Opinion
Docket No. 64297.
1959-08-11
STOFFLET AND TILLOTSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Aaron M. Diamond, Esq., for the petitioner. William C. Baskett, Esq., for the respondent.
Aaron M. Diamond, Esq., for the petitioner. William C. Baskett, Esq., for the respondent.
1. All of the stock of petitioner corporation, a construction enterprise, was held by officers and employees of the corporation. On January 25, 1951, an agreement to sell their stock to new stockholders for a stated consideration was entered into. At the time of this agreement there were three contracts which, for all practical purposes, had been completed by petitioner corporation and it was agreed by the parties that when the final amounts were received by petitioner on these contracts, such payments would be disbursed by petitioner to the old stockholders. The amounts to be disbursed to the old stockholders were agreed upon on July 24, 1951. The amount was $12,888.27. Petitioner claimed this amount in an amended return filed in 1953 as a deduction for executives' salaries in 1951, thereby increasing its net operating loss for 1951 by that amount. The Commissioner disallowed the deduction in his determination of petitioner's 1951 net operating loss carryover to 1953. Held, the Commissioner is sustained. The $12,888.27 did not represent executives' salaries incurred by petitioner in 1951 and was not a deductible payment.
2. When the amount which petitioner corporation was to disburse to the old stockholders on account of the three contracts was agreed upon by the parties, July 24, 1951, petitioner did not have sufficient funds with which to make the distribution. A note was executed for the amount agreed upon, payable to Herbert M. Stofflet, who was acting for himself and the other old stockholders. The note was made payable January 24, 1952, and included interest in the body of the note to that date. The note was not paid until May 23, 1952. A total of $648.73 interest was incurred and paid on the note in 1952, and was claimed by petitioner as a deduction for interest. The Commissioner, in computing petitioner's net operating loss for 1952, disallowed the deduction. Held, the note was the obligation of petitioner and the $648.73 interest which petitioner incurred and paid in 1952 on this note is deductible as interest. The Commissioner's disallowance of the deduction is not sustained.
The respondent determined a deficiency in the income tax and excess profits tax of the petitioner for the taxable year 1953 in the amount of $8,868.46.
The computation of the tax as made by respondent and the reasons for the adjustments are contained in the statutory notice mailed to petitioner on June 25, 1956.
Adjustments to Income
The petitioner, by assignments of error, contests the adjustments made by the Commissioner to the net operating loss carryover from 1951 and 1952 to 1953 claimed by petitioner.
The issues here presented are: (1) Whether the amount of $12,888.27 paid to Herbert M. Stofflet in 1951 by judgment note is deductible by petitioner as a business expense for executives' salaries, and (2) whether the amount of $648.73 paid to Herbert M. Stofflet in 1952 was interest on an obligation of petitioner and is deductible by petitioner as interest.
FINDINGS OF FACT.
A stipulation and a supplemental stipulation of facts have been filed and are incorporated herein by reference.
Petitioner is a corporation organized and existing under the laws of Pennsylvania with its principal office located in Philadelphia. Petitioner's principal business activity is building construction.
Petitioner employed an accrual basis completed-contract method of accounting and filed United States corporation income tax returns for the calendar years 1950 to 1953, inclusive, as follows: For the
+---------------------------------------------------------+ ¦Adjustments to Income ¦ +---------------------------------------------------------¦ ¦Year 1953 ¦ +---------------------------------------------------------¦ ¦ ¦¦ ¦ +---------------------------------------------++----------¦ ¦Net income reported on return ¦¦$20,707.93¦ +---------------------------------------------++----------¦ ¦Additional income and unallowable deductions:¦¦ ¦ +---------------------------------------------++----------¦ ¦(a) Net operating loss deduction ¦¦13,537.00 ¦ +---------------------------------------------++----------¦ ¦Net income corrected ¦¦$34,244.93¦ +---------------------------------------------------------+
Explanation of Adjustment Year 1953 (a) Net operating loss deduction is adjusted as follows: Net operating loss 1951 revised— Shown on amended return (31,163.06) Add: Executive salaries 12,888.27 Balance (18,274.79) Less: Portion carried back to 1950 6,523.80 Balance to carry forward (11,750.99) Net operating loss 1952 revised— Shown on return (36,885.72) Add: Interest paid 648.73 (36,236.99) Total net operating loss 1953 (47,987.98) Net operating loss deduction taken on return for 1953 (61,524.98) Net adjustment 13,537.00
year 1950 with the collector of internal revenue, first district of Pennsylvania; for the year 1951 (an original and an amended return) with the collector of internal revenue, first district of Pennsylvania; for the year 1952 with the director of internal revenue, Philadelphia; and for the year 1953 with the district director of internal revenue, Philadelphia.
Prior to January 25, 1951, petitioner entered into construction contracts with Chester Housing Authority, National Bank of Germantown and Trust Company, and Harshaw Chemical Company. As of that date petitioner had substantially completed these contracts, but had not received the net proceeds due it as retainages.
On January 25, 1951, and until March 5, 1951, the total outstanding capital stock of petitioner was 580 shares distributed as follows:
+-----------------------------+ ¦Name ¦Shares ¦ +--------------------+--------¦ ¦ ¦ ¦ +--------------------+--------¦ ¦Herbert M. Stofflet ¦200 ¦ +--------------------+--------¦ ¦Charles W. Shartzer ¦200 ¦ +--------------------+--------¦ ¦Winona M. Evans ¦50 ¦ +--------------------+--------¦ ¦Herman H. Michner ¦50 ¦ +--------------------+--------¦ ¦Leslie R. Goodell ¦50 ¦ +--------------------+--------¦ ¦Percy Martin Swank ¦30 ¦ +--------------------+--------¦ ¦ ¦580 ¦ +-----------------------------+
This group of shareholders is hereinafter referred to as the sellers. The sellers were all employees or officers of petitioner prior to January 25, 1951.
On January 25, 1951, the sellers entered into an agreement with Henry David Epstein & Co., Inc., Jordan P. Snyder, and John Frost, hereinafter referred to as the purchasers, for the sale of the capital stock of petitioner. The purchasers agreed to pay for the stock a sum which represented the cash balance in petitioner's bank account, plus a sum equal to the appraised value of petitioner's inventory.
The amount of $12,888.27 paid to former stockholders of the taxpayer, in accordance with the terms of an agreement of sale of stock between them and the new stockholders, is not deductible as compensation for services in 1951 nor is it (or any part of it) excludible from the taxpayer's gross income for 1951.The deduction of interest in the amount of $648.73 in 1952 has been disallowed because it does not represent interest on an obligation of the taxpayer.The net operating loss deduction allowable in 1953 is adjusted herein to reflect the foregoing findings.Excerpts from agreement of January 25, 1951:2. That the Sellers, each for himself or herself, agree to sell to the Purchasers and the Purchasers agree to buy from the Sellers the said Five Hundred Eighty (580) shares of the common stock of Stofflet and Tillotson together with all dividends incomes and issuances therefrom and all rights of presumption for the price of sum of One Hundred ($100.00) Dollars per share plus the amount to be allocated to said shares of stock from the valuation of the inventory as hereinafter set forth.3. That in addition to the payments hereinabove set forth for the consideration of the transfer of the stock, the Purchasers shall pay a sum of money to the stockholders in proportion to their stock interest and in an amount equivalent to their proportionate interest in the inventory owned by the Corporation. Said inventory shall consist of equipment, tools, furniture, supplies, materials, dues, insurances, stationery, etc., being the contents and property of the Corporation on the premises known as 2043 Eastburn Ave., Philadelphia, Penna., or elsewhere. Said sum of money shall not exceed Thirty Thousand ($30,000.00) Dollars, but shall be in an amount to be fixed by an appraisal of the said inventory by a representative of the Sellers and a representative of the Purchasers. This appraisal shall be as of the date of settlement as hereinafter fixed.5. It is understood that the sum of Five Thousand ($5,000.00) Dollars has been deposited by the Purchasers as down money with the Sellers, said sum to be forfeited to Sellers as liquidated damages in the event that Purchasers refuse to carry out their agreement to purchase. An additional sum of Fifty-Eight Thousand ($58,000.00) Dollars, which is the cash balance in the bank account of the Corporation, plus such sum as may be determined upon in the manner described hereinabove for the value of the inventory owned by the Corporation shall be paid at the time of settlement; * * *
The sellers agreed that petitioner would have no contracts for the purchase or sale of merchandise or supplies, except in connection with the three aforementioned construction contracts; and both purchasers and sellers agreed that income or expenses involved in the three specific contracts would become the property of the sellers
and would be paid over to them by the corporation. The sellers also agreed that on the settlement, each would deliver an executed release discharging petitioner from any liability to them, for the purpose of inducing purchasers to buy the stock.
Agreement of January 25, 1951:8. That the Sellers and Purchasers covenant and agree that, at the time of settlement:(a) the said Corporation will not have any contract for personal services to be rendered, except such as may have been made by the Purchasers or their duly authorized representative.(b) the said Corporation will not have any contract for the purchase or sale of merchandise or of supplies, except the Chester Housing Authority, the National Bank of Germantown and Trust Company, and Harshaw Chemical Company, and except such as may have been made with the consent and authorization of the Purchasers or their duly authorized representative.(c) That any income or expenses involved in the pending contracts referred to in Paragraph 8(b) hereof shall be the property and obligation respectively of the Sellers or their duly authorized representative.
A separate clause appended to the agreement following the signatures of the purchasers and the sellers stated that petitioner agreed to the terms of the agreement and further agreed to do whatever was necessary to complete its obligations under the agreement. This clause was signed by Herbert M. Stofflet (hereinafter referred to as Stofflet) as petitioner's president and attested by Winona M. Evans as petitioner's secretary.
The agreement was made in Philadelphia, Pennsylvania, and contemplated performance in the same place.
On March 5, 1951, all the stock owned by the sellers was transferred to the purchasers and the purchasers paid as consideration therefor $66,403.20 in cash and gave four notes of $4,250 each. None of these amounts is in controversy. At the same time releases, executed by the sellers, discharging petitioner from any and all claims accruing to the sellers up until the time of settlement, were delivered for the purpose of inducing the purchasers to consummate the agreement of January 25, 1951.
Stofflet acted as agent for the sellers throughout the stock sale transaction.
Between March 5, 1951, and July 24, 1951, Stofflet, acting as agent for the sellers, met with the purchasers for numerous discussions concerning the balance due the sellers under the provisions of paragraph 8(c) of the agreement of January 25, 1951, as to the proceeds of the three aforementioned contracts. The purchasers finally agreed that petitioner corporation should pay and Stofflet, acting as agent for the sellers, agreed to accept a promissory note for $13,292.06 as the full amount due the sellers as proceeds from these contracts. This $13,292.06 promissory note included $12,888.27 which the parties had agreed was due the old stockholders under the terms of the contract and included $403.79 as interest to the due date of the note. On July 24, 1951, the purchasers, on behalf of petitioner corporation, executed their personal judgment note to Stofflet in the amount of $13,292.06. The note was due January 24, 1952, and bore interest at the rate of 6 per cent annum from its due date.
On May 15, 1952, officers of petitioner executed, and on May 22, 1952, the appropriate collector received, petitioner's corporation income tax return for 1951. Items 1 to 31 of the return were not completed, and reference was made to attached schedules. By the profit and loss statement attached to this return, petitioner showed on accrued gross profit from completed contracts of $9,457.67, general and administrative expenses of $46,178.57, and, after other adjustments, a net operating loss of $18,274.79. Included in the general and administrative expenses were executives' salaries of $19,949.18, of which (as shown by a schedule of compensation of officers) $9,269.18 was paid to Stofflet as president.
On May 23, 1952, petitioner paid by check drawn to the order of Stofflet the sum of $13,537. This check was delivered to, and received by Stofflet in full discharge of the judgment note of July 24, 1951, with interest of $244.94 from January 24, 1952, the due date of the note.
On April 21, 1953, officers of petitioner executed, and on April 23, 1953, the appropriate director received, petitioner's amended corporation income tax return for 1951. Items 1 to 31 of the return were not completed, and reference was made to attached schedules. By a profit and loss statement, attached to this return, petitioner still showed an accrued gross profit from completed contracts of $9,457.67, but general and administrative expenses of $59,066.84 (an increase of $12,888.27 over that shown on the original return), and a net operating loss of $31,163.06 (an increase of $12,888.27 over that shown on the original return). Included in the general and administrative expenses were executives' salaries of $32,837.45 (an increase of $12,888.27 over that shown on the original return), of which, as shown by a schedule of compensation of officers, $22,157.45 was paid to Stofflet as president (an increase of $12,888.27 over that shown on the original return).
On March 12, 1953, officers of petitioner executed, and thereafter the appropriate director received, petitioner's corporation income tax return for 1952. Items 1 to 31 of the return were not completed, and reference was made to attached schedules. By the profit and loss statement attached to the return petitioner showed a net operating loss of $36,885.72. One of the deductions taken to produce this net loss was interest paid in the amount of $761.23. The $761.23 interest item included $648.73 accrued interest on the note of $13,292.06 dated July 24, 1951. The Commissioner disallowed the deduction of $648.73 on the ground that it was not paid on an obligation which petitioner owed.
On March 15, 1954, officers of petitioner executed, and on March 16, 1954, the appropriate director received, petitioner's corporation income tax return for 1953. Petitioner deducted $61,524.98 as net operating losses carried forward from the years 1951 and 1952. The Commissioner made adjustments to the net operating loss deductions to be carried forward to 1953 as have been shown in our preliminary statement.
OPINION.
BLACK, Judge:
The questions before us arise under section 23(a)(1)(A) and (b) of the Internal Revenue Code of 1939.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *(b) INTEREST.— All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this chapter.
In its brief petitioner contends that the $12,888.27, which has been discussed in our Findings of Fact and which was disallowed as a deduction by the Commissioner in determining petitioner's net operating loss for 1951, should have been allowed as a deduction for additional salaries for services to petitioner. On the other hand, respondent contends that the $12,888.27 in question was paid the old stockholders, of whom Stofflet was one, as additional sale price of their stock, which sale took place early in 1951.
We do not agree with either version as to what the payment of the $12,888.27 was for. The facts in the record do not support either version. From the facts which have been stipulated and a very considerable amount of oral testimony, we have made a finding of fact that the $12,888.27 in question represented money which the parties had agreed was to be disbursed to the old stockholders by petitioner corporation under the terms of the agreement of January 25, 1951. The amount was clearly not to be paid as additional compensation to Stofflet for any services that he was to render to petitioner. It was on the representation that the $12,888.27 was paid as additional executives' salaries to Stofflet that petitioner filed an amended return for 1951 on April 21, 1953, and undertook to take this amount of $12,888.27 as additional deduction for executives' salaries. Stofflet testified at the hearing and denied that he had received any such additional compensation. He furnished a list of the old stockholders, stockholders after the note dated July 24, 1951, was paid, May 23, 1952. It seems plain that the disbursement to the old stockholders was made in accordance with the agreement of January 25, 1951, respecting the three named contracts. It seems to us that it is entirely clear from all the evidence that the $12,888.27 in question was not paid by petitioner as additional salary incurred and accrued to Stofflet in 1951. Respondent is sustained in his disallowance of the claimed deduction.
Issue (2) is whether petitioner is entitled to an interest deduction in 1952 of $648.73 and that petitioner's net operating loss deduction for 1952 allowed by the Commissioner should be increased by that amount. The facts do show that petitioner did incur and pay interest in 1952 of $648.73 in addition to the principal amount of $12,888.27 which the corporation (petitioner) was obligated to pay the old stockholders. We think petitioner must be sustained as to this issue.
The evidence shows that the note which was executed on behalf of petitioner by its three new stockholders was dated July 24, 1951, and was for the principal sum of $13,292.06 and was due 6 months after date, on January 24, 1952. Therefore, it is plain that the note included $403.79 interest to cover the period between the date of its execution and the date it was due, January 24, 1952. We hold that this $403.79 interest accrued in 1952, the due date of the note. The note was not paid on its due date. In addition to this interest of $403.79, included in the body of the note, petitioner paid interest of $244.94 to cover the interest on the note from the time it was due, January 24, 1952, to the date it was paid, May 23, 1952. The note was to bear interest from the date it was due, January 24, 1952, at the rate of 6 per cent per annum to the date of payment. As a matter of fact, the interest on the note of $13,292.06 from January 24, 1952, to the date it was paid, May 23, 1952, at 6 per cent per annum would be a somewhat larger sum than the $244.94 actually paid. However, petitioner makes no point of that fact and only claims a deduction for interest incurred and paid in 1952 of $648.73.
From the evidence we hold that petitioner did incur and pay in 1952, $648.73 as interest ($403.79 plus $244.94) on an obligation which it owed and paid in full May 23, 1952, and it is entitled to a deduction of that amount in arriving at its net operating loss for 1952. The Commissioner's disallowance of this deduction of interest for 1952 is not sustained. The Commissioner's argument in his brief in support of his disallowance of this $648.73 deduction for 1952 as interest is that the interest, although actually and indisputably paid by petitioner, was paid on behalf of the stockholders and not on an obligation of petitioner. This contention of the Commissioner is contrary to the evidence in the case and we hold against it.
Decision will be entered under Rule 50.
+-----------------------------------------+ ¦Year 1953 ¦ +-----------------------------------------¦ ¦Net income reported on return¦¦$20,707.93¦ +-----------------------------------------+
Additional income and unallowable deductions: (a) Net operating loss deduction 13,537.00 Net income corrected $34,244.93
Explanation of Adjustment Year 1953 (a) Net operating loss deduction is adjusted as follows: Net operating loss 1951 revised— Shown on amended return (31,163.06) Add: Executive salaries 12,888.27 Balance (18,274.79) Less: Portion carried back to 1950 6,523.80 Balance to carry forward (11,750.99)
Net operating loss 1952 revised— Shown on return (36,885.72) Add: Interest paid 648.73 (36,236.99) Total net operating loss 1953 (47,987.98) Net operating loss deduction taken on return for 1953 (61,524.98) Net adjustment 13,537.00