Hooker Electrochemical Co. v. Commissioner

Hooker Electrochemical Co., Petitioner, v. Commissioner of Internal Revenue, Respondent. Edwin R. Bartlett, Petitioner, v. Commissioner of Internal Revenue, Respondent. Harry M. Hooker, Petitioner, v. Commissioner of Internal Revenue, Respondent Hooker Electrochemical Co. v. Commissioner Docket Nos. 10245, 10246, 10247 United States Tax Court 8 T.C. 1120; 1947 U.S. Tax Ct. LEXIS 193; May 27, 1947, Promulgated *193 Decision will be entered for the petitioners. Petitioner corporation declared year end bonuses to officers and employees, to be paid unless prohibited by emergency price control legislation. Upon advice of its attorney that such payments were not prohibited under the law, checks were issued and delivered without restriction. Held, amounts so paid its president and vice president, the individual petitioners here, were properly accrued by the corporations and constructively received by the individuals for tax purposes in 1942, even though the individuals on their own initiative refrained from cashing the checks until 1943, when they secured an official ruling that the payments were legal. Charles G. Tufts, 6 T. C. 217, distinguished. Edgar J. Goodrich, Esq., and Lipman Redman, Esq., for the petitioners. William F. Evans, Esq., for the respondent. Kern, Judge. KERN *1121 The Commissioner determined a deficiency in the income and excess profits taxes of petitioner Hooker Electrochemical Co., in the respective amounts of $ 1,302.08 and $ 12,357.83 for the taxable year ended November 30, 1942; and in the income tax of petitioner Harry M. Hooker in the amount of $ 7,585.31 for the calendar year 1943; and in the income tax of petitioner Edwin R. Bartlett in the amount of $ 4,009.50 for the calendar year 1943. The three proceedings were consolidated for hearing. The question as to the corporation is whether certain amounts of additional compensation voted to its president and vice president were properly accruable by it in its tax year ended November 30, 1942, and as to the individuals it is whether the amounts were constructively*195 received by them in 1942. FINDINGS OF FACT. Petitioner Hooker Electrochemical Co. is a corporation, organized under the laws of New York, with its principal place of business at Niagara Falls. It is engaged in the business of manufacturing and selling heavy and fine chemicals. It kept its accounts on an accrual basis, and it filed its tax returns on that basis with the collector of internal revenue for the twenty-eighth district of New York for its fiscal year ended November 30, 1942. Petitioner Edwin R. Bartlett is an individual, residing at Lewiston, New York. He filed his income tax return, on the cash basis, for the calendar year 1943 with the collector for the twenty-eighth district of New York. He is the executive vice president of Hooker Electrochemical Co. Petitioner Harry M. Hooker is a resident of Lewiston, New York, and is president of Hooker Electrochemical Co. He filed his individual return, on the cash basis, for the calendar year 1943 with the collector for the twenty-eighth district of New York. Petitioners Harry M. Hooker and Edwin R. Bartlett and their respective families held a combined total of less than 9 per cent of the stock of petitioner Hooker Electrochemical*196 Co. *1122 Since at least 1915 it has been the policy of the petitioner corporation to pay its employees year end bonuses as additional compensation for their services, by way of incentive payments, whenever the company's profits justified such payments. Such bonuses were paid in ten such years, including 1940, 1941, and 1942. Its procedure in effectuating this policy, which was understood and relied on by its officers and employees, has been to make estimates at the beginning of each taxable year of the probable earnings and profits of the corporation and of the additional compensation which would be paid upon the basis of such earnings and profits to the officers and employees at the end of the year. Toward the end of the year, when the results of the year's work were available, the directors would adopt a resolution appropriating the exact amount for such payments in the light of actual achievements. The company's policy was believed by its directors to be fruitful of benefits to the company, since the officers and key employees were aware early in the year that a goal was set by the directors and that they could expect to receive substantial additional compensation if, *197 through their efforts, it was realized. The bonuses paid in 1940 and 1941 and those authorized for 1942 were at the rate of 25 per cent of basic salaries. Pursuant to this policy, the corporation paid $ 156,895 as additional compensation to 277 employees in 1937, $ 101,585 to 268 employees in 1940, and $ 127,699 to 282 employees in 1941. In 1942, on January 13, the directors fixed the base salaries, among others, of petitioner Hooker at $ 54,000 and petitioner Bartlett at $ 49,000, and made their usual estimate of anticipated earnings, and fixed the total estimated year end additional compensation award at $ 150,000. On November 12, 1942, the directors adopted a resolution allowing $ 153,030.66 as year end compensation to 295 employees. Included among the employees were the individual petitioners Harry M. Hooker and Edwin R. Bartlett, its president and executive vice president, respectively, whose additional compensation awards were $ 13,500 and $ 12,250, respectively. The language of the resolution of November 12, 1942, relating to the allowance of the compensation, reads as follows: Whereas, due to the loyal and competent services of the officers and employees of the Company during*198 the current fiscal year, the business and the earnings of the Company have been very satisfactory, Now, Therefore, Be It Resolved, That, prior to the close of the current fiscal year, unless prohibited by the provisions of the Emergency Price Control Act of 1942 as amended by the Act of October 2, 1942, Public Law #729, 77th Congress, or of any regulation, ruling or order promulgated thereunder, there be paid to the employees as per list of names, with amounts set opposite thereto, *1123 presented at this meeting, the total of which is $ 153,030.66, same being compensation for services performed by the individuals listed during the fiscal year of 1942 in addition to their regular salaries. Further Resolved, That, in the opinion of this Board, the amount of additional compensation to be paid to the officers and employees in pursuance of the foregoing resolution, plus their regular salaries, will not exceed reasonable compensation for the services rendered by them during the year. On October 2, 1942, the Emergency Price Control Act of 1942 had been amended by Public Law 729, and Executive Order 9250, issued pursuant thereto, became effective on October 3, 1942. This Executive *199 order contained, among others, these provisions: Title II. 5. No increases in salaries now in excess of $ 5,000 per year (except in instances in which an individual has been assigned to more difficult or responsible work), shall be granted until otherwise determined by the Director. * * * * Title VI. 2. Salaries and wages under this Order shall include all forms of direct or indirect remuneration to an employee or officer for work or personal services performed for an employer or corporation, including but not limited to, bonuses, additional compensation, gifts, commissions, fees, and any other remuneration in any form or medium whatsoever * * *; but for the purpose of determining wages or salaries for any period prior to September 16, 1942, such additional compensation shall be taken into account only in cases where it has been customarily paid by employers to their employees. "Salaries" as used in this Order means remuneration for personal services regularly paid on a weekly, monthly or annual basis. Pursuant to provision therefor in Executive Order 9250, on October 27, 1942, the Economic Stabilization Director issued regulations, published in C. B. 1942-2, p. 361, which limited*200 authorized salaries, beginning in 1943, to $ 25,000 per year net after taxes, with specified exceptions with which we are not immediately concerned. These regulations further provided: Sec. 4001.6. Salary Increases. -- In the case of a salary rate of * * * more than $ 5,000 per annum existing on October 3, 1942, no increase shall be made by the employer except as provided in regulations, rulings, or orders promulgated under the authority of these regulations. * * * Sec. 4001.9. * * * (e) No amount of salary shall be paid or authorized to be paid to or accrued to the account of any employee or received by him after the date of approval of these regulations by the President and before January 1, 1943, if the total salary paid, authorized, accrued or received for the calendar year 1942 exceeds the amount of salary which would otherwise be allowable under paragraph (a) of this section and also exceeds the total salary paid, authorized, accrued or received for the calendar year 1941. On November 5, 1942, subsection (e) as set out above, was amended by inserting at the beginning the words: "Unless payment thereof is required under a bona fide contract in effect on October 3, 1942,". *201 On December 2, 1942, the Commissioner of Internal Revenue issued a ruling, T. D. 5186, C. B. 1942-2, p. 348, containing the following pertinent provisions: *1124 Sec. 1002.13. Commissioner's Approval Required. -- Section 1 of the Act provides in effect that salaries, so far as practicable, shall be stabilized at the levels which existed on September 15, 1942. * * * in the case of a salary rate of more than $ 5,000 per annum existing on October 3, 1942, * * * no increase shall be made by the employer, except as provided in section 1002.14, without prior approval of such increase by the Commissioner. * * * Sec. 1002.14. Commissioner's Approval Not Required. -- * * * a bonus based upon a fixed percentage of salary where the percentage has not been changed does not require approval by the Commissioner even though the amount may be increased due to an authorized increase in salary. * * * The ruling further set out the following example: (5) Employees of the Z Corporation have customarily received a bonus of 5 per cent of their annual salary at the end of each calendar year. If, for example, one of the employees received $ 6,000 in 1941 but *202 received salary of $ 7,000 in 1942 due to a salary increase on July 1, 1942, a bonus of $ 350 may be paid to him for 1942 without prior approval of the Commissioner, notwithstanding that his bonus for 1941 was only $ 300. Conferences were held between the officers of petitioner and its attorney as to what restrictive effect, if any, the executive order and regulations might have upon the payment of the year end bonuses to any of the 295 employees covered by the plan. After investigation, the attorney reached the conclusion, and so advised the executive officers, that the restrictions therein contained did not apply to any of the payments so authorized by the directors. Consequently, checks were drawn in the amounts indicated, totaling $ 152,717.82 (after old age benefit deductions from the amount of $ 153,030.66) to 295 officers and employees. Included therein was a check, No. H-102, for $ 13,500 to petitioner Hooker, and a check, No. H-103, for $ 12,250 to petitioner Bartlett. All the checks were signed by the proper officers, and were dated November 27, 1942. In accordance with the company's bookkeeping practice, when the checks were drawn and issued the total amount of such *203 checks was immediately charged to "additional compensation for 1942" and credited to "accounts payable." This had the effect of setting up an immediate liability on the general ledger. Simultaneously, a "cash" entry was made in the cash book, deducting from cash balances the entire amount represented by the issued checks. This had the effect of treating the entire amount as paid, reducing the "cash" or "surplus" accounts, and clearing the general ledger liability. All the checks were delivered by mail except the two for Hooker and Bartlett, which were delivered to their respective secretaries, who delivered them to the payees. The bank account of the petitioner corporation at all times pertinent hereto contained balances of many times the amounts represented by these checks. Petitioners Hooker and Bartlett did not present their checks for payment because they wished to secure an official ruling from the *1125 Salary Stabilization Unit that the payments did not violate any of the new provisions of law. At the time of the issuance of the checks in question these petitioners were not in immediate need of the money represented by the checks issued to them. They were not inclined*204 to run any risk of embarrassing either themselves or the corporation of which they were executive officers by cashing them and thereby getting into some difficulty. They, therefore, requested the attorney to make official application for approval, in spite of his considered opinion that such approval was unnecessary. The attorney, under their instructions, presented the question in person to a local representative of the Salary Stabilization Director, who approved the payments. He later revoked his approval, assigning as a reason that in his opinion the payments were not required by any bona fide contract in effect on October 3, 1942, the director's meeting at which they were voted not having been held until November 12, but approved the payment of $ 2,250 to petitioner Hooker and $ 5,428.61 to petitioner Bartlett. Petitioners Hooker and Bartlett directed the attorney to appeal the matter to higher authority, and, pending the outcome thereof, petitioner Hooker returned check No. H-102, in the amount of $ 13,500 to the corporation's treasurer, and asked him to issue in exchange therefor two checks, in the amounts of $ 2,250 and $ 11,250, totaling the same amount. This was done, *205 and such checks were Nos. H-102 and H-102A, respectively. Petitioner Bartlett returned to the treasurer his check No. H-103 in the amount of $ 12,250, and received in exchange therefor two checks, Nos. H-103 and H-103A, in the respective amounts of $ 5,428.61 and $ 6,821.39, totaling $ 12,250. Both Bartlett and Hooker deposited their checks for $ 2,250 and $ 5,428.61, and on or about December 31, 1942, they deposited with the corporation's treasurer the checks for $ 11,250 and $ 6,821.39, requesting him to hold them subject to later instructions from them. Sometime in February 1943, when the books were about to be closed for the fiscal year ended November 30, 1942, the treasurer canceled these unpaid checks and restored the amounts thereof to surplus. He believed this to be the most convenient account to which the funds could be credited and from which he could issue new checks upon demand and without further authorization. On the corporate income tax return for the fiscal year ended November 30, 1942, the company deducted the $ 18,071.39 represented by these two checks as "additional compensation," with the notation that they had not yet been paid, pending approval by the Commissioner. *206 On February 18, 1943, the Commissioner sustained the ruling of the regional office of the Salary Stabilization Unit. On April 12, 1943, Executive Order No. 9250 was rescinded, together with the regulations referred to. Thereafter, the attorney wrote to the Salary Stabilization Unit, requesting specific approval of the disputed amounts, and on November 3, 1943, received a letter stating that "approval is granted *1126 for the payment of additional compensation to the above-mentioned employees for the year 1942." Subsequently, on November 8, 1943, petitioners Hooker and Bartlett asked for and received checks in the respective amounts of $ 11,250 and $ 6,821.39. Each filed amended individual income tax returns for 1942, reporting the entire amounts of the bonus payments. The amount of $ 25,750, representing the aggregate of the bonus payments to petitioners Hooker and Bartlett, was properly accruable by petitioner Hooker Electrochemical Co. as an ordinary and necessary expense of doing business in the fiscal year ended November 30, 1942. The amount of $ 13,500 was constructively received by petitioner Harry M. Hooker in the calendar year 1942. The amount of $ 12,250 was constructively*207 received in the calendar year 1942 by Edwin R. Bartlett. OPINION. The issue, as it relates to petitioner Hooker Electrochemical Co., is whether the amounts of bonus payments awarded by its board of directors on November 12, 1942, were properly accruable as an ordinary and necessary expense of doing business during its fiscal year ended November 30, 1942. The facts are all set out in detail and we refrain from unnecessary repetition thereof. The Internal Revenue Code, in section 43, provides that deductions: * * * shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. The only question here is whether the amounts were "accrued," or, to be more exact, whether they were properly accrued so as to be deductible in 1942. Section 19.43-2 of Regulations 103 provided on this subject: * * * Each year's return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable*208 effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances, and it follows that if he does not within any year deduct certain of his expenses, * * * he cannot deduct them from the income of the next or any succeeding year. * * * It is the respondent's position that the amounts involved here were only contingently incurred in 1942. The basic salaries were fixed in January, and estimates were made of additional compensation to be paid if profits were realized in the amount anticipated. Profits were so realized, and on November 12, 1942, the board of directors made the *1127 awards of additional compensation, but provided in its resolution that payment thereof would be made only if they were not prohibited by the then new Executive order. The matter was referred to an attorney for investigation. He advised them it was his opinion that payment was not prohibited by the Executive order, and checks were thereupon issued, without restriction. Within a few days regulations were promulgated which seem to justify*209 the judgment of the attorney that the amounts were properly payable without the necessity of official approval. With respect to the respondent's contention that the items were contingently incurred, it is obvious that the action of the directors recognized that services had been rendered which were of the indicated value to the corporation. On these points no question is raised here. Apparently, the directors felt there was a responsibility on the part of the company to pay additional compensation and wished to make provision to discharge that liability. They wished to do so, however, only if it was legally permissible. Had this not been expressed it would have been implied, since it is an implied condition of every contract or undertaking that a party will not be required to do anything that is unlawful. We think the effect of the language of this resolution had no greater effect than an implicit proviso that the payments called for should not be illegal. This proviso or condition was inserted in the resolution by its draftsman, the attorney for petitioner corporation, for the purpose of protecting the corporation and was for its benefit. As such, it could be waived or disregarded*210 by petitioner corporation at its discretion. The later issuance of valid checks pursuant to the resolution, and after counsel had advised it that the payments called for therein were legal, constituted such a waiver and removed any contingency as to the payment during the corporation's fiscal year 1942 of the amounts called for by the resolution. It would be difficult to think of more convincing proof than actual payment to establish that there was no such contingency in payment as to preclude the accrual of the items to be paid. In Smith-Lustig Paper Box Manufacturing Co., 1 T. C. 503, and Cotton States Fertilizer Co., 47 B. T. A. 748, the taxpayers were, by contractual restrictions, unable legally to incur a liability for the payments involved. Here, the awards were made, and ordered paid if they were not illegal, and, upon their legality having been determined to the satisfaction of petitioner corporation, they were paid within the taxable year. The distinction is clear. We are of the opinion that the petitioner corporation properly accrued the amounts in 1942. It may be pointed out that this conclusion is in accord*211 with respondent's own ruling on a comparable question. See I. T. 3716, 1945 C. B. 140. *1128 The next issue relates to the question whether there was receipt, actual or constructive, of the amounts involved by the individual petitioners. There is no dispute that the checks were received by them in 1942, or that there were ample funds in the bank with which to pay them. The officers testified they failed to cash the checks on their own initiative, because they were disturbed about the possibility of embarrassing the company and themselves if it were later to be contended that the payments were in violation of the law, and for that reason they insisted on seeking an official ruling and refrained from reducing to possession the proceeds of the checks to the extent that they had failed, as of the end of their taxable year, to receive official approval. They were under no instruction or compulsion of any kind to refrain from cashing the checks. There is before us no evidence of any sort from which we could infer any restriction on their right to cash the checks so received. Under these facts, we are of the opinion that they received actually or constructively*212 the amounts called for by the checks in question in 1942. See Urban A. Lavery, 5 T. C. 1283. Respondent relies on Charles G. Tufts, 6 T. C. 217. In that case the employer corporation "was not willing to pay the amount [of increased salary] to the petitioner in 1942," no payment thereof was made by check or otherwise, and "the additional amount was not accrued as a liability on the books of the employer prior to December 31, 1942, and was not credited on those books to the account of the petitioner during that year." In those important respects that case is distinguished from the instant case. Decision will be entered for the petitioners.