Opinion
Docket Nos. 6139-65, 6143-65.
Filed June 4, 1968.
T, the majority stockholder and principal executive officer of X, a small family corporation, became ill in 1957 and received payments of $100 a week from X for a prolonged continuous period of over 5 or 6 years. X had no pension plan for employees and its other employee benefits were on a modest scale. It never gave sick pay to any other employees for any continuous period in excess of 2 weeks. Held, the amounts received by T during 1960-1962 did not in fact represent bona fide sick pay for an employee but were paid to him because he was the majority stockholder; they are taxable to him as dividends, and are not deductible by X. Cf. Alan B. Larkin, 48 T.C. 629, affirmed 394 F.2d 494 (C.A. 1).
Raymond M. Pezzo, for the petitioners.
Robert M. Pearl, for the respondent.
The Commissioner determined deficiencies in the income tax of petitioners as follows:
Petitioners Taxable year Additions ended Deficiency to tax -------------- Sec. Sec. 6651(a) 6653(a) Samuel and Sophie {December 31, 1960 $850.19 Levine Docket No. {December 31, 1961 1,333.74 $91.15 $64.15 6139-65 ............ {December 31, 1962 1,029.47 86.80 Selco Supplies, Inc. {August 31, 1961 1,748.79 Docket No. {August 31, 1962 1,682.15 6143-65 ............ {August 31, 1963 1,612.76 Petitioners Samuel and Sophie Levine, and petitioner Selco Supplies, Inc., have agreed to all adjustments made by the Commissioner except those relating to the treatment of amounts received by Samuel Levine from Selco during the years in issue. The question presented is whether these amounts constituted, in whole or in part, payments received under a wage continuation plan during absence due to illness, excludable from Samuel Levine's gross income and deductible by Selco, or whether they were in fact merely dividends to Samuel Levine.FINDINGS OF FACT
The stipulation of facts filed by the parties together with the exhibits attached thereto, are incorporated herein by this reference.
The petitioners in docket No. 6139-65, Samuel and Sophie Levine, reside in Poughkeepsie, N.Y., which was their legal address on the date their petition in this case was filed. They filed their joint income tax returns for the calendar years 1960, 1961, and 1962 with the district director of internal revenue, Albany, N Y
The petitioner in docket No. 6143-65, Selco Supplies, Inc. (hereinafter sometimes referred to as Selco), was organized under the laws of the State of New York on August 22, 1945, and has its principal place of business in Poughkeepsie, N.Y., which was its legal address on the date its petition in this case was filed. Selco filed corporation income tax returns for its fiscal years ending August 31, 1961, August 31, 1962, and August 31, 1963, with the district director of internal revenue, Albany, N.Y. Its principal business activity is the sale of janitorial and maintenance supplies, such as polishing machines, scrubbers, and vacuum cleaners.
Samuel Levine has at all times relevant owned well over a majority of the outstanding stock of Selco. During the period involved herein, he held 83,000 of the approximately 96,000 shares of Selco's outstanding stock, the remainder being divided on a roughly equal basis between his sons, Charles and Howard Levine. The officers of Selco during this period were as follows:
Samuel Levine ............. President until August 31, 1961 Sophie Levine ............. Secretary until August 31, 1961; president from September 1, 1961 Howard Levine ............. Vice president; secretary from September 1, 1961 Charles Levine ............ Treasurer
Selco was a small company. It had six to eight full-time employees. For the taxable years ended August 31, 1961-63, it reported gross income, deductions, and net taxable income, as follows:
Year ending Aug. 31 Gross Deductions Net taxable income Income 1961 ...................... $69,326.99 $60,965.22 $361.77 1962 ...................... 77,048.07 76,481.23 566.84 1963 ...................... 87,380.00 86,377.00 1,003.00 Included in the foregoing deductions were compensation of officers and other salaries and wages, as follows: Compensation Salaries and Year Ending Aug. 31 of officers wages 1961 ............................. $10,800 $23,606.97 1962 ............................. 19,442 27,518.47 1963 ............................. 22,285 30,883.00 Samuel Levine became ill in August 1957, and underwent surgery for cancer in September 1957. While in the hospital, he shared a room with an employee of the Internal Revenue Service, who on one occasion inquired as to whether Selco had a "sick pay plan," and advised that any such plan should be in writing. Thereafter, on October 1, 1957, a meeting was held at the home of Samuel Levine at which Samuel, Sophie, and Charles Levine were present, for the purpose of getting a "sick pay plan" into writing. The minutes of that meeting, as recorded and transcribed by Sophie Levine, provide in part as follows: RECORD OF MINUTES MINUTES OF A SPECIAL MEETING OF THE OFFICERS OF SELCO SUPPLIES, INC. HELD AT POUGHKEEPSIE NEW YORK ON THE FIRST DAY OF OCTOBER, 1957* * * * * * *
Also at this meeting, Howard E. Levine was elected by unanimous vote as Vice President.
At this meeting the Officers unanimously voted that the President be allowed to draw sick pay for the duration of his illness.
It was also voted upon at this meeting that anyone who might become ill be allowed to draw sick pay for the duration of their illness providing they are regular employees.
If the Corporation does not show a profit, such benefits will be adjusted in accordance with the profits of the Company. Under no circumstances can the sick pay amount to more than $100.00 per week.
(Signed) SOPHIE LEVINE,
Secretary SELCO SUPPLIES, INC.
Prior to the meeting of October 1, 1957, Selco had no written plan and no program, policy, or custom having the effect of a plan, concerning the payment of wages to employees during absence due to illness or physical injury. The employees of Selco, other than members of the Levine family, were never shown the minutes of the meeting held on October 1, 1957, nor were they ever shown any written rules or regulations pertaining to sick pay benefits. Them employees, were, however, told by either Samuel or Sophie Levine that they would be paid for any days of work missed because of illness, and they in fact received "sick pay" from Selco whenever they were absent from work because of illness. Such "sick pay," however, generally covered relatively short periods of from 1 to 3 days, and on occasion covered a period of 10 days or 2 weeks. There is no convincing evidence that any employee in fact received or would have received or was told that he would receive sick pay for any continuous period of time substantially in excess of several weeks.
From 1957 and throughout the years in issue (1960-62), as well as thereafter, Samuel Levine has received $100 per week from Selco. Although he retained the title of president until the latter part of 1961, he performed no services for the corporation from the time of his illness in 1957 until some time in 1964 or 1965. After his first operation for cancer in September 1957, he had five other operations, and spent most of his time during those years either in hospitals or in Florida, recuperating from his illness. He is presently acting in an advisory capacity to Selco, going to Selco's place of business once or twice a week when he is in Poughkeepsie, and giving advice over the telephone during the winter, when he is required to live in a warm climate.
Samuel Levine was born on January 30, 1900, so that he was under the age of 65 during all the years in issue herein. At no time did Selco have any written employee's pension or annuity plan, nor did Selco have any practice regarding the termination of services, due to age, of its employees.
Although Samuel Levine reported income from Selco of $5,200 in each of the years 1960, 1961, and 1962, petitioners in their joint returns excluded as "sick pay" from the "wages" received by both of them the amounts of $4,800, $5,200, and $5,800, respectively. In addition to other adjustments to petitioners' income, the Commissioner restored to income all amounts excluded as "sick pay," recharacterizing the payments as dividends. Petitioners Samuel and Sophie Levine now concede the correctness of all determinations made by the Commissioner in his statutory notice of deficiency to them dated July 23, 1965, including the additions to tax under sections 6651 (a) and 6653(a) of the Internal Revenue Code of 1954, other than the adjustments relating to sick pay. As to these, petitioners now contend that for each of the calendar years 1960, 1961, and 1962, $4,800 was properly excluded from their income as "sick pay," and that $400 a year constituted the payment of "salary."
In his statutory notice of deficiency to petitioner Selco Supplies, Inc., dated July 23, 1965, the Commissioner, in addition to other adjustments, disallowed deductions taken by Selco in its fiscal years ended August 31, 1961, 1962, and 1963, of $5,200, $5,800, and $5,200, respectively, on the grounds that these amounts, treated as payments of "sick pay" by Selco, actually represented nondeductible dividend distributions to its major stockholder, Samuel Levine. Selco concedes the correctness of all determinations made by the Commissioner with the exception of the disallowance of the amounts mentioned above, except that it is now contended that $600 of the $5,800 deducted in its fiscal year ended August 31, 1962, represented regular payment of salary to Samuel Levine rather than sick pay benefits. Should the payments made to Samuel Levine be found to constitute dividends, however, Selco concedes that it had current earnings and profits within the meaning of the Internal Revenue Code of 1954 during each of the taxable periods involved herein at least equal to the payments made to Samuel Levine.
OPINION
Samuel Levine was the majority stockholder and principal executive officer of Selco Supplies, Inc., a small family corporation. He underwent a cancer operation in September 1957, and on October 1, 1957, he and other officers of Selco held a meeting at his home at which it was voted that he "be allowed to draw sick pay for the duration of his illness," and it was also voted that "anyone who might become ill be allowed to draw sick pay for the duration of their illness providing they are regular employees." A limit of $100 per week was placed upon such "sick pay." The officers who voted the foregoing benefits were all members of Levine's immediate family, and no copy of any resolution, minutes, or any other writing setting forth these benefits was ever shown to any employee. Although it is quite true that employees were told that they would receive pay while absent on account of illness, there is no convincing evidence that they were informed of the existence of any "plan," or that such compensation would be paid indefinitely during a long period of illness extending for many months or years. And the evidence establishes that such sick pay was in fact paid to other employees for only relatively short periods. We hold that the amounts paid to Levine during the tax years 1960-62 did not in fact constitute sick pay excludable from gross income under section 105(d), I.R.C. 1954. In our opinion, the amounts were not given to him because he was an employee but were paid to him because of his dominant position as the principal stockholder of Selco; they were taxable as dividends.
We reach this conclusion notwithstanding the liberal interpretation given to the statute by section 1.105-5(a) of the regulations, where it is indicated that the plan need not be in writing and that the plan may provide different benefits for different employees. But the fundamental premise of the regulations is not only that there must be a plan, see John C. Lang, 41 T.C. 352, 355-357; Estate of Leo P. Kaufman, 35 T.C. 663, 666, affirmed 300 F.2d 128 (C.A. 6), but also that there must be some rational basis other than ownership of the business to justify discrimination among employees; i.e., that the so-called sick pay in question must in fact represent bona fide sick pay for employees rather than distributions to stockholders. Alan B. Larkin, 48 T.C. 629, affirmed 394 F.2d 494 (C.A. 1). The mere circumstance that the payments may be labeled sick pay for employees is not conclusive, and the Court is justified in examining the situation carefully to determine whether the label in fact speaks the truth. See Alan B. Larkin, supra, 48 T.C. at 633.
We cannot conclude that the payments in controversy, at least during the tax years 1960-62, represent bona fide sick pay to Levine as an employee. Selco was a small company. Its reported net income was almost negligible. It had only a small number of employees, and it provided benefits for them only on a modest scale. It had no pension plan for employees, and it gave them vacations of 1 week for the first year of employment and 2 weeks a year thereafter. It in fact gave them bona fide sick pay for relatively short periods of illness. But it is utterly incredible in view of its limited income and other circumstances that it would have undertaken the comparatively staggering financial burden of continuing to pay wages to its employees over an indefinite extended period of years of illness. While it is true that a bona fide plan for sick pay might have provided for a longer period on behalf of the president than would have been adopted for other employees, we do not believe that such period would have covered so extended a span of years as is before us now if he were not the principal stockholder and in fact the true owner of the business.
As we interpret Selco's "plan," assuming that it otherwise qualifies as a sick pay "plan," it would make payments to its employees for the "duration" of their illness only if such "duration" were a reasonable period of time. We reject as wholly unrealistic an interpretation whereby it was undertaking an obligation for any longer period in respect of its employees, and we conclude that Levine was receiving the payments in question in 1960-62, not because he was an employee, but because he was the principal stockholder. Such payments do not represent bona fide sick pay to an employee; rather, they constitute taxable dividends and are not deductible by Selco.
In view of the conclusion reached by us we do not pause to comment upon the discrepancy between the Levines' position that only $4,800 of the $5,200 received by him each year was sick pay and the position of the corporation that the entire $5,200 represented sick pay; nor is it necessary to consider the Government's further contention that there was no "plan" at the time Levine first became ill.
Decisions will be entered under Rule 50.