’s. The Tax Court held that res judicata did not apply because the prior case didn’t definitively decide the character of the income. It ruled that while the prior case found Johnson couldn’t trace community property, it didn’t address whether income from Texas lands was inherently community property. The court found Texas rents, issues, profits, and cattle income were community property, but New Mexico land income was Johnson’s separate income. A partnership agreement with Johnson’s wife was deemed ineffective for tax purposes.

    Facts

    W.D. Johnson and his wife, residents of Missouri, filed separate tax returns, each reporting half of their income, except for Johnson’s personal service income. The IRS attributed all income from Texas and New Mexico lands and Texas cattle to Johnson. The Johnsons had moved from Texas to Missouri, bringing community property with them. Over time, they reinvested this property in various ventures, commingling it with earnings and separate property. Johnson was unable to trace the original community property into his current assets, except for the Slash ranch.

    Procedural History

    The IRS assessed a deficiency for 1937. Johnson petitioned the Tax Court. The IRS argued res judicata based on prior proceedings concerning tax years 1927-1929. Those earlier cases went to the Eighth Circuit Court of Appeals, which initially remanded for further evidence. After a second hearing, the Board (now Tax Court) again ruled against Johnson, and the Eighth Circuit affirmed. The current case was then brought before the Tax Court for the 1937 tax year.

    Issue(s)

    1. Whether the doctrine of res judicata bars Johnson from relitigating the characterization of income as community or separate property.
    2. Whether income from lands in Texas and New Mexico and income from cattle in Texas is community or separate income.

    Holding

    1. No, because the prior case didn’t definitively decide the character of the income from the specific properties in Texas and New Mexico at issue in this case.
    2. (a) Rents, issues, and profits from Texas lands, whether separate or community property, are community income. (b) Income from New Mexico lands is of the same character as the land itself (separate). (c) Income from Texas cattle is community income.

    Court’s Reasoning

    The court distinguished the current case from the prior tax disputes. While the prior cases addressed the commingling of community and separate property, they didn’t decide the specific character of income from Texas and New Mexico lands under community property laws. The court stated, “Any right, fact or matter in issue and directly adjudicated upon, or necessarily involved in, the determination of an action…is conclusively settled…and can not again be litigated between the parties.” Because the core issue regarding the state-specific nature of the income had not been decided, res judicata didn’t apply.

    Regarding the income characterization, the court applied Texas law, which deems rents, issues, and profits from land as community property, even if the land is separately owned. However, New Mexico law treats income from land the same as the land itself. The court found that the cattle income was also community property, because under Texas law, the increase of cattle falls into the community. Because Johnson directly traced a community asset into the Slash Ranch, income from that ranch was also community property.

    Practical Implications

    This case clarifies the limits of res judicata in tax law, particularly regarding community property. Attorneys must show that the specific legal question at issue was actually decided in the prior case. The case emphasizes that the characterization of income as community or separate property is determined by the law of the situs of the property. Attorneys should carefully analyze the source of funds used to acquire property and understand that income from separate property in Texas can still be community income. This ruling highlights the importance of understanding state-specific community property laws when advising clients on tax matters, particularly for those who reside in non-community property states but own property in community property states.