Denton v. Commissioner

James M. Denton, John R. Denton, Petitioners, v. Commissioner of Internal Revenue, Respondent Denton v. Commissioner Docket Nos. 36852, 36853 United States Tax Court 21 T.C. 295; 1953 U.S. Tax Ct. LEXIS 22; November 24, 1953, Promulgated *22 Decision will be entered for the petitioners. 1. Transferee Liability -- Sec. 311, I. R. C. -- In Equity. -- Petitioners were officers and stockholders in a corporation formed in 1941. Deficiencies in the corporation's taxes were determined for 1943 and 1944 based in large part on the disallowance of officers' salaries as unreasonable. The corporation did not contest the deficiencies. The respondent claims the petitioners are liable as transferees for the deficiencies to the extent of a dividend distributed to them in 1943 and unreasonable salaries paid to them in 1943, 1944, and 1945. The corporation was not insolvent nor rendered insolvent in 1943 or 1944 by virtue of the dividend distribution or the salary payments. It was insolvent at the end of fiscal 1945. Held, the petitioners were not liable as transferees in equity for the amounts received in 1943 and 1944 because the corporation was not insolvent nor rendered insolvent by the payments made. Held, further, the petitioners were not liable for alleged unreasonable salaries paid in 1945 because of failure by the respondent to prove the unreasonableness of the salaries. 2. Transferee Liability -- Sec. 311, *23 I. R. C. -- At Law. -- (a) In 1945 petitioners signed a contract, in connection with a proposed purchase of stock from another officer, to stand good for the corporation's undisclosed tax liabilities. No transfer of assets of the corporation to the petitioners was involved in this transaction. Held, without deciding the validity of the contract, petitioners were not liable as transferees at law because no transfer of corporate assets occurred in connection with the execution of the contract. (b) In 1945 while petitioners were directors, the corporation purchased 24 of its own shares from another officer. A Connecticut statute provided that the directors assenting to such purchase while the corporation was insolvent should be personally liable for corporate debts. Held, the petitioners were not liable as transferees by virtue of the statute because no transfer of corporate assets to petitioners accompanied or grew out of the purchase. John S. Murtha, Esq., for the petitioners. James R. McGowan, Esq., for the respondent. Tietjens, Judge. TIETJENS *296 The Commissioner has determined the following deficiencies in taxes of Hartford Chrome Corporation: Fiscal year ended Nov. 30 Tax Deficiency [1943] Income $ 209.30 [1943] Excess profits 29,295.75 [1944] Excess profits 16,216.08 Total $ 45,721.13 Transferee liability was determined by the Commissioner for the above deficiencies in the amount of $ 26,362.85 against the petitioner John R. Denton and in the amount of $ 18,988.92 against the petitioner James M. Denton. The respondent now concedes that John's liability does not exceed $ 24,512.86. The deficiencies*25 determined against the Hartford Chrome Corporation were based in large part on disallowance of a portion of its officers' salaries as unreasonable compensation. The petitioners, who were officers of the Corporation, allege this disallowance to be in error. They further allege error on the part of the respondent in determining the petitioners to be liable as transferees and assert that assessment of liability is barred by the statute of limitations. FINDINGS OF FACT. The stipulated facts are so found and the stipulation is incorporated herein by reference. The Hartford Chrome Corporation (hereafter called the Corporation) was incorporated March 25, 1941, under the laws of Connecticut. Its income and excess profits tax returns for the fiscal years ended November 30, 1943 and 1944, were filed with the collector of internal revenue for the district of Connecticut. *297 Its organizers were John R. Denton, H. H. Keane, and T. J. Curtin. The Corporation had $ 5,000 of capital stock represented by 100 shares of common stock with a par value of $ 5 a share originally distributed as follows: Number of shares John R. Denton [51] H. H. Keane [24] T. J. Curtin [24] Qualifying share [100] *26 Later in 1941 James M. Denton, a brother of John, acquired 20 shares from the latter. The Corporation went into the industrial hard chrome business which consisted of salvaging metal parts spoiled in grinding -- a technical process involving the use of chemicals and electricity. Before formation of the Corporation, John had worked for some 8 years in the chrome plating department at Pratt & Whitney and was thoroughly familiar with the techniques of the business. Keane was a college graduate, having majored in business, finance and engineering, and for several years prior to 1941 had worked for Colt's Patent Firearms. During the Corporation's formative period John, Keane and Curtin were its only employees. They performed most of the work of setting up the plant and equipment for the beginning of actual production. In August 1941 James went to work for the Corporation as secretary and treasurer. Production was begun about June 1941. In number of employees growth was gradual and never exceeded about 30. A shop superintendent was employed in 1942 at an annual salary of about $ 15,000 and later an office manager was also hired. Throughout the fiscal years ended November 30, 1943, *27 1944, and 1945, the Corporation's officers were: John R. Denton, President, T. J. Curtin, Vice President, James M. Denton, Treasurer and Secretary, and H. H. Keane, Vice President. These officers were also corporate directors during those periods. From the time James joined the Corporation in 1941 these men performed the duties required to carry on the Corporation's business. From March to June 1943 John served in the Army, stationed at Little Rock, Arkansas. He was recalled to service in April 1944 and was discharged October 30, 1945. Part of this time he was stationed at Aberdeen, Maryland, and spent several weekends in Hartford where he attended to some Corporation business. During his military service he performed such Corporation business as he was able and was paid his salary pursuant to a corporate resolution providing for 50 per cent pay while in military service. At first James performed office work and sometime in 1942 started a sales and advertising *298 campaign with John to increase business. Keane performed miscellaneous duties, some minor in character, and took off 3 months during the period under consideration due to a sinus condition which developed because*28 of exposure to chromium. Curtin was frequently absent from his duties during the period and his devotion to the business was "spasmodic." All, while able, devoted much overtime to the Corporation's business. The gross sales and the net income before taxes of the Corporation were as follows: Period Gross sales Net income Year ended Nov. 30, 1942 $ 241,686.90 $ 57,960.48 Year ended Nov. 30, 1943 393,704.30 82,499.35 Year ended Nov. 30, 1944 234,110.67 27,899.22 Six months ended May 31, 1945 120,549.46 18,135.27 During the fiscal years ended November 30, 1943, 1944, and 1945, the Corporation paid the following sums as compensation to its officers: Year ended Nov. 30 [1945] John R. Denton $ 32,230.33 $ 21,720.66 $ 17,160.10 T. J. Curtin 28,271.63 11,494.30 4,583.26 James M. Denton 26,385.64 22,327.58 21,899.94 H. H. Keane 28,271.63 17,910.88 23,200.02 Totals $ 115,159.23 $ 73,453.42 $ 66,843.32 During its fiscal year ended November 30, 1943, the Corporation declared and paid a cash dividend of $ 15,000 on its common stock. Of this total John received $ 4,650 and James $ 3,000. The Corporation, after giving effect to*29 the deficiencies in taxes subsequently determined for the taxable years ended November 30, 1943 and 1944, was not insolvent but on the contrary had earned surplus of $ 3,975 on November 30, 1943, and $ 3,055 on November 30, 1944. As of November 30, 1945, the Corporation's liabilities exceeded its assets by $ 13,958.82. Sometime prior to November 1945 the Dentons and Keane decided it would be better if Curtin were eliminated from participation in the Corporation's affairs and a memorandum outlining a proposal to acquire Curtin's 24 shares of stock was prepared. On or about November 13, 1945, the two Dentons, Keane, and Curtin signed an agreement wherein after reciting that the two petitioners and Keane, jointly described as "parties of the second part," are "desirous of purchasing or retiring" the stock interest, viz., 24 shares, of Curtin, the "party of the first part," they agreed as follows: 1. In the event of any undisclosed tax liability not appearing on the statement of the said corporation as of September 29, 1945, being the date agreed upon for the valuation of said stock to be sold or retired, the parties hereto agree to pay *299 to the Hartford Chrome Corporation, *30 its successors and assigns, their proportionate share of any such undisclosed tax liability not appearing on the aforesaid statement, and upon receipt of notice by said corporation of any such final assessment, they do hereby mutually agree to pay to said corporation within thirty (30) days after such notice of any final assessment their proportionate share of any such liability. The proportionate share of each individual signing these presents shall be determined as the percentage equivalent to the fraction made up as follows: The numerator shall be the aggregate of money received by the individual from the corporation during the year or years in question, whether it be in the form of executive or productive salaries, over the denominator which shall be the aggregate amount of monies received by all officers of said corporation covering both executive and productive salaries during said period. On November 14, 1945, the Dentons and Keane released Curtin from any and every claim they held against him. The Corporation also released Curtin from any and every claim held against him "with the exception of any sum due or hereafter to become due by reason of any undisclosed tax liability*31 by this corporation to the Federal Government." The Corporation purchased Curtin's 24 shares of stock on November 13, 1945, for $ 12,516.57 and held them as treasury stock until January 14, 1946, when they were sold for $ 8,280 (20 shares to James and 4 shares to V. C. Hickey). No assets of the Corporation were transferred to the petitioners in connection with this transaction. In December of 1946 an investigation was begun of the Corporation's tax returns for the fiscal years ended November 1943, 1944, 1945, and 1946. Certain concessions were made and adjustments of allowable compensation paid to officers agreed to, which resulted in the deficiencies here contested. On January 6, 1950, V. C. Hickey, then treasurer of the Corporation signed a waiver of restrictions on assessment and collection of deficiency in tax and acceptance of overassessment, consenting to the proposed adjustments. Thereafter additional income tax of $ 209.30 for the Corporation's fiscal year ended November 30, 1943, plus interest of $ 9.73, was assessed in April 1950; additional excess profits tax of $ 29,295.75 for the Corporation's fiscal year ended November 30, 1943, plus interest of $ 9,856.39, was assessed*32 in April 1950; additional excess profits tax of $ 16,216.08 for the Corporation's fiscal year ended November 30, 1944, plus interest of $ 4,496.32, was assessed in April 1950. Consents to the extension of periods, within which assessments might be made of income and excess profits taxes of the Corporation for the fiscal years here in question, were signed by various corporate officers from time to time. These consents all bore the corporate seal. The period was thus extended to June 30, 1950. John had severed all his connections with the Corporation by December 17, 1947, and James by October 28, 1948. *300 The deficiencies here in question did not appear on any 1945 financial statement of the Corporation and as late as November 30, 1947, had not appeared as liabilities on any financial statement of the Corporation. On June 26, 1951, the Commissioner addressed letters to John and James giving notice that of the deficiencies determined against the Corporation, amounts aggregating the addressee's total liability as a transferee of the Corporation's assets would be assessed. The statement accompanying these notices in explanation of the adjustments made stated that for the year*33 ended November 30, 1943, the deduction "for officers' salaries has been decreased in the amount of $ 29,476.87" and for the following year stated that deduction "for amounts paid to three officers of the Corporation, in addition to their salaires, has been eliminated." This latter amount totaled $ 13,275.01. No allocation of the amounts disallowed among the compensation of the various officers was shown. The Corporation did not contest the deficiencies determined against it, and on May 18, 1950, the Corporation mailed identical letters to the Dentons and to Keane and Curtin asking them to pay the deficiencies in accordance with their contract of November 13, 1945. John, through his attorney, denied liability by letter. The others either did not respond or denied liability over the telephone. None has paid any amount on account of the Corporation's tax deficiencies. The Corporation has made periodic payments against its 1943 and 1944 deficiencies. As of October 30, 1952, these payments aggregated $ 10, 768.36. The unpaid balance as of that date with interest was $ 44,443.52. The last financial statement of the Corporation prepared before the hearing of this proceeding and covering*34 the fiscal year ended November 30, 1951, showed the following assets: cash, $ 557.24, and accounts receivable, $ 14,102.09, or a total of $ 14,659.33. OPINION. At the outset we dispose of the petitioners' claim that the assessment of transferee liability against them was barred by the statute of limitations. The petitioners admit that the periods of limitation for assessment were extended by consents given by the Corporation and that the Corporation could not be heard to question the authority under which the consents were given. Nevertheless they argue that since the Corporation's board of directors did not expressly authorize the consents, they, the petitioners, not being in privity with the Corporation can here assert the lack of authority. We find no merit in this contention. We think the consents were properly executed by corporate officers. It is admitted their validity could not be questioned by the Corporation. Simply because at the *301 time the last consent was given the petitioners had severed their connections with the Corporation should not place them in position to escape the effect of those consents. This Court has held that the statute which provides that*35 the period of limitations for assessment of transferee liability shall be within 1 year after the expiration of the period of limitation for assessment against the taxpayer (see section 311 (b) (1)) means "the original period of limitation against the taxpayer as properly extended by consents." Rite-Way Products, Inc., 12 T. C. 475. We find nothing in the statute or the cases which would confine this construction of the statute only to transferees who happened to be in privity with the taxpayer at the time a consent was executed. The assessment of transferee liability against the petitioners is not barred by the statute of limitations. We turn to the question of petitioners' liability as transferees in equity for unpaid taxes of the Corporation. The provision of the Internal Revenue Code providing for such liability is as follows: SEC. 311. TRANSFERRED ASSETS. (a) Method of Collection. -- The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this chapter*36 (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting claims and suits for refunds): (1) Transferees. -- The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this chapter. * * * * Any such liability may be either as to the amount of tax shown on the return or as to any deficiency in tax. * * * * (f) Definition of "Transferee". -- As used in this section, the term "transferee" includes heir, legatee, devisee, and distributee. On the liability in equity phase of the case the Commissioner alleges that the Corporation transferred $ 4,650 to John as a dividend in 1943 and also transferred to him the following amounts as unreasonable salary: $ 10,387.88 in 1943, $ 6,391.69 in 1944 and $ 3,083.29 in 1945. With reference to James, like allegations are made, the amounts, however, being $ 3,000 as a dividend in 1943, and $ 5,105.67, $ 5,649.96, and $ 5,233.29 as unreasonable salary in the*37 years 1943, 1944, and 1945, respectively. It is further alleged that as a result of these transfers the Corporation was left without funds to pay its tax deficiencies and as of November 30, 1945, its assets were exceeded by its liabilities. To hold a party liable as transferee in equity for a transferor's delinquent taxes it must be proved (1) that the alleged transferee received *302 assets of the transferor and (2) that the transferor was insolvent at the time of, or was rendered insolvent by, the transfer of assets. J. Warren Leach, 21 T. C. 70. Thus, a necessary item of proof for the years 1943 and 1944 is here lacking. We have no proof of insolvency of the Corporation in those years and to the contrary, have found as a fact that it was solvent. The payment of amounts in those years to the petitioners as compensation, even though unreasonable, did not render the Corporation insolvent. Accordingly, the petitioners cannot be held liable in equity for the amounts received by them from the Corporation in 1943 and 1944. The year 1945 presents a little different problem, for by November 30, 1945, the Corporation had become insolvent. No determination*38 of deficiencies for that year was made by the Commissioner and his affirmative allegations that the amounts of $ 3,083.29 and $ 5,233.29 were received by John and James, respectively, as unreasonable salaries constitute new matters on which the Commissioner has the burden of proof. We do not think this burden has been met and we are unable to make findings that any portion of the salaries paid to the petitioners in 1945 was unreasonable. We hold that the petitioners are not liable as transferees in equity. This leaves us with the problem of the petitioners' liability at law. To sustain his contention that the petitioners are so liable the Commissioner makes a two-pronged argument. First, he would base such liability on the contract executed on November 13, 1945, by the petitioners and Keane and Curtin whereby they agreed to pay a proportionate share of any "undisclosed" tax liabilities of the Corporation. Second, he argues that the petitioners became liable under Connecticut law by their conduct as directors of the Corporation in approving the purchase by the Corporation of its own shares while insolvent. 1 *39 We think the Commissioner must fail in these arguments for the following reasons. The liability which is sought to be imposed on the petitioners is, in the words of section 311, "the liability at law * * * of a transferee of property of a taxpayer * * *" (Emphasis supplied). We take this to mean that in order to hold the petitioners liable at law as transferees there must be found some liability on their part which arose either by express agreement or by operation of law in connection with or because of the transfer to them of the taxpayer's *303 property. In Willard M. Whitney, 26 B. T. A. 212, it was said in regard to section 280, the predecessor of section 311, that before "the respondent may proceed under section 280 a person must be a transferee of property from the taxpayer in circumstances which make him liable at law or in equity for the tax." Cf. United States v. Scott, 167 F. 2d 301. Such is not the situation here. No assets or property of the Corporation were transferred to the petitioners in connection with, in support of, or in consideration of their execution of the contract, the terms of *40 which are set out in our findings. Neither did they receive any property of the Corporation in connection with the purchase of Curtin's shares by the Corporation. The purchase price in that transaction passed to Curtin and not to the petitioners. These transactions, the November 13, 1945, contract and the sale of stock to Curtin, were entirely unrelated to the transfers of property on which the Commissioner relies to measure the petitioners' liability, i. e., the alleged unreasonable salaries in 1943, 1944, 1945 and the dividend in 1943, and we do not think those transfers can be properly combined with either the contract or the Connecticut law in such a way that transferee liability at law will result. Perhaps the petitioners could be held for the Corporation's unpaid taxes in an action at law based either on the contract or the provisions of the Connecticut statute cited by the Commissioner. Cf. Commissioner v. Keller, 59 F. 2d 499. Those questions we need not decide, for even were the petitioners so liable, their liabilities under the contract or the Connecticut law would not be those of a "transferee of property" within the meaning of section*41 311 as we construe it, and the summary collection procedure provided in that section would not be available to the Commissioner. M. H. Graham, 26 B. T. A. 301, appeal dismissed 63 F. 2d 997. We hold that on the facts before us the petitioners are not liable at law as transferees of the Corporation's property. In view of our disposition of the above questions it is not necessary to decide whether the Commissioner properly determined the deficiencies against the Corporation set out in our preliminary statement, the propriety of which determination is attacked by the petitioners. Decision will be entered for the petitioners. Footnotes 1. The General Statutes of Connecticut (Revision of 1949), Vol. II, Sec. 5181: * * * No corporation shall acquire, purchase and hold its own stock unless to prevent loss upon a debt previously contracted, except with the approval of stockholders owning three-fourths of its entire outstanding capital stock given at a stockholders' meeting warned and held for that purpose; and such corporation shall not vote upon shares of its own stock. No corporation shall purchase any of its own stock when it is insolvent, or by such purchase shall render itself immediately insolvent. If any corporation shall purchase its own stock when it is insolvent, or by such purchase shall render itself immediately insolvent, the directors assenting to such purchase shall be personally liable for any debts of such corporation existing at the time of such purchase. * * *↩