Stearns v. Commissioner

Estate of Lester O. Stearns, Deceased, Inez Stearns, Administratrix and Inez Stearns, Surviving Wife, Petitioner, v. Commissioner of Internal Revenue, Respondent Stearns v. Commissioner Docket No. 21345 United States Tax Court 14 T.C. 420; 1950 U.S. Tax Ct. LEXIS 253; March 16, 1950, Promulgated *253 Decision will be entered that there is a deficiency in income tax of $ 2,459.67 and there is no penalty for "substantial underestimation of estimated tax." For several years decedent, Lester O. Stearns, was employed as sales manager of a manufacturing corporation under a written contract for an indefinite term. On March 16, 1943, the board of directors of the corporation adopted a resolution terminating his employment as of May 31, 1943. The corporation paid him his salary to May 31, 1943. Stearns claimed the corporation was without authority to terminate his employment and sued the corporation for breach of contract and for damages. On December 31, 1945, the suit was compromised by the payment to Stearns of $ 15,000, of which Stearns paid his attorney $ 5,000. Held, the $ 10,000 net which Stearns received in 1945 was not "back pay" as defined in section 107 (d) (2), I. R. C., and petitioner is not entitled to the benefit of section 107 (d) (1), I. R. C., in the computation of tax for 1945. John J. Flynn, Esq., for the petitioner. Robert N. Willan, Esq., for the respondent. Black, Judge. Disney, J., dissenting. Opper, J., dissenting. Disney, J., agrees with this dissent. BLACK *420 The Commissioner has determined a deficiency of $ 2,459.67 in petitioner's income tax for the year 1945 and a penalty of $ 247.75 for "substantial underestimation of estimated tax." The deficiency results from the addition to the $ 7,802.73 net income reported on the income tax return of Lester O. Stearns of: (a) Contract settlement payment, $ 6,129.04; and (b) medical expense, $ 306.45. These adjustments are explained in the deficiency notice as follows: (a) The settlement payment received from Columbia Radiator Company, due to a breach of contract, is held to constitute taxable income in the taxable year. The tax on such income may not be computed under the provisions of Section 107 of the Internal Revenue Code. (b) The above correction of adjusted gross income necessitates an adjustment of the*255 allowable medical expense deduction in conformance with the provisions of Section 23 (x) of the Internal Revenue Code. The petitioner assigns errors as follows: 1. Error in holding that the sum of $ 15,000.00 received by the taxpayer from Columbia Radiator Company was taxable income in 1945 and not "back pay" within the provisions of Sec. 107 d (1) and (2) A (II) and (IV) of the Internal Revenue Code. 2. Error in asserting a penalty of $ 247.75 in conformance with provisions of Section 294 (d) (2) of the Internal Revenue Code for substantial underestimation of estimated tax. In his brief respondent states: "Respondent concedes that petitioner is not subject to a penalty for substantial underestimate of estimated tax for the year 1945." Therefore, petitioner's liability for a penalty for underestimation of tax is no longer in issue. *421 FINDINGS OF FACT. The facts which were stipulated are hereby found as stipulated and are made a part hereof by reference. The petitioner is the estate of Lester O. Stearns, who died August 1, 1947. The wife of decedent, Mrs. Inez Stearns, is the administratrix of the estate. The income tax return of Lester O. Stearns for the year 1945 was filed*256 with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland. On or about October 19, 1939, Lester O. Stearns entered into a written agreement of employment with the Columbia Radiator Co., Versailles Township, Pennsylvania. The Columbia Radiator Co. will sometimes hereinafter be referred to as Columbia. The written agreement between Columbia and Stearns contained, among other things: Item Tenth: That this Agreement shall be cancelled immediately upon the death of the Employee or on the dissolution of the Company, and that upon the happening of either event the Company shall be liable for no payment of salary accruing thereafter. That this Agreement, prior to October 31, 1941, may be cancelled by either party, but only upon the giving by one party to the other of six (6) months' notice in writing of such election to terminate. In the event of the termination hereunder by the Company, the Company shall be obligated to pay the Employee his salary only until the date of his accepting other employment, but in no case shall the obligation continue longer than six (6) months after the giving of said notice by the Company. In the event of the termination hereunder*257 by the Employee, the Company shall be obligated to pay the Employee his salary only to the date of his leaving the employ of the Company, as such date shall be determined by the Company, but in no case shall the obligation continue longer than six (6) months after the giving of said notice. That this Agreement shall continue and shall be in full force and effect until the same shall have been cancelled in the manner hereinabove provided. From November 1, 1941, pursuant to the agreement, the company increased Stearns' salary to $ 12,000 per annum and this sum was the amount of salary per annum he was entitled to receive at the time he became separated from the employment of the company. On or about November 1, 1939, Stearns reported for duty as general manager of sales of Columbia and thereafter devoted himself exclusively to the services of the company as general manager of sales and later as vice president of the company up to about March 18, 1943, when the company notified him that it was canceling and terminating the agreement. The resolution of the board of directors of Columbia terminating Stearns' employment reads as follows: Whereas, by reason of government restrictions and*258 limitations upon the sale of heating products, the Company now has, and will for sometime to come have, no need for the services of a General Manager of Sales; Now, Therefore, Be It Resolved, That the agreement between the Company and Mr. Lester O. Stearns, dated as of October 19, 1939, be and the same hereby *422 is, under the provisions of item Tenth thereof, cancelled and terminated as of May 31, 1943, and Mr. Stearns' employment by the Company be and the same hereby is terminated as of the same date; And, That the proper officers be, and they hereby are, authorized and directed forthwith to notify Mr. Stearns of said cancellation and termination, and to express the regret of this Board in being required, for economic reasons, to dispense with his services. The above resolution was adopted by the board of directors of the company at a meeting held March 16, 1943. The company paid Stearns a sum of $ 1,000 per month for March, April, and May, 1943. Stearns at all times after dismissal offered and was willing to perform the duties of said position from the date of his dismissal to about September 21, 1943. On or about September 21, 1943, Stearns commenced a tool supply business*259 with two other partners. As a result of being dismissed by Columbia Stearns, on or about December 13, 1943, commenced suit against the company in the Court of Common Pleas of Allegheny County, Pennsylvania. On or about May 1, 1944, Stearns filed in the court a statement of claim in support of his action, which claim states the nature of the suit brought. The statement contains, among other allegations, the following: 14. Plaintiff avers that, although by the terms of the contract permitted so to do, defendant did not prior to October 31, 1941, cancel said agreement, nor did plaintiff so cancel the same, nor was there any six months' notice in writing of such election to terminate given by either party. Plaintiff avers that no such notice having been given prior to October 31, 1941, the provisions of said "Item Tenth" with relation thereto, including the obligation to pay for a period of six months after termination of employment never went into force or effect. Paragraph 20 of the statement reads: 20. Plaintiff avers that defendant paid his monthly salary, to wit, $ 1,000.00 per month, for March, April, and May of 1943, but since said time has not paid plaintiff any salary whatsoever, *260 and has refused to permit plaintiff to perform the duties of said position, which he has at all times offered and been willing to do. The concluding paragraph of the statement of claim reads: 22. Wherefore, Defendant became and is still indebted to plaintiff in the sum of six thousand ($ 6,000.00) Dollars (less the net earned commissions aforesaid of $ 496.51), being the monthly salary for the months of June to November, 1943, both inclusive, with interest from September 1, 1943, the average due date of said payment which accured [sic] up to the time of the bringing of this suit, to recover which this suit is brought. Plaintiff reserves the right to bring suit for additional sums as they become due and payable. On or about December 21, 1945, Stearns entered into a settlement agreement with Columbia wherein and whereby the suit was settled by payment to Stearns of the sum of $ 15,000. Upon receipt of the $ 15,000, Stearns executed and delivered to Columbia the following acquittance and release: *423 Know All Men by These Presents, that I, Lester O. Stearns, in consideration of the sum of Fifteen Thousand Dollars ($ 15,000) to me in hand paid by Columbia Radiator Company, *261 a Pennsylvania Corporation, having its principal place of business within Allegheny County, Pennsylvania, the receipt of which I hereby acknowledge, have remised, released and forever discharged and I do hereby for myself, my heirs, executors, administrators and assigns remise, release and forever discharge said Columbia Radiator Company, its successors and assigns of and from all debts, claims, demands, actions, causes of actions, suits, dues, sum and sums of money, accounts, reckonings, covenants, contracts, controversies, agreements, promises and all liabilities of any kind or nature whatsoever, at law, in equity or otherwise, against the Columbia Radiator Company, which I ever had, now have, or which I, my heirs, executors, administrators and assigns hereafter can, shall or may have, from the beginning of the world to the date of these presents, included in such release and discharge, but not by way of limitation thereof, in full payment and satisfaction of any and all damages suffered by me on account of the breach (as alleged by me but denied by Columbia Radiator Company) of a certain contract of employment between us dated October 19, 1939 and on account of which an action *262 was brought by me against Columbia Radiator Company in the Court of Common Pleas of Allegheny County, Pennsylvania, at Number 2303 January Term, 1944; also included, but not by way of limitation of the above, is the full and complete release and discharge from any and all right therein, and/or otherwise, given to me to be employed by Columbia Radiator Company; the right therein, and/or otherwise, given to me to be elected an officer of said Company; the right therein, and/or otherwise, given to me to purchase certain shares of the capital stock of said Company at certain prices, terms, times and conditions; and the right therein, and/or otherwise, given to me to receive payment of certain cash or other sums for services as an employee and/or officer of said Company. Stearns paid from this sum of $ 15,000 attorney fees in the amount of $ 5,000. This latter amount is not involved here. For the calendar year 1945 the sum of $ 15,000 exceeded 15 per cent of Stearns' gross income for that year. For the taxable year 1943 Stearns received gross income of $ 4,255.32, and for the taxable year 1944 Stearns received gross income of $ 1,112.56 and no net income. As of March 17, 1943, Stearns*263 had no claim against the Columbia Radiator Co. other than for the current month's salary and his rights under his employment contract with the company. OPINION. The respondent having conceded that he erred in imposing a penalty of $ 247.75 for underestimation of estimated tax for the year 1945, we have but one issue left for our determination. That issue may be stated as follows: Was a net amount of $ 10,000 received by Stearns in 1945 in settlement of his suit for breach of an employment contract and of all his claims arising under said contract "back pay" within the meaning of section 107 (d) of the Internal Revenue Code? There is no real dispute between the parties as to the facts and we have endeavored to give full details of these facts in our findings *424 above. The differences between the parties arise because of their differences as to the applicable law when applied to the facts which are present here. The applicable statute is section 107 (d) of the Internal Revenue Code, printed in the margin. 1 *264 Treasury Regulations 111, section 29.107-3, which deals with "back pay attributable to prior taxable years," is in substantially the same language as the statute itself and no useful purpose would be served in printing it here. It will be observed that a reading of section 107 (d) (2), defining "back pay," discloses the following: * * * remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: * * * [Emphasis supplied.] Decedent Stearns had been employed for several years by Columbia as its sales manager and in the latter years of his employment received $ 1,000 per month as salary. On March 16, 1943, the board of directors of Columbia adopted a resolution canceling and terminating his employment as of May 31, 1943. Stearns was paid his salary to that date and none of that salary is involved here. Columbia refused to pay him after that date, and Stearns sued Columbia for breach of contract and for*265 damages. This suit was settled by compromise on December 21, 1945, and Stearns was paid $ 15,000 in full settlement of his claim. Can it be said that this $ 15,000, or any part thereof, was back pay "for services performed prior to the taxable year for his employer" within the meaning of the applicable statute? We do not think it can be so held. *425 In the release and acquittance which Stearns signed when he settled with Columbia he agreed, among other things, that the payment of $ 15,000 was: * * * full payment and satisfaction of any and all damages suffered by me on account of the breach (as alleged by me but denied by Columbia Radiator Company) of a certain contract of employment between us dated October 19, 1939 and on account of which an action was brought by me against Columbia Radiator Company * * *; also included, but not by way of limitation of the above, is the full and complete release and discharge from any and all right therein, and/or otherwise, given to me to be employed by Columbia Radiator Company; the right therein, and/or otherwise, given to me to be elected an officer of said Company; the right therein, and/or otherwise, given to me to purchase certain*266 shares of the capital stock of said Company at certain prices, terms, times and conditions; and the right therein, and/or otherwise, given to me to receive payment of certain cash or other sums for services as an employee and/or officer of said Company. In Norbert J. Kenny, 4 T. C. 750, we gave some of the legislative history of section 107 (d). In that connection we said: The reports of the Congressional committees show that the committees were concerned with the problem of how far the scope of the definition of "back pay" should extend. The definition first proposed was too limited and was rejected by the Finance Committee of the Senate. Thereafter, in conference, the definition of "back pay" was broadened to the definition enacted, with the explanation in the report of the Committee of Conference that "The term [back pay] refers only to remuneration, the payment of which has been deferred by reason of the unusual circumstances of the type specified in the definition." * * * It seems to us that the $ 15,000 which Stearns received on December 21, 1945, in the compromise settlement of his suit against Columbia was not received as "remuneration" for*267 prior services rendered to Columbia "the payment of which has been deferred by reason of the unusual circumstances of the type specified in the definition," as described by the conference committee in its report. Therefore, when all the facts in the instant case are considered and consideration is given as to whether the $ 10,000 here in question falls within the definition of "back pay" as defined by Congress, we think the answer must be in the negative. We so hold. Decision will be entered that there is a deficiency in income tax of $ 2,459.67 and there is no penalty for "substantial underestimation of estimated tax." DISNEY; OPPER Disney, J., dissenting: I agree with Judge Opper's dissent, but in addition it seems to me that the $ 10,000 which petitioner received comes well within the definition of back pay; that is, that it is "remuneration * * * and other similar compensation * * * for *426 services performed * * *." The definition in section 107(d)(2) provides that such remuneration for services performed includes those which would have been paid prior to the taxable year except for the intervention, inter alia, of dispute as to liability to pay such remuneration, *268 which is determined after the commencement of court proceedings. It seems to me that this language very reasonably was intended to include a situation where, being discharged, an employee sued for breach of contract and recovered, by judgment or by compromise. Indeed such discharge and, therefore, suit for breach of contract seems the usual situation which would entail the delay in payment and commencement of court proceedings, described in the statute; for, if the employee had actually rendered the services, it would appear unlikely that there could be any "dispute as to liability," so that discharge and suit for breach of contract seems the situation probably intended to be covered by the statute. The majority opinion seems to be based upon the idea that the amount is, because received in settlement of a suit for breach of contract, not remuneration "for services performed." But Webster's New International Dictionary defines "remuneration" as "To pay an equivalent for (any service, loss, expense or other sacrifice) or to pay an equivalent to (one) for such services, etc.; to recompense; requite; compensate; pay; as, to remunerate men for labor * * *." To me this case presents*269 a clear example of paying "an equivalent" for service. Such equivalency seems to be a basis of the suit for breach of contract, for certainly the petitioner therein sought the equivalent of what he would have received. Therefore, it seems to me that to take the view that the $ 10,000 was remuneration not for services performed, but for damages, is to restrict the statute much within its reasonable intendment. I, therefore, dissent. Opper, J., dissenting: In Norbert J. Kenny, 4 T. C. 750, we regarded an R. F. C. loan as "similar" to the delaying events expressly described in section 107 (d) (2) (A) (i)-(iii). Damages for failure to pay salary for services rendered seem to me at least similar to the salary itself, particularly where any failure to render the services was due to the apparently wrongful refusal of the employer to continue the relationship. In Norbert J. Kenny, supra, we did not require exact compliance with the definition under the provision referring to "any other event determined to be similar in nature." Here the language is, "including wages, salaries, retirement pay, and other similar compensation." *270 (Emphasis added.) I think we should consider these damages likewise as "similar compensation" and apply the back pay provision. Footnotes 1. SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY. * * * * (d) Back Pay. -- (1) In general. -- If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 per centum of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, as determined under the regulations prescribed by the Commissioner with the approval of the Secretary. (2) Definition of back pay. -- For the purposes of this subsection, "back pay" means (A) remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: (i) bankruptcy or receivership of the employer; (ii) dispute as to the liability of the employer to pay such remuneration, which is determined after the commencement of court proceedings; (iii) if the employer is the United States, a State, a Territory, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any of the foregoing, lack of funds appropriated to pay such remuneration; or (iv) any other event determined to be similar in nature under regulations prescribed by the Commissioner with the approval of the Secretary; * * *↩