McDougal v. Commissioner of Internal Revenue

F.C. and Frankie McDougal (plaintiffs) owned a racehorse named Iron Card. F.C. promised horse trainer Gilbert McClanahan (plaintiff) a one-half interest in Iron Card if McClanahan trained Iron Card. Iron Card began racing successfully, and the McDougals received numerous offers to buy Iron Card, including one for $60,000. However, the McDougals decided to keep Iron Card. On October 4, 1968, the McDougals transferred a one-half interest in Iron Card to McClanahan. On November 1, 1968, the McDougals and McClanahan entered an oral partnership agreement under which they agreed to race Iron Card as long as feasible and then offer Iron Card for breeding. The McDougals and McClanahan were to share the venture’s profits equally, but losses would be borne by the McDougals alone. On their 1968 tax return, the McDougals reported gross income of $22,891 from their farm and deducted $1,390 in depreciation and $9,200 in training fees for Iron Card. The McDougals subsequently filed an amended tax return in which they claimed to have transferred the one-half interest in Iron Card to McClanahan as compensation for services rendered. The McDougals thus claimed a $30,000 business-expense deduction, calculated based on one-half of the $60,000 offer the McDougals had received for Iron Card. The McDougals further acknowledged a $25,000 long-term capital gain on the transfer of the interest in Iron Card. The McDougals and the McClanahans claimed to have jointly transferred Iron Card to their partnership on November 1, 1968, and claimed that the partnership had a basis in Iron Card of $33,610. The Commissioner of Internal Revenue (the commissioner) (defendant) determined deficiencies in the McDougals’ and the McClanahans’ tax returns, asserting that (1) the McDougals and McClanahan had entered into a joint venture as of October 4, 1968, and (2) the McDougals contributed Iron Card and McClanahan contributed services to the venture. The commissioner claimed that under that interpretation, the McDougals recognized no gain on the transfer. The McDougals and McClanahans challenged the deficiency determination in tax court.