Summary
In Gemological Institute of America v. Commissioner, 17 T.C. 1604 (1952), affd. 212 F.2d 205 (9th Cir. 1954), a percentage of earnings was earmarked for a dominant individual in a manner arguably related to services rendered.
Summary of this case from World Family Corp. v. Comm'r of Internal RevenueOpinion
Docket No. 26183.
1952-03-27
GEMOLOGICAL INSTITUTE OF AMERICA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, COMMISSIONER.
Austin H. Peck, Jr., Esq., and Henry C. Diehl, Esq., for the petitioner. R. E. Maiden, Jr., Esq., and Raymon B. Sullivan, Esq., for the respondent.
Petitioner corporation, which included in its activities the giving of instructive courses in gemmology, held, not exempt from tax under section 101(6), I.R.C., because part of its net earnings inured to the benefit of an individual. Austin H. Peck, Jr., Esq., and Henry C. Diehl, Esq., for the petitioner. R. E. Maiden, Jr., Esq., and Raymon B. Sullivan, Esq., for the respondent.
The Commissioner determined against petitioner the following tax deficiencies and penalties:
+----------------------------------------------------------+ ¦ ¦ ¦ ¦25 per cent¦ +-----------------------------+-----+----------+-----------¦ ¦Tax ¦Year ¦Deficiency¦penalty ¦ +-----------------------------+-----+----------+-----------¦ ¦ ¦(1944¦$1,009.98 ¦$252.50 ¦ +-----------------------------+-----+----------+-----------¦ ¦Declared value excess-profits¦(1945¦1,562.52 ¦390.63 ¦ +-----------------------------+-----+----------+-----------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------+-----+----------+-----------¦ ¦ ¦(1944¦1,693.18 ¦423.30 ¦ +-----------------------------+-----+----------+-----------¦ ¦Income ¦(1945¦2,674.19 ¦668.55 ¦ +-----------------------------+-----+----------+-----------¦ ¦ ¦(1946¦3,854.02 ¦963.51 ¦ +----------------------------------------------------------+
Two issues were raised by the petition; one of these, the question of liability for delinquency penalties, was disposed of in petitioner's favor by stipulation of the parties that failure to file corporation income and declared value excess-profits tax returns was due to reasonable cause and not to willful neglect. The sole issue remaining is whether petitioner was exempt from Federal income and declared value excess-profits tax under the provisions of section 101(6) of the Internal Revenue Code. A supplemental stipulation agreed to by the parties establishes the deficiencies for declared value excess-profits tax for the years before us.
FINDINGS OF FACT.
Some of the facts were stipulated, and are so found.
Petitioner is an Ohio corporation organized October 8, 1942 with its principal place of business located in Los Angeles, California.
In the spring of 1931, a venture, known as the Gemological Institute of America, was formed by Robert M. Shipley and Beatrice Shipley, his wife, for the purpose of offering courses of instruction in the science of gemmology
+-----------------------------------------------------------------------------+ ¦Taxable year ended December 31 ¦ ¦ ¦ ¦ +-------------------------------------------+----------+----------+-----------¦ ¦ ¦1944 ¦1945 ¦1946 ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Gross income: (Tuition, books sold, dues, ¦$50,429.29¦$72,771.95¦$185,972.17¦ ¦sales of equipment, etc.) ¦ ¦ ¦ ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Less: ¦ ¦ ¦ ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Expenses (Books, insurance, legal, ¦30,626.55 ¦43,597.38 ¦146,152.61 ¦ ¦depreciation, taxes, etc.) ¦ ¦ ¦ ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Salary: Shipley ¦4,500.00 ¦4,500.00 ¦4,500.00 ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Shipley's share of profit ¦7,651.37 ¦11,837.30 ¦18,128.18 ¦ +-------------------------------------------+----------+----------+-----------¦ ¦Total expense ¦$42,777.92¦$60,934.68¦$168,780.79¦ +-------------------------------------------+----------+----------+-----------¦ ¦Net income ¦$7,651.37 ¦$11,837.27¦$17,191.38 ¦ +-----------------------------------------------------------------------------+
During 1944, 1945, and 1946 petitioner gave its regular courses of instruction in gemmology. There were four correspondence courses and two residence courses. The correspondence courses covered the subjects from the fundamentals of gemmology to an intensive study of diamonds. The residence courses consisted primarily of laboratory work and the study of instruments used by jewelers in evaluating gems and precious stones. Each of the correspondence courses required about 9 months for completion. The normal procedure was to study the correspondence courses for 9 months of the year, and to take 4 years to complete all the correspondence courses. The residence courses were taken during the vacation periods or at the end of the 4 years.
About 95 per cent of petitioner's students were correspondence students. Because of the war in 1944, there were no residence courses. The number of new enrollments during the taxable years was approximately as follows:
+---------+ ¦1944 ¦200¦ +-----+---¦ ¦1945 ¦350¦ +-----+---¦ ¦1946 ¦900¦ +---------+
Petitioner was approved by the Veterans Administration to give correspondence courses under the ‘G.I. Bill.‘
During the years 1944 through 1946 petitioner had from 7 to 25 employees of which 2 to 5 were faculty members. Similar courses of instruction were conducted by the mineralogical departments of Columbia University, University of Michigan, and the University of Colorado.
Petitioner's other activities also included the development and the distribution of instruments used in gemmology. Petitioner published books, including text books and a quarterly. These were sold to students and others seeking a knowledge on the subject of gemmology. Petitioner's students were not limited to its members or employees of members. Anyone interested in taking the courses could enroll upon the payment of the tuition.
OPINION.
JOHNSON, Judge:
Petitioner, claiming exemptions from tax on corporations under section 101(6), asserts that it was organized and operated exclusively for scientific and educational purposes, and that no part of its net earnings inures to the benefit of any private shareholder or individual.
In presenting the issues, respondent alleges, inter alia, that part of the petitioner's net earnings inured to the benefit of an individual, and, therefore, petitioner is precluded from the benefits of the section.
In order to be exempt, under this section, petitioner must meet each of three tests:
(1) It must be organized and operated exclusively for one or more of the specific purposes;
(2) Its net income must not inure in whole or in part to the benefit of private shareholders or individuals; and
(3) It must not by any substantial part of its activities attempt to influence legislation by propaganda or otherwise.
‘The words 'private shareholder or individual’ in section 101 refers to persons having a personal and private interest in the activities of the organization.‘ Regulations 111, section 29.101-2(d). The facts prove that Shipley was a ‘person with a personal and private interest‘ in the petitioner. Actually, Shipley was the dominant individual in the corporation. While technically he did not create the corporation, he was the founder of the original venture, and upon transferring his activities to the petitioner, he became the most valuable and the most essential individual in the corporation.
Petitioner argues, because of Shipley's ability and past services, that he ‘was entitled to receive much more than the nominal amount set up as flat salary.‘ This is not disputed. However, when petitioner further says that Shipley's compensation was not part of its net earnings but was only measured by the amount of its net earnings, we can not accept this argument as it is unsupported by the facts. In 1944 Shipley's compensation over and above his $4,500 salary was $7,651.37. The petitioner's net earnings for that same year, after deducting this amount as a business expense, was the same amount, $7,651.37. In 1945 Shipley's compensation, not including salary, was $11,837.30 and the petitioner's net income was $11,837.27. In 1946 Shipley's compensation, again not including salary, was $18,128.18 and petitioner's net income was $17,191.38.
Regardless of what these amounts are called, salary or compensation based on earnings, it is obvious that half of the net earnings of petitioner inured to the benefit of an individual, viz., Shipley. These earnings are too material to be ignored. Roger L. Putnam, 6 T.C. 702. Cf. Edward Orton, Jr. Ceramic Foundation, 9 T.C. 533, affd. 173 F.2d 483. Such a distribution of net earnings is unequivocally prohibited by the statute. The petitioner has failed to meet one of the essential tests of section 101(6). Therefore, it does not qualify for the exemptions because all requirements of the section must coexist. This holding renders it unnecessary to consider respondent's other contentions.
Because the parties agreed to a stipulation of facts concerning the deficiencies for the declared value excess-profits tax, and for the penalties, a redetermination of the deficiencies must be made.
Decision will be entered under Rule 50.