Brodie v. Commissioner

Renton K. Brodie, Petitioner, v. Commissioner of Internal Revenue, Respondent. Thomas J. Wood, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mark Upson, Petitioner, v. Commissioner of Internal Revenue, Respondent. John F. Rogers, Petitioner, v. Commissioner of Internal Revenue, Respondent Brodie v. Commissioner Docket Nos. 109183, 109184, 109185, 109186 United States Tax Court 1 T.C. 275; 1942 U.S. Tax Ct. LEXIS 14; December 16, 1942, Promulgated *14 Decision will be entered for the respondent. The board of directors of a corporation, of which petitioners were employees, had in a prior year established a five-year plan for additional remuneration to certain executives and employees of the company. The plan provided that at the end of each fiscal year the president of the company should determine the persons to receive additional compensation out of the fund established and the amount to be paid to each. In the taxable year the president of the company directed the purchase, out of the fund, of certain paid-up retirement annuity contracts with death benefit clauses for petitioners and delivered such annuity contracts to them. Petitioners had no option to receive in cash the amounts which were thus expended in lump sum payments for the annuity contracts. Held, that the amounts thus expended were expended for petitioners' benefit and represented additional compensation to them and they are taxable thereon under the provisions of section 22 (a), Revenue Act of 1938. Raymond J. Moore, 45 B. T. A. 1073, distinguished. F. F. Dinsmore, Esq., for the petitioners. DeWitt M. Evans, Esq.,*15 for the respondent. Black, Judge. Smith, Turner, and Hill, JJ., concur only in the result. Leech, J., dissents. Van Fossan, J., dissenting. BLACK *275 Respondent determined deficiencies in the income taxes of the petitioners for the year 1938 as follows: Docket Petitioner No. Deficiency Renton K. Brodie 109183 $ 11,009.68 Thomas J. Wood 109184 3,848.20 Mark Upson 109185 1,667.23 John F. Rogers 109186 1,040.59 *276 Each petition contains an identical assignment of error except as to amounts involved. The assignment of error in Docket No. 109183, Renton K. Brodie, petitioner, is typical of all. It reads: The taxpayer takes exception to the inclusion in income for 1938 of alleged compensation constructively received in the sum of $ 25,000.00 represented by an annuity purchased for the taxpayer by The Procter & Gamble Company, a corporation, his employer, on the ground that the payment for said annuity contract is not taxable to the taxpayer at the time of the payment therefor by The Procter & Gamble Company or at the time of the receipt of the annuity contract by the recipient for the reason that such payments are not income at said*16 time to the recipient. FINDINGS OF FACT. Petitioners are individuals who reside in Cincinnati, Ohio, and filed their income tax returns for the year 1938 with the collector of internal revenue for the first district of Ohio. They all are employees of the Procter & Gamble Co., an Ohio corporation, sometimes hereinafter called the company. On June 12, 1934, the board of directors of the company adopted a resolution as follows: Resolved that the following plan for special remuneration of some of the executives who are largely responsible for, and certain other employees who contribute to the success and development of the business of The Procter & Gamble Company and Subsidiary Companies, by providing for additions to their compensation based upon a percentage of the consolidated annual net profit of the Companies, be and the same is hereby adopted as follows: 1. This plan shall be effective for a period of five (5) consecutive years, commencing July 1, 1934. 2. At the end of each fiscal year there shall be set aside in the special remuneration fund an amount not in excess of three percent (3%) of the consolidated net profit of the Companies, conditional upon there being left at least*17 Fourteen million Dollars ($ 14,000,000.00) of net profit after deducting said amount. 3. The said fund or any part thereof, shall be available during the period referred to in Paragraph 1, at the discretion of the President of The Procter & Gamble Company, for the special remuneration of executives who are largely responsible for, and certain other employees who contribute to the success and development of the business. 4. The details of the accounting to determine the consolidated net profit of the Companies shall be exclusively in charge of the officers of The Procter & Gamble Company, subject to approval or modification by this Board, and no person who may, at any time, be selected to share in the fund provided for in Paragraph 2 hereof, shall have any right to question any item entering into the accounting in the determination of consolidated net profit. 5. At the end of each fiscal year the President of The Procter & Gamble Company shall determine the persons to receive additional compensation out of said fund, and the amount to be paid to each, subject to this proviso, that this Board shall determine to what extent, if any, the President of The Procter & Gamble Company shall*18 share in the distribution of the fund. 6. While the amount received by any individual for any year under this resolution shall be considered as earned remuneration in addition to salary paid, *277 it shall be understood that this plan does not give to any employee or executive any contract rights against any Company for the distribution of the fund or for compensation in addition to the salary paid to him. On July 6, 1937, the above resolution was amended by the board of directors of the company as follows: Resolved, that Paragraph 5 of the Resolution providing for a five-year-plan for special compensation for some of the Executives of the Company who are largely responsible for, and certain other employees who contribute to the success and development of the business adopted by this Board at its meeting held June 12, 1934, as the same appears in Volume 3, Pages 399 and 400, of the Minutes of this Board, be amended so as to read as follows: At the end of each fiscal year the President of The Procter & Gamble Company shall determine the persons to receive additional compensation out of said fund, and the amount to be paid to each. The President also shall be entitled to share*19 in the distribution of the fund, and shall receive an amount equal to fifteen percent (15%) thereof, but in no event to exceed one hundred thousand Dollars ($ 100,000.00) for any fiscal year, and this share shall be paid to him without further action by this Board. Further Resolved, that this amendment to Paragraph 5, of said Resolution shall be effective for the fiscal year ended June 30, 1937, and for the remaining fiscal years covered by the original Resolution. In 1935 bonuses were paid in cash by the company to the petitioners out of the fund provided under the foregoing resolution. For the year 1938 a portion of the funds derived under the foregoing resolution was used in the purchase by the company of certain special single premium retirement annuity contracts. The cost of the contracts was deducted from income as a business expense by the company in its income tax returns for the periods during which the said contracts were purchased. The amounts of salaries and cash bonuses and amounts paid for annuity contracts delivered to the petitioners over the period 1936 to 1938, inclusive, are as follows: Renton K. Brodie Paid for Cash annuity Year Salary bonus contracts Total [1936] $ 40,000 $ 50,000 $ 90,000 [1937] 40,000 60,000 100,000 [1938] 40,000 17,000 $ 25,000 82,000 Thomas J. Wood [1936] $ 21,000 $ 10,000 $ 31,000 [1937] 25,000 18,000 43,000 [1938] 25,000 5,000 $ 15,000 45,000 Mark Upson [1936] $ 21,000 $ 10,000 $ 31,000 [1937] 25,000 18,000 43,000 [1938] 25,000 5,600 $ 7,000 37,600 John F. Rogers [1936] $ 18,000 $ 5,000 $ 23,000 [1937] 18,000 10,000 28,000 [1938] 18,000 $ 7,000 25,000 *20 *278 The cost to the company of said special single premium retirement annuity contracts was fair and reasonable and substantially equal to the cost of duplication of the same contract with the same company under the same circumstances. The Connecticut General Life Insurance Co. will not accept the surrender of the said special single premium retirement annuity contracts and pay any money to petitioners therefor. Each annuity contract was labeled "Special Single Premium Retirement Annuity with Income Settlements at Optional Ages NonParticipating." The insurance company agreed to pay in monthly installments a definite "life income", commencing on the annuitant's seventieth birthday. If he should die after that day but before he received 120 monthly payments, the remaining payments were to be made serially to his beneficiary. Prior to the annuity date the annuitant might elect to receive a life income with or without a "Ten-years Certain" feature. If the annuitant should die during the continuance of the contract the company agreed to pay to his designated beneficiary (or survivor) a certain sum as a "death benefit." During the first three years that sum is the amount of the*21 premium or consideration paid for the contract and thereafter it is the amount of such consideration plus an interest surcharge. The right to change the beneficiary was reserved to the annuitant. The contract also provided: Assignment. All payments hereunder are for the support and maintenance of the Annuitant or Beneficiary, as the case may be. Neither this contract nor any payment hereunder may be assigned; and the contract and all payments shall be free from the claims of all creditors to the fullest extent permitted by law. In taking out the annuity contracts for certain of its executives and employees, including petitioners, the company considered that it was not only good business but a recognition of its moral obligation *279 to make the future of certain of its important officials and employees secure from want. The company wished to test the advantages to the company, as well as to the employees, of retirement allowances in the nature of pensions, the chief feature of which was to be personal to the employee so that his rights could not be assigned, nor could he surrender his rights and obtain any present consideration. Upon investigation it found that there was *22 no insurance company that then wrote such a contract, but that the Connecticut General Life Insurance Co., at least in one instance, had written such a contract for another manufacturing company and its employees. Accordingly, the matter was taken up with that life insurance company as the only one that would write a contract with the provisions therein acceptable to the company. The nonassignability of the contract and the absence of any provision of a cash surrender value were essential features, without which the company would not have been interested in obtaining the contract. Richard R. Deupree was at all material times heretofore mentioned president and a director of the company. In so far as petitioners were concerned, he selected the recipients of the annuity contracts and determined the amount of each contract and bonus allotment. The recipient had no option or advance notice of what he might receive. Deupree exercised his own judgment and discretion and took into consideration the age, financial condition, family obligations, and other pertinent factors in each case. Each petitioner made a written application for his annuity contract on a printed form furnished by the*23 insurance company for that purpose, which application was also signed by the Procter & Gamble Co. During the year 1938 the Procter & Gamble Co. paid to the insurance company the sum of $ 54,000 for the annuity contracts involved in these proceedings. Attached to the returns of the petitioners were information returns received from the company representing the respective sums paid to the life insurance company for the corresponding contracts. The premiums on the contracts were paid from the special remuneration fund heretofore described. No amounts were reported by the petitioners as income arising from the payment by the company of the lump sum annuity premiums and the receipt of their several contracts. The Commissioner in his determination of the deficiencies added these respective amounts to the income of petitioners. The statement by the Commissioner of his reasons for such determination contained in the deficiency notice to Renton K. Brodie, Docket No. 109183, is typical of the others, and is as follows: (a) During the year 1938 you received from The Procter & Gamble Company as additional compensation for personal service an annuity contract issued by the Connecticut General*24 Life Insurance Company at a cost to the company *280 of $ 25,000.00. In accordance with the provisions of section 22 (a) of the Revenue Act of 1938, your gross income has been increased by the amount of $ 25,000.00 to reflect the receipt of such contract. The foregoing findings of fact are based upon a stipulation of facts signed by the parties and introduced in evidence at the hearings and an agreed stipulation by the parties as to what would be the testimony of Richard R. Deupree if he were called as a witness in these proceedings. Any part of the stipulation of facts not set out in the foregoing findings, except as to the year 1939, is made a part of these findings of fact and is incorporated herein by reference. OPINION. These proceedings have been consolidated. The issue in each proceeding is identical and the facts are the same except as to the names of the different individuals involved, their positions and length of service with the company, and the amounts of alleged income involved. The same question as to the admissibility of certain of the stipulated facts was raised by these petitioners at the hearing as was raised in Richard R. Deupree, I. T. C. 113. As *25 in that proceeding, the presiding Member reserved his ruling upon the admissibility of such evidence. Inasmuch as the question involved is precisely the same, our ruling is the same, and our findings of fact have been prepared accordingly. For a more detailed account of our ruling see Richard R. Deupree, supra. In his determination of the deficiencies respondent relied upon section 22 (a) of the Revenue Act of 1938. This section reads in part as follows: SEC. 22. GROSS INCOME. (a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, * * * Neither the pleadings nor the stipulation of facts shows whether the petitioners used the cash basis in filing their income tax returns. The cases have been tried, however, as if petitioners were on the cash basis, and we shall assume that such was the case. It is clear from the facts, which have been stipulated, that the petitioners did not receive in cash the extra compensation with which the Commissioner is seeking to tax them. But a taxpayer on the cash basis can be taxed on income which he has not *26 actually received, if under the facts present it can be held that he has constructively received it. The doctrine of constructive receipt was discussed by us in some detail in Richard R. Deupree, supra, and we shall not repeat that discussion here. We held in the Deupree case that there was constructive receipt of the income in question and that the taxpayer was taxable thereon. *281 Our decision in that case was largely based upon the fact that Deupree's failure to receive $ 50,000 in cash instead of an annuity policy costing $ 50,000 was due entirely to his own volition. We set out briefly in that opinion the facts present in the record which we thought justified such a conclusion. In these proceedings the facts are different in some very substantial respects from what they were in the Deupree case. In the instant case the failure of petitioners to receive in cash the amounts of the extra compensation fund which were used by the company to purchase the annuity contracts which were delivered to them was not due to their own volition. In fact they apparently were not consulted about the matter prior to the company's decision to purchase the annuity contracts. *27 In the "Stipulation as to Testimony of Richard R. Deupree" which was filed at the hearing, it was agreed that if called as a witness he would testify, among other things (after stating what he conceived to be the advantages of the plan to purchase annuity contracts, both to the company and the employees involved), as follows: Based on this general philosophy I took into consideration the age, financial condition, family obligations, etc., insofar as I knew them and decided each individual case in the light of these factors and in accordance with my best judgment. Neither the amount of bonus nor the amount of annuity was known in advance by any recipient. He had no option, indeed no advance knowledge, as to what he might receive. Under these circumstances and the authorities cited in Richard R. Deupree, supra, we do not think that it can be held that petitioners "constructively received," as those terms are generally understood, the cash which the company used in purchasing the annuity contracts. We do not think these petitioners were in the position to go to the company and say: "You have some money which, under the special remuneration plan adopted, I am entitled to receive*28 in cash. However, I would prefer to have a certain amount of that cash invested in an annuity contract and I direct you to purchase such a contract in my name and pay for it out of the cash which is due me as extra compensation." If such had been the case, the petitioners would have as effectively received the amount in question as if it had been paid to them in cash. We so held in the case of Richard R. Deupree, supra. But, for reasons just above stated, we do not think the same situation can be so held to exist in these proceedings. However, while we do not think that the doctrine of constructive receipt as it is commonly understood can be correctly applied in these proceedings, it is undoubtedly true that the amount which the Commissioner has included in each petitioner's income was used for his benefit, albeit not at his own direction, in the purchase of an annuity contract, and the contract so purchased was issued in the name of the annuitant and was *282 delivered to him and was part of the plan for his additional remuneration. Do these facts result in the receipt of income in the amounts determined by the Commissioner? Respondent contends that they do, and he*29 relies principally upon the broad and comprehensive language of section 22 (a), supra. In this contention we think respondent must be sustained. In George Mathew Adams, 18 B. T. A. 381, we held that life insurance premiums paid by a corporation on life insurance policies taken out on the life of the employee and payable to a beneficiary designated by him represented extra compensation to such employee and was taxable to him. In that case the taxpayer made pretty much the same contentions as petitioners make here. We stated the contentions of the taxpayer in the Adams case to be in part as follows: It was also urged on behalf of the petitioner that the premiums in question did not constitute income to him, since they were not received by him and he did not have the free use and disposition thereof, but that, if it were considered that the petitioner had received additional compensation through the action of the corporation, the amount thereof would not be in excess of the cash surrender value of the policies. * * * In the instant case the petitioners urge, as among their strongest reasons why the amounts in question should not be taxed as income*30 to them, the fact that they did not have the free use and disposition of such funds and that the annuity contracts which they received could not be assigned and had no cash surrender value. Notwithstanding the several contentions made by the taxpayer in the Adams case, we held that the insurance premiums paid by the corporation on the life insurance policies taken out for Adams were taxable to him. In giving our reasons for so holding, among other things, we said: As shown by the findings of fact, each person upon whose life an insurance policy was written made application for the policy himself and the policy was issued to the applicant. The applicant was permitted to designate the beneficiaries and in no case was the corporation designated as a beneficiary. Section 213 of the Revenue Act of 1921, under the provisions of which the petitioner's tax returns for 1922 and 1923 were filed, defines gross income as including "gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid." We think that the premiums paid upon the life insurance policies taken out on the life of the petitioner constituted*31 additional compensation for him for the years 1922 and 1923, within the meaning of the taxing act. Consequently, we are of the opinion that the amounts of $ 3,299.21 and $ 2,515.81 constituted additional compensation of the petitioner for the calendar years 1922 and 1923, respectively, and that the respondent committed no error in including such amounts in his taxable income for the respective years. Section 213 of the Revenue Act of 1921, cited in our opinion above, is *283 the same as section 22 (a) of the Revenue Act of 1938, upon which the Commissioner relies in the instant proceedings. For a holding like that made in the Adams case, see N. Loring Danforth, 18 B. T. A. 1221; Frank D. Yuengling, 27 B. T. A. 782; affd., 69 Fed. (2d) 971; Commissioner v. Bonwit, 87 Fed. (2d) 764; certiorari denied, 302 U.S. 694. In the latter case the court in reversing the Board, among other things, said: * * * Hence the premium payments can be considered income to the respondent [Bonwit] only if they were made as additional compensation*32 for his services to the corporation. Several cases have held that payment of insurance premiums by an employer constituted additional compensation to an employee whose life was insured in favor of his wife and children or other beneficiaries designated by him. [Citing authorities.] The Board of Tax Appeals distinguished these cases from the case at bar, but the differences they point out seem to us insufficient basis for an opposite result. In the instant proceedings there can be no doubt that the sums of money which the company expended for the annuity contracts, which were procured by the company upon the joint applications of the company and the employee in question and then delivered to the employees, were intended as extra compensation for the year 1938. The facts set out in our findings of fact abundantly establish that proposition. The Board said in N. Loring Danforth, supra, "That the purpose, plan and effect was to give petitioner this additional compensation for his services is manifest. The benefit was directly to him, and the corporation received no more benefit than any employer derives when it increases the compensation of its employee. *33 * * *" The facts being what they are, we can see no distinction in principle from the issue involved in the instant proceedings and that which was involved in the above cited cases. It seems to us that our decision must be the same. It is true that the Commissioner in some of his administrative rulings has treated premiums paid by an employer for annuity contracts taken out for employees differently from the way he has treated insurance premiums paid by an employer on life insurance policies taken out on the life of the employee. For example, in I. T. 2891, C. B. XIV-1, p. 50, it was ruled as follows: Advice is requested relative to the treatment under the Revenue Act of 1934 of amounts paid by an employer toward the purchase of retirement annuity contracts for the benefit of his employees. It is held that contributions made by an employer for the purpose stated do not constitute income constructively received by the employees. Such amounts are not, therefore, required to be included in the Federal income tax returns of the employees for the year or years in which paid. The aggregate of the amounts contributed by the employee beneficiary toward the purchase of a retirement annuity, *34 but not the amount contributed by the employer, constitutes *284 "the aggregate premiums or consideration paid for such annuity" within the meaning of section 22 (b) of the Revenue Act of 1934. Amounts received by employees in the form of annuities are to be returned for Federal income tax purposes in the manner and to the extent provided in that section. To the same effect is the ruling of the Bureau in I. T. 3346, C. B. 1940-1, p. 62. The Treasury has no regulations dealing specifically with the subject matter covered by the foregoing administrative rulings. Notwithstanding these prior administrative rulings, the Commissioner strongly insists in the instant proceedings that the amounts herein involved are taxable to petitioners under the broad and comprehensive provisions of section 22 (a), supra. As we have already stated, the statute being what it is and the facts being what they are, we think the Commissioner must be sustained. We think the case of Raymond J. Moore, 45 B. T. A. 1073, is distinguishable on its facts. In that case we held that so much of the premiums on each retirement annuity contract as was paid in each year by the*35 trustee out of funds furnished by the employer for the retirement annuity contracts involved in that proceeding did not constitute income to the several officers and employees of the corporation who were beneficiaries of the retirement plan. In that case we rested our decision primarily on the fact that the corporation employer had set up a pension trust in behalf of certain of its employees and we relied upon section 165 of the Revenue Act of 1936, printed in the margin. 1 *36 In the instant proceedings the company has not set up any pension trust. In each instance the petitioner made a written application in his own name to the Connecticut General Life Insurance Co. on a special form provided for that purpose. Each application was also signed by the Procter & Gamble Co. The annuity contracts were issued directly to the petitioners and were fully paid for out of the special remuneration fund mentioned in our findings of fact, without any restrictions or conditions attached as to term of employment, cessation of employment, or contribution by the annuitant. For these and other reasons we think the instant proceedings are distinguishable from Raymond J. Moore, supra. If and when petitioners begin to draw their annuities, assuming *285 that the law remains what it now is, they will receive a tax benefit from the compensation payments with which they are now being taxed. For example, section 22 (b) (2) of the Internal Revenue Code reads in part as follows: * * * Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income*37 the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * * See also the new subparagraph (B) added as an amendment by the Revenue Act of 1942 to section 22 (b) (2) of the Internal Revenue Code. It would seem to require no argument that if petitioners are taxed as extra compensation for the lump sum premiums which the company paid in 1938 for the annuity contracts out of the funds especially created for additional compensation, such sums would represent aggregate premiums or consideration paid by petitioners for "such annuity" under the provisions of the foregoing statute. Decision will be entered for the respondent. VAN FOSSAN Van Fossan, J., dissenting: The processes of reasoning by which the payments by the corporation are construed in the prevailing opinion to constitute income to petitioners seems to me to distort the reasonable intendment*38 of the statute. The cases are also indistinguishable from the well considered opinion of Judge Leech in Raymond J. Moore, 45 B. T. A. 1073. I therefore dissent. Footnotes 1. SEC. 165. EMPLOYEES' TRUSTS. A trust created by an employer as a part of a stock bonus, pension, or profit-sharing plan for the exclusive benefit of some or all of his employees, to which contributions are made by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25 (a)↩.