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Pelton v. Commissioner of Internal Revenue

March 20, 1936


Petitions for Review of Decisions of the United States Board of Tax Appeals.

Author: Sparks

Before EVANS and SPARKS, Circuit Judges, and LINDLEY, District Judge.

SPARKS, Circuit Judge.

Deficiencies in income taxes were determined against petitioners by the Commissioner of Internal Revenue for the years 1924, 1925, 1926 and 1927, upon the ground that the Pelton Clinic was an association within the meaning of section 2 (a) (2) of the Revenue Acts of 1924 and 1926, 26 U.S.C.A. ยง 1696 and note. Appeals were taken from two decisions of the Board of Tax Appeals which confirmed the determination of the Commissioner. They involve the same facts and the same questions and they were consolidated for hearing.

In substance, the findings of the Board are as follows: Between 1913 and 1920, Ora L. Pelton, Sr., Ora L. Pelton, Jr., and S. L. Gabby were practicing physicians and surgeons in Elgin, Illinois. The Peltons specialized in surgery, and Gabby specialized in internal medicine.They occupied offices with a common waiting room, and shared office expenses, but were not partners.

On September 1, 1920, they entered into an indenture whereby they transferred to themselves, as trustees, property of an estimated value of $14,000, consisting of office furniture and equipment, instruments, laboratory equipment, library and x-ray equipment.The junior Pelton died in 1929, leaving the senior Pelton and Gabby as surviving trustees.

The indenture authorized the trustees to use the properties conveyed to them in any manner they might deem advisable, to operate clinics and any business or professional pursuit allied therewith, to retain any professional assistance necessary to discharge such duties, including that of the trustees, in a professional capacity insofar as possible, and to incur indebtedness and invest and reinvest in securities.

The trustees were required to maintain accurate accounting records, to furnish annual statements to the beneficiaries, and to distribute the net income annually or oftener. For their services as trustees they were to receive salaries not in excess of $25,000 a year. They had power to divide their duties and to assume appropriate titles, and they were not to be liable in a personal capacity for the duties performed by them.

Vacancies among the trustees were to be filled by the beneficiaries, and holders of fifty-one percent of the beneficial interests had power to modify the trust.

The trust was to be designated as "The Pelton Clinic," "The Pelton Clinic, not Inc.," or "The Pelton Clinic Trust," and was to last ten years, at the end of which time the assets were to be distributed to the beneficiaries then of record.

At the beginning, Pelton, Sr., had a beneficial interest of forty percent, representing 200 units; Pelton, Jr. had thirty-five percent, representing 175 units; and Gabby had twenty-five percent, representing 125 units, and provision was made for the disposition to his wife or other relatives of any units of which any one of the beneficiaries died possessed.

The beneficial interests were to be represented by shares, which were transferable, and of which a record was to be kept. Options to purchase at $30 per share were to be given to other beneficiaries before any interests were sold to outsiders.

Amendments to the original indenture were made by the beneficiaries of January 1, 1924. One changed the option purchase price from $30 per unit to the book value of the unit, and the other provided for the retention of $10,000, or seventy-five percent of the net income for each year, whichever was the greater, to be used in acquiring fixed or other assets for the trust.

The proportionate share of each doctor was originally determined according to his agreed value to the Clinic, based on earning capacity and not on the property contributed. They were the sole beneficiaries through all the taxable years involved. During all the years the clinic employed at least one physician in addition to the three trustees, and during the last two years, 1926 and 1927, it employed three additional physicians. While by far the largest part of its income was derived from the professional services of the trustee-beneficiaries, it also derived some ...

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