Heiner v. Mellon

Background

Two men, A. W. Mellon and R. B. Mellon, formed partnerships in 1918 to liquidate two distilling corporations and sold large whiskey inventories in 1919–1920. The partnerships reported gains on their partnership returns, but the Mellons did not include one-third of the whiskey-sale profits on their personal 1920 tax returns. The Commissioner assessed deficiencies; the taxpayers sued for refunds and won in the lower courts.

Reasoning

The key question was whether profits from whiskey sales in 1920 were taxable income to the partners that year. The Court said yes. It explained that liquidation does not change the basic rule of annual accounting: profits from business operations in a year are taxable that year. A technical dissolution or state-law limits on distribution do not stop a partner’s distributive share from being part of his taxable income. The Court also held the surviving partners were not treated as a separate trust for federal tax purposes and that the partnership books properly determined the income.

Real world impact

The ruling requires partners to report and pay federal income tax on their share of partnership profits in the year those profits arise, even if the partnership is winding up and no cash is yet distributed. It reverses the lower-court refunds and affirms the Commissioner’s authority to assess tax based on partnership accounting. Taxpayers and accountants must treat liquidation gains like ordinary yearly income for reporting and payment.