Opinion
Docket No. 6301-66.
1968-03-18
VINCENT E. OSWALD AND ELEANOR H. OSWALD, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Sidney B. Gambill and William J. Kenney, for the petitioners. Joseph M. Abele and Donald Howser, for the respondent.
Sidney B. Gambill and William J. Kenney, for the petitioners. Joseph M. Abele and Donald Howser, for the respondent.
SEC. 162(a)— UNREASONABLE SALARY REPAID TO PAYOR.— A repayment of a part of an officer's salary for 1960 is deductible where made as required by a bylaw adopted by the payor corporation at the time of its incorporation in 1952 which required, inter alia, that a part of an officer's salary disallowed as a deduction for income tax purposes be repaid to the corporation.
The Commissioner determined deficiencies in the petitioners' income tax of $16,765.12 for 1963 and $2,462.91 for 1964.
The parties have settled a number of issues and the only remaining issue is whether the petitioners are entitled to a deduction of $5,000 for 1964 representing the return of that amount by Vincent to Electric Manufacturing & Repair Co. which had paid that amount to him as salary in 1960.
FINDINGS OF FACT
Eleanor H. Oswald and Vincent E. Oswald (hereinafter called Vincent) are married persons residing at 651 Valleyview Road, Pittsburgh 16, Pa., which was their legal address at the time of filing the petition in this case.
Vincent was president from 1959 through 1964 of Electric Manufacturing & Repair Co. (hereinafter called Electric), a Pennsylvania corporation. His compensation from Electric for its fiscal year ended October 31, 1960, as reported by him and Electric, was salary of $15,000, bonus of $30,120, computed as 4 percent of sales, and a bonus of $5,000.
A revenue agent upon audit of Electric's 1960 income tax return, determined that reasonable compensation of Vincent for Electric's fiscal year ended October 31, 1960, was $45,120 and he proposed that the additional $5,000 paid should be disallowed as a deduction. This determination was accepted by Electric on June 5, 1964, and a resulting deficiency was paid in 1964.
The original incorporators of Electric were:
+-------------------------------------------------------------+ ¦ ¦Shares of ¦ +----------------------------------------------+--------------¦ ¦ ¦common stock ¦ +----------------------------------------------+--------------¦ ¦S.R. McBride ¦50 ¦ +----------------------------------------------+--------------¦ ¦William S. Richardson and Gladys I. Richardson¦50 ¦ +----------------------------------------------+--------------¦ ¦Robert B. Lampkin ¦50 ¦ +----------------------------------------------+--------------¦ ¦Vincent ¦500 ¦ +-------------------------------------------------------------+
Fifty shares of 7-percent cumulative preferred stock of $100 par value were issued to William S. Skelly and were redeemed by the corporation on January 29, 1955.
The bylaws of Electric, approved at its first meeting of incorporators held on December 16, 1952, contain the following provisions:
Any payments made to an officer of the Corporation such as a salary, commission, bonus, interest, or rent, or entertainment expense incurred by him, which shall be disallowed in whole or in part as a deductible expense by the Internal Revenue Service, shall be reimbursed by such officer to the Corporation to the full extent of such disallowance. It shall be the duty of the Directors, as a Board, to enforce payment of each such amount disallowed. In lieu of payment by the officer, subject to the determination of the Directors, proportionate amounts may be withheld from his future compensation payments until the amount owed to the corporation has been recovered.
At a meeting of the board of directors of Electric on August 12, 1964, the following resolutions, among others, were adopted:
Mr. Oswald stated that it had been directed to his (Mr. Oswald's) attention that a provision contained in the By-laws of the Corporation, Article 3, Section G obligated:
Any payments made to an officer of the Corporation such as a salary, commission, bonus, interest, or rent, or entertainment expense incurred by him, which shall be disallowed in whole or in part as a deductible expense by the Internal Revenue Service, shall be reimbursed by such officer to the Corporation to the full extent of such disallowance. It shall be the duty of the Directors, as a Board, to enforce payment of each such amount disallowed. In lieu of payment by the officer, subject to the determination of the Directors, proportionate amounts may be withheld from his future compensation payments until the amount owed to the corporation has been recovered.
It was the opinion of legal counsel that the foregoing By-law provision constituted a binding and enforceable claim on the part of the Corporation for recovery of any salary, commission, bonus, interest, or rent which shall be disallowed in whole or in part as a deductible expense by the Internal Revenue Service.
As a result of the foregoing, Mr. V. E. Oswald, and Mr. James S. Hook offered to deliver their checks payable to the order of the Corporation, in the amounts of $5,000.00 and $1,200.00 in full settlement of their existing obligation to the Corporation on account of the I.R.S. partial disallowance of the officers' compensation.
Upon motion duly made and carried, the following resolution was adopted:
RESOLVED, that the offers of Messrs. Oswald and Hook to pay to the Corporation the amounts of $5,000.00 and $1,200.00 respectively be and hereby accepted as discharged in full of their obligations to the Corporation.
Vincent repaid Electric $5,000 by his check dated August 18, 1964.
Vincent was the owner of 400 of the 500 outstanding shares of stock of Electric throughout the calendar years 1962 and 1963. James Hook held the other 100 shares of Electric as the guardian for Gretchen Oswald, daughter of Vincent.
On June 27, 1964, Vincent and Hook exchanged the 500 shares of common stock of Electric for 100,000 shares of the common stock of Pittsburgh Reflector Co. following a recapitalization of Pittsburgh Reflector Co., described in a letter ruling dated May 19, 1964.
All of the shareholders of Pittsburgh Reflector Co. had not made their exchanges provided for in the ruling of May 19, 1964, and on September 30, 1964, the following numbers of shares of Pittsburgh Reflector Co. were outstanding:
+--------------------+ ¦ ¦Shares ¦ +-----------+--------¦ ¦Class A ¦2,758 ¦ +-----------+--------¦ ¦Class B ¦20,704 ¦ +-----------+--------¦ ¦New common ¦283,862 ¦ +-----------+--------¦ ¦Total ¦307,324 ¦ +--------------------+
The numbers of shareholders of Pittsburgh Reflector Co., as of September 30, 1964, were as follows:
+--------------------------+ ¦ ¦Shareholders ¦ +----------+---------------¦ ¦Class A ¦18 ¦ +----------+---------------¦ ¦Class B ¦123 ¦ +----------+---------------¦ ¦New common¦455 ¦ +----------+---------------¦ ¦Total ¦596 ¦ +--------------------------+
On September 30, 1964, the following shareholders owned 159,743 shares of the new common stock of Pittsburgh Reflector Co.:
+--------------------------------------------------------------+ ¦ ¦Shares ¦ +-----------------------------------------------------+--------¦ ¦E.H. Oswald, wife of petitioner ¦25 ¦ +-----------------------------------------------------+--------¦ ¦Gretchen Oswald ¦5,175 ¦ +-----------------------------------------------------+--------¦ ¦Vincent ¦134,273 ¦ +-----------------------------------------------------+--------¦ ¦T. M. Hook, brother-in-law of Vincent and custodian ¦ ¦ +-----------------------------------------------------+--------¦ ¦under the Uniform Gift for Minors Act of Pennsylvania¦ ¦ +-----------------------------------------------------+--------¦ ¦for Gretchen Oswald ¦20,000 ¦ +-----------------------------------------------------+--------¦ ¦Total ¦159,473 ¦ +--------------------------------------------------------------+
None of the above shareholders held any of the class A or class B shares of said corporation.
The lawyer for Electric at the time of incorporation wrote the bylaw and a lawyer at a directors meeting of Electric in 1964 advised Vincent to repay the $5,000 to Electric because the bylaw was enforceable and required repayment.
All stipulated facts are incorporated herein by this reference.
OPINION
MURDOCK, Judge:
The Commissioner supplies no real support for his disallowance of the deduction claimed by the petitioners. He argues first, ‘Petitioner's repayment in 1964 was voluntary and not compulsory’ but the evidence is directly to the contrary. The bylaw was adopted in 1952 and its effect was prospective. The record of a meeting of the board of directors of Electric on August 12, 1964, shows the opinion of legal counsel to be that the bylaw requiring this repayment ‘constituted a binding and enforceable claim on the part of the Corporation.’ Vincent testified that he made the repayment because legal counsel advised him that he would have to repay the $5,000 because the bylaw required him to repay it and could be enforced.
The Ernest Berger, 37 T.C. 1026, case involved facts materially different from those herein. The salaries in Berger were paid in 1953 and 1954 whereas the corporate action under which they were returned was not taken until 1956 after the Commissioner had disallowed portions of the salaries. Here the bylaw was adopted in 1952 at the time the corporation was formed and it was still in effect when the salaries of Oswald and Hook were paid in 1960 and when those salaries were held to be excessive and returned in 1964. Oswald returned the $5,000 after receiving legal advice that the bylaw was enforceable and the repayment was necessary. If he had not repaid it, it could have been withheld from his later salary. It was a deductible expense of his business as an officer of Electric under the circumstances of its return to Electric.
The Commissioner stated that he ‘agrees with the petitioner that section 1341’ is not applicable. The petitioner mentioned that section but does not press its applicability. The briefs do not require any discussion of that section herein.
The Commissioner's other argument is that in any event ‘the repayment is not deductible because it did not serve any business purpose and was not ordinary and necessary to petitioner's position as an officer of the corporation.’ The bylaw clearly served a business purpose of Electric since it enabled Electric to recover the amount of the ‘unreasonable’ salary which caused it to lose the deduction. Obviously this recovery would help Electric to pay the resulting deficiency and would add to the funds of the corporation for all purposes. The purpose of the bylaw was not to give Vincent a tax deduction, as claimed by the Commissioner. A deduction, if allowed to Vincent, will reduce his tax for 1964 but he would be better off financially if he did not have to repay the corporation. The Commissioner claims that the tax saving to Vincent would be greater than the deficiency paid by Electric. Not only is there a lack of evidence to support this claim but this point would not be decisive if proven to be true. Vincent had to lose the $5,000 before he could have a tax deduction and it would be less than $5,000. Cf. Joseph P. Pike, 44 T.C. 787; Laurence M. Marks, 27 T.C. 464. The bylaw was prospective and not retroactive in its effect. Cases involving a voluntary retroactive agreement are not in point here. The bylaw applied to all officers of Electric, not to Vincent alone. It was necessary in his business as an officer of Electric to abide by the bylaw. Cf. Commissioner v. Tellier, 383 U.S. 687. The Electric stock was owned by Pittsburgh Reflector Co. when Vincent returned the $5,000 and Pittsburgh Reflector Co. had many stockholders at that time.
The Commissioner has not cited any case involving a factual situation like, or even similar to, the one here present. Cf. United States v. Lewis, 340 U.S. 590; Healy v. Commissioner, 345 U.S. 278. Cases cited which are distinguishable on their facts are not controlling.
Decision will be entered under Rule 50.