Court Opinion

ID: 4608500
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:42:51.792909+00
Date Added: 2024-06-11T07:53:43.213943
License: Public Domain

C. S. FERRY & SON, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.C. S. Ferry & Son, Inc. v. CommissionerDocket Nos. 23211, 36759.United States Board of Tax Appeals18 B.T.A. 1261; 1930 BTA LEXIS 2488; February 20, 1930, Promulgated *2488  A reasonable allowance for salaries of corporate officers, rendered under a contract providing for a distribution of profits determined.  Philip Nichols, Esq., for the petitioner.  G. S. Herr, Esq., Ralph S. Scott, Esq., and Edwin M. Niess, Esq., for the respondent.  PHILLIPS *1261  These proceedings were consolidated for hearing and involved deficiencies in income tax for the calendar years 1922, 1923, 1924, and 1925, in the respective amounts of $1,061.13, $4,614, $9,206.36, and $7,695.43.  The petitions assert four errors, three of which are waived.  The remaining issue is whether respondent erred in disallowing as deductions certain salaries paid to petitioner's officers in the years 1923, 1924, and 1925.  FINDINGS OF FACT.  Petitioner is a corporation organized on January 1, 1922, under the laws of Massachusetts with its principal office at 40 Center Street, Pittsfield, Mass., and is the successor to a partnership of the same name which began business in 1886, and whose members at that time were Charles K. Ferry and his father.  They began by purchasing a small lumber yard in Pittsfield in 1887.  Fred G. Ferry, brother of Charles, *2489  became a member of the firm.  The father died in 1899.  From the first and continuing through the years in question the two brothers were in active control first of the partnership and later of the corporation.  The partnership was and petitioner is engaged in the retail lumber business with occasional sales *1262  to other retailers.  These sales were made in the City of Pittsfield, which has a population of about 40,000, and in the adjacent country districts.  While other concerns engaged in this business have failed, from the inception of the partnership this business has never closed a year with a loss.  Charles K. Ferry and Fred G. Ferry have since the organization of petitioner been its president and treasurer, respectively, and Earl Ferry, son of Fred G. Ferry, its secretary.  Petitioner owned a lumber yard at Pittsfield and during the taxable years employed in its office in addition to the above a bookkeeper, a stenographer and a girl who operated the bookkeeping machine.  The yard force consisted of a foreman and from twenty to twenty-five men.  Charles K. Ferry and Fred G. Ferry have from the beginning given all their time to the business except that Charles K. Ferry, *2490  who is a director in two banks in Pittsfield, has given a small part of his time to making appraisals for loans by the banks, his judgment being generally accepted by the other appraisers.  The office hours were first from 7 a.m. to 6 p.m. and later from 7.30 a.m. to 5 p.m. Both the brothers often worked over time and at home in the evenings making estimates for contractors who were purchasing their lumber.  Charles K. Ferry did the purchasing and also attended generally to outside matters.  Fred G. Ferry attended to accounting matters and other office work and at times made sales.  During the years in question the par value of petitioner's outstanding stock was $100,000 of which 47 1/2 per cent was owned by Charles K. Ferry; 47 1/2 per cent by Fred G. Ferry, and 5 per cent by Earle Ferry.  Under date of February 24, 1923, a contract was entered into between petitioner as party of the first part and Charles K. Ferry as party of the second part, the material parts of which read: WHEREAS the party of the first part is desirous of obtaining the services of the party of the second part in the conduct of the business of the party of the first part, NOW THEREFORE the parties covenant*2491  and agree to and with each other, as follows: The party of the second part covenants and agrees to give to the party of the first part his best energies, his undivided efforts, and such time in the conduct of the business as the party of the first part may require for a period of one year from January 1, 1923, to December 31, 1923, inclusive.  The party of the first part covenants and agrees to pay to the party of the second part, during the period of this contract, a salary of seventy-five (75) dollars per week, payable weekly, and in addition to the foregoing weekly cash salary, it is also understood and agreed between the parties that the party of the second part is entitled, if the conditions warrant, to receive a further payment in accordance with the terms of the vote of the Board of Directors of C. S. Ferry & Son, Inc. at a meeting held on February 24, 1923, which vote was as follows: *1263  "On motion duly made, seconded and carried, it was unanimously voted that the President and Treasurer be and they are hereby authorized, directed and empowered to execute and sign in the name of the corporation, contracts for services with the following named persons the period*2492  beginning January 1, 1923, and ending December 31, 1923, at the following weekly wages: Charles K. Ferry - Seventy-five (75) Dollars per week.  Fred G. Ferry - Seventy-five (75) Dollars per week.  It is also understood that in addition to the aforesaid weekly cash salary, in the event that the corporation makes a net profit for the year ending December 31, 1923, of not less than Eighteen Thousand (18,000) Dollars as shown by the auditor's report, then each of the above-named shall be entitled on December 31, 1923, to draw an additional salary or bonus at the rate of Twenty-five (25) Dollars per week, per man, it being understood that if the corporation makes a net profit for the year ending December 31, 1923, of Twenty-Thousand (20,000) Dollars or more than Twenty Thousand (20,000) Dollars, then the entire excess of net profits over and above Twenty Thousand (20,000) Dollars shall be divided pro rata equally between the above-named persons and the pro rata share of each shall be due and payable on December 31, 1923.  If the net profits for the year ending December 31, 1923, as shown by the auditor's report, do not exceed Fifteen Thousand Four Hundred (15,400) Dollars, it is understood*2493  and agreed that no payment other than the weekly cash payments shall be made to the above-named persons." In the event of the termination of this contract by reason of death or otherwise, all payments by the party of the first part to the party of the second part shall be pro rated as of the time of said termination.  A like contract was entered into on the same date between petitioner and Fred G. Ferry, and like contracts were entered into between the same parties in the years 1924 and 1925 for those years, except that in the contracts for 1925 the salary of each brother was fixed at a flat rate of $150 per week with an equal division of all profits over $20,000.  Under the above contracts petitioner paid to Charles K. Ferry and Fred G. Ferry in equal parts the following sums in the following years: $47,825 in 1923, $79,483.02 in 1924, and $74,197.48 in 1925.  The gross sales of petitioner amounted to $451,952.02 in 1923, $523,668.07 in 1924, and $548,686.27 in 1925.  The net profits as shown by the books amounted to $20,000 at the end of each of said three years.  Petitioner returned net income for 1923 of $26,953.64; for 1924 of $23,550.70, and for 1925 of $20,000.  Petitioner's*2494  surplus and undivided profits at the end of the years 1922, 1923, 1924, and 1925 were, respectively, the following amounts: $22,072.28, $33,067.45, $36,896.89, and $45,503.05.  Petitioner has paid the following dividends on the following dates: on December 31, 1923, $9,000; on December 31, 1924, $10,000; and on November 25, 1925, $10,000.  For the year 1922 petitioner's gross sales amounted to $355,716.34.  It returned as its net income for said year the amount of $40,362.53 and took a deduction for the salaries of three officers in the amount of $14,020.  *1264  Respondent has disallowed the salaries of Charles K. Ferry and Fred G. Ferry as follows: all except a salary of $100 per week to each for 1923; all except a salary of $75 per week to each for 1924; all except a salary of $150 per week to each for 1925.  Twenty-four thousand dollars annually is a reasonable allowance for the services of both of said officers for the years 1923, 1924, and 1925.  OPINION.  PHILLIPS: The issue in this proceeding arises out of the action of the Commissioner in refusing to allow as a deduction certain payments made to the officers of the petitioner, who also owned 95 per cent of its*2495  capital stock, as salaries.  Sections 234(a) of the Revenue Acts of 1921 and 1924 permit the deduction from gross income of ordinary and necessary expenses of transacting business, including "a reasonable allowance for salaries or other compensation for personal services actually rendered." The contracts made between the petitioner and its officers provided for the payment of stipulated weekly salaries and, if the earnings exceeded a certain amount, for the payment of all of such excess earnings to these officers in equal shares.  The Commissioner allowed the deduction of the fixed weekly salaries but refused to allow any part of the excess earnings as salaries.  It may be pointed out that there is no reason why a corporation should not compensate its officers or employees upon the basis of a share in the profits earned, and when the effect of such an arrangement is to provide reasonable compensation for services rendered, such compensation is deductible in computing net income.  But when such officers or employees are stockholders in control of the corporation and the payments are substantially in accord with stockholdings, the question naturally arises whether such arrangement*2496  is one for the payment of compensation or the distribution of profits.  This is particularly so where, as here, all profits in excess of a stipulated amount are to be paid to such officers and stockholders.  Such a situation presents strong evidence of an intent to distribute profits as salaries and, where the Commissioner has determined that the amounts paid thereunder are not reasonable, must be overcome by a sufficient showing that the salaries are reasonable in amount and in fact represent compensation for personal services rendered.  See ; ; ; affd., ; ; . The evidence submitted by the petitioner fails to establish that the amounts claimed as deductions constitute reasonable compensation *1265  for services rendered.  But when we consider the extent of the operations of the petitioner, the long experience of these officers and the uniform success*2497  with which they have conducted the affairs of the petitioner, we are convinced that the amount allowed by the Commissioner is inadequate.  In determining what amount is reasonable we must also consider that part of such compensation was contingent.  Upon the record made in this proceeding we are of the opinion that $24,000 should be allowed as a deduction in each of the years involved for the services rendered by these two officers.  Decision will be entered under Rule 50.