Court Opinion

ID: 4588662
Source: CourtListenerOpinion
Date Created: 2020-11-20 18:42:32.342934+00
Date Added: 2024-06-11T07:50:06.648795
License: Public Domain

KLUG & SMITH CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Klug & Smith Co. v. CommissionerDocket No. 5191.United States Board of Tax Appeals18 B.T.A. 966; 1930 BTA LEXIS 2552; January 31, 1930, Promulgated *2552  Commissioner's disallowance of a deduction for officers' salaries reversed.  A. T. Smith, Esq., and Virgil Y. Moore, Esq., for the petitioner.  W. Frank Gibbs, Esq., and O. W. Swecker, Esq., for the respondent.  MURDOCK *966  The Commissioner determined a deficiency in the income and profits taxes of the petitioner for the year 1918 in the amount of $11,923.69.  The petitioner claims that the Commissioner erred in disallowing as a deduction $18,597.10 of the amount paid to its officers as salaries in 1918.  FINDINGS OF FACT.  The petitioner is a Wisconsin corporation with its principal officers in the City of Milwaukee.  L. J. Klug is its secretary and treasurer.  He was graduated in civil engineering in the University of Wisconsin in 1898.  In 1900 he had a fellowship at the University.  Since that time and until 1912 he has been engaged in engineering work as an employee of various corporations or as an employee of the City of Milwaukee.  He is a member of several engineering societies.  Fred W. Smith is president of the petitioner.  He is not a college graduate, but studied his profession in his spare time while employed by various*2553  corporations from 1901 until 1911, at which later time he went into business for himself as a consulting engineer.  He is a member of several engineering societies.  These two men have very high professional standing as consulting engineers.  In 1912 they formed a partnership under the name of Klug & Smith and carried on a business as consulting engineers.  Later, the partners began to superintend the construction of work designed by them, to buy the materials, and to hire the necessary labor to complete the work.  In some cases clients paid material and labor bills, while in other cases the partnership paid the bills and was promptly reimbursed by the clients.  At the beginning of the year 1917, which year immediately precedes the taxable year here in question, these two men formed the petitioner corporation to carry on their partnership business, which by that time had grown to be an extensive and prosperous one.  During 1917, and during the taxable year here in question, the business was continued without material change from the way in which it had *967  been conducted under the partnership.  The two men, Klug and Smith, personally conducted almost all of the business*2554  of the petitioner.  They were approached by clients, after which they designed the work to suit the clients, purchased materials, employed labor and supervised the erection and construction of the buildings and other structures built.  They employed only one technical man in 1918, who worked under their direct supervision.  The petitioner made no profit from the purchase of materials or the employment of labor for its clients, but any benefit so derived was passed on to its clients.  The petitioner was compensated on the basis of a percentage of the cost of the work done.  It 1917 the total cost of the buildings erected by the petitioner was about $800,000 and in 1918 it was about $1,300,000.  The par value of the petitioner's capital stock outstanding on December 31, 1918, was $100,000.  At a special meeting of the board of directors of the petitioner, held on the second day of February, 1918, the following resolution was adopted: WHEREAS, the earnings of the corporation are due largely to the engineering knowledge and training of Fred. W. Smith, and L. J. Klug, President and Secretary, respectively, and it is necessary to fix their compensation for services during the time each*2555  shall be actively engaged in the business of the corporation during the year 1918.  Now, therefore, BE IT RESOLVED, that the salaries of Fred W. Smith, President, and L. J. Klug, Secretary, for the year 1918, be and hereby is fixed at the sum of One Thousand Dollars per month to each of them, payable to each at the end of each and every month, and that at the end of the year each of them shall receive as salary the further sum of an amount equal to one-third of the net profits of the corporation; provided, however, that if either of said officers shall not be active in the affairs of the corporation for any period exceeding one week at any one time, a proportionate deduction shall be made from such salary.  A resolution exactly like this one had been adopted for 1917, the only previous year during which the corporation had been in existence.  In interpreting the resolution for 1917 and in paying the salaries for that year, all expenses, including the regular salaries of $12,000 each to Klug and Smith, were deducted from the petitioner's gross income, and the remainder was divided into three equal parts, one part representing the additional compensation to be paid Klug, one*2556  part representing the additional compensation to be paid Smith, and the remaining part representing the net income of the petitioner after deduction of all salaries to Klug and Smith.  The total compensation to Klug and Smith for that year, thus arrived at, was $47,242.30.  For the year 1918, and pursuant to the resolution of February 2, 1918, the petitioner credited Klug and Smith with regular salary *968  of $12,000 each and with an additional amount of $15,814.63 as extra compensation.  On its return it deducted $55,629.26, the total of the above amounts, as an ordinary and necessary expense of the business for 1918.  The Commissioner allowed $37,032.16 of this amount and disallowed the balance of $18,597.10.  In determining the deficiency, the Commissioner used $41,304.15 as the amount which represented the net income of the petitioner for the year 1918 after allowing officers' salaries, as above set forth.  Fifty-five thousand six hundred twenty-nine dollars and twenty-fix cents was a reasonable allowance for salaries or other compensation for personal services actually rendered the petitioner by Klug and Smith in the taxable year.  This amount was an ordinary and*2557  necessary expense paid or incurred by the petitioner during the taxable year in carrying on its trade or business.  OPINION.  MURDOCK: Section 234(a)(1) of the Revenue Act of 1918 allowed, in computing the net income of a corporation, the deduction of 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 compensations for personal services actually rendered.  Evidence has been offered of the training, experience and value to the corporation of the officers Klug and Smith.  From this evidence it appears that these two men were largely responsible for the profits resulting from the business of the corporation, which business they had only shortly before carried on as partners.  Clients employed the petitioner in order to secure the services of these two men.  In rendering these services, the two men worked early and late.  After deduction of their compensation, the corporation had sufficient net income remaining to represent a reasonable return on the par value of its capital stock.  We do not know just why the Commissioner disallowed a part of the deduction claimed. *2558  Unless there is something about the circumstances of the particular case which suggests the necessity for the substitution of our judgment of the reasonableness of salaries for that of the directors of the corporation, we will be slow to make such substitution.  There is no such necessity in this case.  ; ; ; ; cf. . Judgment will be entered under Rule 50.