Whittelsey, Inc. v. Commissioner

H. Newton Whittelsey, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Whittelsey, Inc. v. Commissioner Docket No. 8642 United States Tax Court 9 T.C. 700; 1947 U.S. Tax Ct. LEXIS 66; October 15, 1947, Promulgated *66 Decision will be entered under Rule 50. 1. Petitioner was engaged during the taxable year in rendering naval architectural and marine engineering services to the United States Navy under cost plus a fixed fee contracts. Its capital stock was owned by four stockholders, who were regularly engaged in the active conduct of its business. Capital was not a material income-producing factor of the business. The principal stockholder secured the contracts, supervised the performance thereof, directed and instructed petitioner's employees, and was the only person in petitioner's organization who had the scientific knowledge, skill and experience necessary to complete the contracts entered into by petitioner. Held, petitioner is a personal service corporation, whose income is to be ascribed primarily to the activities of its principal stockholder. 2. The Navy paid "vacation wages" to petitioner as a part of its contracts. At the end of the year petitioner had $ 3,458.90 of undisbursed "vacation wages," which it set up in a reserve for the employees entitled thereto. Petitioner reported the entire amount of "vacation wages" received as income, and claimed the entire amount as a*67 deduction. Petitioner was on the cash receipts and disbursements basis. Held, respondent correctly disallowed the undisbursed portion of "vacation wages." 3. The evidence fails to establish that certain sums disallowed as contributions were advertising expenses deductible as ordinary and necessary expenses of petitioner's trade or business. Max Rockmore, Esq., and Sidney Meyers, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent. Arnold, Judge. Disney, J., dissenting. ARNOLD *700 Respondent determined a deficiency of $ 7,844.91 in excess profits tax for the fiscal year ended November 30, 1942. The issues are (1) whether petitioner is a personal service*68 corporation; (2) whether *701 respondent erred in restoring to petitioner's taxable income $ 3,458.90 representing "vacation wages" of employees; and (3) whether certain amounts, aggregating $ 90, which were disallowed by respondent as contributions are deductible as ordinary and necessary business expenses. FINDINGS OF FACT. Petitioner, a New York corporation, was organized in December 1939, with its principal place of business in New York, N. Y. It was engaged in the naval architecture and marine engineering business. Its income tax return was made upon the cash receipts and disbursements basis and was filed with the collector for the second district of New York. Its original paid in capital was $ 1,040, for which 520 shares of no par value common stock were issued. In or about February 1941 petitioner capitalized undistributed surplus from its operations for the fiscal year 1940 in the amount of $ 1,238.72. No additional stock was issued representing the capitalized earnings and no other change occurred in petitioner's capital structure from its organization through the taxable year 1942. During the taxable year petitioner's officers, directors, and stockholders, with*69 shares held by each, and the time each stockholder devoted to petitioner's business were as follows: Stockholders and directors Official title Shares Time owned devoted to business H. Newton Whittelsey President [250] 100% Myrtle S. Whittelsey, wife of H. Newton Whittelsey Vice president [150] Part time Souther Whittelsey, son of H. Newton Whittelsey and Myrtle S. Whittelsey. Secretary [60] 100% Augustus W. Kelley Treasurer [60] 100% Total shares outstanding [520] Myrtle S. Whittelsey was cosigner on petitioner's checks with H. Newton Whittelsey. Souther Whittelsey assisted his father, but was not a naval architect or a marine engineer. Kelley handled the invoicing and the disbursement of funds. On or about December 17, 1941, petitioner entered into a "Contract for Plans, Specifications and Professional Services" with the United States of America, referred to in the contract as the Department, in connection with the construction of certain naval vessels, namely 180 foot sub-chasers and mine sweepers. The Chief of the Bureau of Ships, acting for the Secretary of the Navy, executed the contract for the Department. H. Newton Whittelsey, as president, *70 executed the contract for petitioner, which is referred to in the contract as the "Engineer." The contract, sometimes referred to as contract NObs-348, describes the engineer as "an organization *702 which is prepared to furnish professional naval architectural and marine engineering information and consultation services (hereinafter referred to as 'services') and to produce plans, specifications, and related data (hereinafter referred to as 'drawings') * * *." The engineer was required by article 1 to "provide such services and furnish such drawings as may be directed by the Contracting Officer [Chief of the Bureau of Ships] or his designated representative." Article 2 provided for the increase, decrease, or cancellation of projects as the interests of the Department may require. Article 3 provided that "whenever the Department deems it necessary to call upon the Engineer to furnish services or drawings for a project, one or more job orders will be prepared jointly by the Department and the Engineer, specifying in detail the work to be done by the Engineer." Additional job orders could be prepared or existing job orders canceled. Article 4 provided that "Each job shall include*71 a statement of the estimated cost agreed upon by the Department and the Engineer." The total cost of all job orders relating to one project constituted the estimated cost of the project, which was to be revised to reflect the estimated cost of all authorized changes. The estimated cost did not include any element of profit to the engineer. Article 5 related to material changes; article 6 to traveling expenses. Article 7, which deals with performance, provided in part as follows: (b) In rendering services or producing drawings the Engineer, in cooperation with and subject to the supervision and control of the Department's representatives will use his best endeavors, ingenuity, scientific knowledge and skill. The Engineer will collaborate closely with any shipbuilding contractor designated by the Department in order that the actual work of construction, repair, or conversion of a vessel will best meet the facilities and construction methods of such contractor. All work done by the Engineer under this contract is to be coordinated with the Engineer's obligations with respect to other projects for the United States Navy Department, the United States War Department, the United States*72 Maritime Commission, and private contractors performing work for the said Departments and the United States Maritime Commission. * * * The remaining articles in the contract pertinent hereto provide for changes in the project or job orders by written order of the Department; a schedule jointly prepared by the engineer and the Department showing sequence of work to be performed and proposed completion dates; compensation to the engineer on a cost plus 7 per cent basis; semi-monthly payments to the engineer; a release from the engineer of all claims against the project; that as payments are made "the designs, plans, specifications, and data, or any part thereof * * * shall, thereupon, become the sole property of the Department * * *"; termination of the contract under specified conditions; that "In preparing the designs for the construction, repair, or conversion of vessels, the Engineer will omit any features necessitating the use of a particular patented or proprietary article, method of operation, material, or item *703 of equipment to the exclusion of all others * * *," except that when following the Department's directions or plans and specifications the engineer was required*73 to furnish the Department with suitable offices, drafting room, and clerical assistance at or near the engineer's place of business; the contract and no interest therein could be transferred by the engineer; claims for money due under the contract could be assigned, but not copies of any plans, specifications, or other similar documents annexed or attached to the contract and marked, "Secret," "Confidential," or "Restricted"; the engineer was required to keep records and books of account showing the costs, which books and records were to be available at all reasonable times to representatives of the Department; and the engineer was prohibited from disclosing information in relation to its work and was responsible for safeguarding all secret, confidential, and restricted matter in its possession. Under date of June 26, 1942, petitioner entered into a contract with Pullman-Standard Car Manufacturing Co., which had been authorized by the Navy to proceed with the construction of 222 180-foot sub-chasers and mine sweepers. This contract describes petitioner as the "Design Agent," specifically refers to the work already done by petitioner under contract NObs-348, and states that "the Design*74 Agent shall continue with the remaining work of designing said vessels and of producing the plans, specifications and related data for said vessels, with the furnishing of such engineering services relative thereto as may be required by Pullman-Standard and/or the following yards * * *." The terms of the Pullman-Standard contract were substantially the same as the terms of petitioner's contract of December 17, 1941, and the work started under prime contract NObs-348 was continued. During the 'taxable year petitioner entered into a contract with Expanded Steel Corporation for development of a hatch beam for use on the Liberty type ships being built for the Maritime Commission. This contract was also a cost plus a fixed fee undertaking. From the three contracts petitioner received gross income during the taxable year of $ 421,478.82; $ 225,218.78 on contract NObs-348, which included its fee, $ 195,821.03 on its contract with Pullman-Standard, which included its fee on work done, and $ 439.01 on its contract with Expanded Steel Corporation. During the taxable year petitioner also received $ 2,887.50 from Penn Shipyards as final payment on a contract entered into prior to the taxable*75 year, and $ 50,000 from Gulf Shipbuilding Corporation on a contract completed prior to December 1, 1941, except for consultation services. The remaining income item of the petitioner was an amount of $ 181, received from the Navy for installation of a safe. During the taxable year petitioner employed an aggregate of 176 employees, but its average number of employees was 93. A breakdown *704 of the employees, with the wages paid each group, exclusive of overtime, during the taxable year is as follows: Employees Wages paid group [3] department chiefs $ 22,233 [3] division heads 13,838 [7] squad leaders 25,253 [6] senior draftsmen 9,984 [32] regular draftsmen 51,573 [49] junior draftsmen 73,063 [52] tracer-trainees 44,290 [1] office manager 2,100 [1] senior accountant $ 3,100 [2] junior accountants-bookkeepers 2,125 [3] senior stenographers 4,323 [6] junior stenographers 3,424 [10] junior clerks 3,716 [1] messenger [176] Total 259,220 During the taxable year petitioner paid its employees wages for overtime in the total amount of $ 56,455.32, or a total of wages and overtime of $ 315,675.32. The compensation of its officers totaled $ 39,095.33 for the*76 taxable year. Petitioner's business was divided into three departments, the hull, the machinery, and the electrical and ventilating departments. Each department was in charge of a chief and an assistant, known as a division head. The chiefs of the hull and machinery departments were chief draftsmen. The chief of the electrical and ventilating department was a professional engineer licensed by the State of New York. Each chief was responsible for coordinating the work done in his department and helped to coordinate the work done in his department with the work done in the other two departments. The chiefs conferred with H. Newton Whittelsey regularly and received instructions from him as to what was to be done and how Whittelsey wanted the work done. Whittelsey was the only man in petitioner's organization capable of completely coordinating the work of all departments and producing a complete set of working plans for the construction of ships by the shipyards. The "squad leaders" were employees who were placed over the section leaders to coordinate their efforts and keep the work moving as scheduled. The section leaders were responsible for a certain section or portion of the*77 work to be done. The "tracer-trainees" were employees who traced out the pencil drawings in ink, as the Navy required that everything be done in ink. A draftsman is someone who puts down on paper the ideas given to him. Only the more experienced draftsmen were capable of making suggestions and doing original design work. Practically everybody in petitioner's organization used a drafting board except the office employees, whose work was indicated by their positions and was not a material income-producing factor. The working plans were developed section by section, department by department, until finally a complete set of working plans was evolved. When completed the working plans consisted of 500 to 600 plans roughly 30 x 80 inches, plus all the little details. When completed, any shipyard could take the plans and build and equip the ships. *705 At the time contract NObs -- 348 was executed, speed in the production of complete working plans for the construction of naval vessels was of the utmost importance to the nation. Whittelsey was the only man in petitioner's organization capable of estimating the time necessary to produce the working plans and the cost thereof. *78 His estimates were based upon "type plans" or "outline plans" and specifications submitted by Navy for the mine sweepers and sub-chasers the Navy wanted constructed. In producing the complete working plans Whittelsey had to schedule the work as to time of performance so that it would follow in its proper sequence. He indicated on the schedules his ideas, suggestions, and what he wanted. After the work was completed, it was initialed by the various draftsmen, squad leaders, section leaders, and division and department heads, and was held for Whittelsey's approval. No plans were complete or released to the Navy until finally approved by Whittelsey. The numerous changes requested by the Navy were cleared through him alone, as no other person in the organization was qualified to work the changes requested into the overall plan. Whittelsey was also an expert on the prefabrication of hulls, and his prefabrication methods and planning reduced the time required to construct the ships. Only 30 ships were built with the hull as originally designed by the Navy. The remaining ships, approximately 270 in number, were built with a hull redesigned by Whittelsey. Whittelsey was the only person*79 in petitioner's organization who made any outside contacts relative to business. Petitioner had no solicitors. The contracts performed during the taxable year were secured without competitive bidding. It was primarily his scientific knowledge, skill, and experience in designing and building ships that the Navy sought and prompted it to enter into the contracts. He was the one who conferred and consulted with the experts of the Navy and with the officials in the shipyards on questions of development of plans, designing, specifications, equipment, and construction. During the taxable year petitioner had a contract with the Marine Draftsmen's Association, the effect of which was to entitle members of the union to one day's vacation with pay for each month of work. The Navy recognized this obligation of the petitioner as a portion of the cost of overhead and paid to petitioner during the taxable year $ 10,440.27 as vacation allowances. This sum was reported by petitioner as a part of its gross income. Due to the pressure of work, which was 52 to 76 hours per week, petitioner deemed it inadvisable to give some of its employees time off for the vacations they had earned. At the *80 end of the taxable year petitioner had paid out $ 6,981.37 as vacation allowances and had $ 3,458.90 on hand that had been earned by and belonged to employees who had been unable to get time off for their vacations. Petitioner set the $ 3,458.90 up as a reserve and deducted it from gross income. Respondent denied the deduction for *706 the reason that petitioner kept its books and filed its returns on the cash receipts and disbursements basis. During the taxable year petitioner was solicited by and contributed the following sums to the organizations listed: National Association of Regulars, U. S. Army $ 50 Patrolmen's Benevolent Association of N. Y. C. [5] Post Office Clerks' Benevolent Association [35] The amounts were deducted on petitioner's return as contributions. Respondent denied the deductions for the reason that the organizations did not meet the requirements of section 23 of the Internal Revenue Code. OPINION. The principal issue in this case is whether petitioner qualifies as a personal service corporation under section 725 (a) of the Internal Revenue Code, which is set forth in the margin. 1 Respondent concedes that petitioner is qualified thereunder to*81 the extent of stock ownership by the principal shareholders and to the extent that capital is not a material income-producing factor in petitioner's business. In the light of this concession we need discuss only whether the income of the corporation is to be ascribed primarily to the activities of shareholders who are regularly engaged in the active conduct of the affairs of the corporation. *82 On this point respondent contends that nonstockholder employees of the petitioner contributed so substantially to the services rendered by petitioner that personal service classification must be denied, citing Regulations 112, section 35.725-2. Respondent admits that Whittelsey secured the contracts and was the final cog in supervision of the work performed thereunder, but he contends that this is not enough to qualify petitioner as a personal service corporation. Petitioner, he says, relied upon nonstockholders to do a substantial amount of the work which produced the income, and their work was predominant and greatly overshadowed the contribution by Whittelsey. The crux of this issue is whether petitioner's income is to be ascribed primarily to the activities of Whittelsey and the other stockholders. Basically, this means Whittelsey, who, under section 725 (a), is considered *707 the owner of stock standing in his wife's name. None of the other stockholders had the scientific knowledge, skill, education, experience, and contacts requisite to secure or perform the contracts. In these particulars petitioner was essentially a one-man corporation, wholly dependent upon Whittelsey. *83 He made all the business contacts, he secured all of petitioner's contracts, he provided the necessary architectural and marine engineering experience, he was the only man in petitioner's organization who could estimate the cost of performing the cost-plus contracts and petitioner's fees, and its income depended heavily upon the accuracy and correctness of his estimates. He scheduled the time of performance of the work and completion of the contracts, he supervised the work done under the contracts, he worked out the innumerable changes demanded by the Navy during the course of the performance of the contracts, and he directed and integrated the overall operation so that the shipyards would have the complete working plans necessary for the continuous construction of sub-chasers and mine sweepers for use by the Navy. Whatever portion of the petitioner's income is to be ascribed to these factors must be ascribed entirely and not just primarily to the activities and efforts of Whittelsey. The contributions made by most of petitioner's nonstockholder employees were minor in character. The work of its office personnel, i. e., junior clerks, junior accountants or bookkeepers, *84 stenographers, messengers, etc., was primarily clerical in nature and could not be said to be a material income-producing factor. The tracer-trainee employees merely inked in the drawings prepared by the draftsmen, squad leaders, and division and department heads. The importance of their work is indicated by their average salary of $ 813 per annum, no allowance being made for labor turnover. Their work required no exercise of judgment or discretion and entitled them to no higher status than petitioner's office personnel. The different grades of draftsmen prepared drawings in accordance with the work assigned to them by the division heads or chiefs of the departments. Draftsmen were told what was to be done and were supervised by the employees over them. Only the more experienced draftsmen were capable of making suggestions and doing original design work. The squad leaders coordinated the work of the sections under them and kept the work moving as scheduled. The division heads assigned the work and, with the chief of the department, kept the work of their department on schedule and coordinated the work of the other departments. The chiefs conferred with Whittelsey, received*85 instructions from him, made suggestions to him for approval or rejection, and, with their assistants, the division heads, operated their departments. None of them was qualified to perform Whittelsey's multiple activities, and *708 all of them relied upon Whittelsey for direction, instruction, and supervision. Some measure of the importance of the various classifications of employees may be gained from the average annual salaries paid. The chiefs of the three departments received about $ 7,411 each. The division heads averaged $ 4,613 and the squad leaders $ 3,607. There were no changes during the taxable year in the three departmental chiefs and it is unlikely, but not established, that there were changes in the division heads. There may have been some turnover in the squad leaders, which would not be reflected in their average annual salaries. There were changes in the draftsmen employed and their average salaries were probably in excess of the amounts indicated by the table showing a breakdown of employees and total wages paid exclusive of overtime. For the three grades of draftsmen, senior, regular, and junior, the average annual salaries were $ 1,664, $ 1,612, and *86 $ 1,491, respectively. The testimony shows that of all these employees only about fifteen were qualified to make suggestions regarding the drawings and specifications. The inference we draw from these facts is that the employees were constantly directed and instructed with respect to their drawing board assignments and, with few exceptions, did no original drawings or designing under the contracts performed during the taxable year. Any original work and all supervised work had to receive the approval of the employee's immediate supervisor and the approval of Whittelsey, who was the final authority on all drawings, plans, and specifications. Considerable emphasis has been laid by respondent upon the completeness of the "type plans" or "outline plans" and specifications furnished the petitioner by the Navy. The record indicates that the Navy provided petitioner with 14 outline plans and an 80-page list of Navy requirements. Whittelsey interpreted these plans and specifications and developed them in minute detail in accordance with the Navy's general specifications and requirements. He worked into the detailed plans the changes made from time to time by the Navy and yet kept within*87 the original design and overall requirements for the construction of sub-chasers and mine sweepers. The location of specialized equipment, machinery, power equipment, and all the innumerable items required by a ship at sea called for the exercise of his special skills and judgment, due to their effect on the speed, displacement, functional purpose, operation, seaworthiness, and other qualities that the Navy wanted built into the vessels. The engines, motors, and special equipment were acquired from the manufacturers and petitioner did no designing work thereon. But the matter of installation, strengthening of structural ship members to support heavy machinery, the location on the ship, and the relationship to other machinery and *709 equipment so as to acquire maximum utility and performance were all matters for Whittelsey's special talents and ability. It was his responsibility to so plan the ship with its machinery and equipment that the Navy would secure maximum efficiency in operation under all conditions. Architectural ability and marine engineering skill were both necessary to visualize, design, and produce the detailed drawings of the ships ordered by the Navy and*88 furnished with specialized equipment for the jobs that the sub-chasers and mine sweepers were to perform. It is clear from this record that Whittelsey was the only person in petitioner's organization who could and did render these highly specialized personal services. It is equally clear that in the limited time that he had to perform the job, Whittelsey had to, and did, rely upon employees who were supervised, directed, and instructed by him. The detailed drawings the employees produced were at his direction. In spite of the large number of employees working under him, we are of the opinion that petitioner's income is to be ascribed primarily to his activities. Almost any of petitioner's employees could have been replaced without harm to the scheduled production of the drawings, but it is quite obvious from this record that petitioner could neither have secured nor performed the contracts without Whittelsey. We have examined with interest the cases cited by the parties. In one of the earliest cases on this question, Bryant & Stratton Commercial School, Inc., 1 B. T. A. 32, it was pointed out that the statutory definition precluded any definitive*89 classification and required the application of a flexible judgment to the facts in each case. The taxpayer in that case employed 27 to 30 teachers, who worked under the supervision of the two principal stockholders. The latter laid out all of the courses of instruction, supervised it, and to some extent actually gave instruction. Incidental income was derived by the school from the sale of school books and supplies and from the rental of 200 typewriters. Nevertheless, it was held that the taxpayer was a personal service corporation, the income of which was attributable primarily to the activities of its two principal stockholders. Respondent relies upon our decision in Patterson-Andress Co., 6 B. T. A. 392, and Continental Accounting & Audit Co., 7 B. T. A. 330. In the Patterson-Andress case we said, p. 398: * * * During these same years [1919 and 1920] the corporation paid to some fifteen, twenty or more employees, who were not stockholders, $ 39,500 and $ 60,000, respectively, amounts almost as great as those distributable to the stockholders. We know nothing of the services performed by these employees, except*90 that one was art director and two others did lettering upon the advertisements. In our opinion it can not be said that in such circumstances the income is to be attributed primarily to the activities of the stockholders. They secured the clients -- it was to their experience and guidance that clients looked, but the performance of the *710 duties undertaken, from the time of the first step to the checking and preparation of a statement of the proper charges for advertising, required the services of an organization which outnumbered the stockholders by six or seven to one. We do not mean to hold that personal service classification must be denied in all cases where there are employees under the supervision of stockholders, but where, as here, employees so greatly outnumber the stockholders and there is no evidence of the character of the service performed by most of them and they receive substantially one half of the earnings over the expenses other than salary, we can not find that the income is to be ascribed primarily to the activities of the stockholders. In our opinion this clause means more than that the stockholders shall obtain the clients and supervise the work, or*91 that clients shall look to their experience; it means, among other things, that the corporation may not rely upon non-stockholders to do a substantial amount of the work which produces the income whether such work be detailed or supervisory. Just as another clause excludes from personal service classification those corporations where capital contributes materially to the income, so does this clause exclude corporations where the services of employees so contribute. Subsequent decisions by this Court and the appellate courts have granted personal service classification even though there were a number of employees, where "the services of such employees were of a subordinate character not productive of income primarily." H. S. Jaudon Engineering Co., 15 B. T. A. 161, 167; MacMartin Advertising Agency, Inc., 11 B. T. A. 162; Williamson & Rauers Co., 12 B. T. A. 476; Sweeney & James Co., 10 B. T. A. 966; Botsford-Constantine & Tyler, 10 B. T. A. 565; Cocks-Clark Engraving Co., 8 B. T. A. 468; Fuller & Smith v. Routzahn, 23 Fed. (2d) 959.*92 In the latter case the Circuit Court, in discussing the purpose of the statute, stated: * * * The law was directed at absentee stock ownership. If the service rendered is in the nature of personal service and is rendered by the owners of the business, the law intended a separate classification for income and excess profits taxes. It was intended to give corporations performing services of this nature and in this manner the same tax position as a partnership. The dominating purpose was to distinguish between corporations engaged in trade, merchandising, and manufacturing, in which much capital is required, and without which profits may not be earned, and corporations performing personal services, in which large capital is not usually required or necessary to its efficient conduct. The discrimination is between income earned by capital and income earned by personal effort. * * * We think this record demonstrates that the income here was earned by personal services. Petitioner was not engaged in trade, merchandising, or manufacturing. Capital was not required or necessary for the efficient conduct of its business. The Navy contracted for the professional services and engineering*93 skill of the petitioner. The services sought and the engineering skill desired were Whittelsey's. The employees, while numerous, were assistants of more or less experience working under Whittelsey's directions. The presence of numerous employees is not necessarily fatal to petitioner's contention, as shown by the cases hereinafter discussed. George B. Ricaby Co. v. Nauts, *711 19 Fed. (2d) 271; see also George B. Ricaby Co., 1 B. T. A. 512, in which the taxpayer had as many as 75 real estate salesmen, three branch managers, 7 to 15 brokerage salesmen, a sales manager, and an office force of 12 to 17 people. The Board denied personal service classification, but the Circuit Court allowed such classification. In Fuller & Smith, supra, the taxpayer had telephone operators, clerks, stenographers, bookkeepers, office boys, artists, and a research director, and it contracted for work with outside artists. The number of employees is undisclosed, but the point was made that, except for the research director, the duties performed were purely clerical or minor. In H. K. McCann Co., 14 B. T. A. 251,*94 personal service classification was granted a taxpayer that employed 245 persons and averaged 145 persons during the taxable years. The salaries paid nonstockholding employees was in excess of $ 278,000, as compared with salaries paid stockholders of over $ 66,000. We there found that the service assistants were capable efficient men whose functions were to handle routine matters in the service of clients and to relieve the stockholder in charge of the account of such duties as he could delegate to them in order that he might devote his time to other phases of the advertising service. In Carter MacDonald & Miller, Inc., 14 B. T. A. 522, in granting personal service classification to the taxpayer, we stated, p. 527: The law does not require that the principal stockholders should personally perform all the various functions included in the service performed, and the employment of clerks, stenographers, salesmen and others to perform detail duties does not deprive a corporation of the right to personal service classification. * * * In F. Merges & Co., 11 B. T. A. 444, the taxpayer, a one-man corporation with 60 employees*95 and approximately 300 local agents, was granted personal service classification. In Honig-Cooper Co., 11 B. T. A. 896, the regular employees outnumbered the stockholders 13 to 1, but personal service classification was granted. In view of the foregoing discussion of authorities and the facts and circumstances of this case, it is our opinion that the income of the petitioner is to be ascribed primarily to the activities of H. Newton Whittelsey. The petitioner, having met the tests laid down by the statute, is entitled to personal service classification. The second issue is whether petitioner, a taxpayer on the cash receipts and disbursements basis, is entitled to deduct a so-called reserve for vacation allowances amounting to $ 3,458.90. Actually this sum had been earned by petitioner's employees, but, due to the pressure of work, they had been unable to get the time off for vacation, and petitioner had not paid out the $ 3,458.90 to them. Under its method of accounting petitioner is entitled to deduct this sum only when paid out or disbursed. It can not account for and report *712 income partly on the accrual and partly on the cash basis. *96 Massachusetts Mutual Life Insurance Co. v. United States, 288 U.S. 269; Bennett Properties Co., 45 B. T. A. 696; Fred W. Leadbetter, 39 B. T. A. 629. On this issue we hold for the respondent. The final issue is petitioner's right to deductions, totaling $ 90, which it claimed on its return as contributions. It is conceded that the organizations to which these payments were made do not qualify as charitable organizations. Petitioner now urges that the amounts represent ordinary and necessary expenses for advertising in the publications of these organizations. We find no testimony to the effect that this was the purpose of the expenditures. In the absence of proof establishing that the amounts represented advertising expense, we must approve the respondent's determination. Decision will be entered under Rule 50. DISNEY Disney, J., dissenting: Findings of fact in this case disclose that wages, including overtime, plus compensation for officers, totaled approximately $ 354,000, of which only about $ 39,000 was compensation for officers. H. Newton Whittelsey was president. To his*97 efforts and ability the majority opinion, in effect, primarily ascribes the earnings of the corporation, and therefore concludes that it is a personal service corporation. I note, however, that the three department chiefs, the three division heads, and the seven squad leaders included employees who were paid approximately $ 61,000, as against about $ 39,000 to the officers, including Whittelsey. It therefore appears that the corporation considered its officers to be earning much less than the leaders of its employees. The $ 39,000 is about 11 per cent of the $ 354,000 paid employees and officers. It is impossible for me, in the light of these figures, reflecting the attitude of the corporation in valuing the services of its officers, including Whittelsey, to conclude that the corporate income is "to be ascribed primarily to the activities of its principal stockholder," Whittelsey. The record does not show the amount of compensation paid to him alone, but, assuming that it is far the larger portion of the $ 39,000 paid to all officers, it still is a very small percentage of the total amount paid to employees. The attitude of the corporation, thus definitely proved towards compensation*98 of its president and other officers, it seems to me, is a better indication of the importance of his activities than the record otherwise shows. I think the importance of employees is not to be so minimized as the majority opinion holds. This is not a case, therefore, where I believe there is a personal service corporation. I therefore dissent. Footnotes 1. SEC. 725. PERSONAL SERVICE CORPORATIONS. [Added by § 301, Second 1940 Act; amended by § 223, 1942 Act.] (a) Definition. -- As used in this subchapter, the term "personal service corporation" means a corporation whose income is to be ascribed primarily to the activities of shareholders who are regularly engaged in the active conduct of the affairs of the corporation and are the owners at all times during the taxable year of at least 70 per centum in value of each class of stock of the corporation, and in which capital is not a material income-producing factor; but does not include any foreign corporation, nor any corporation 50 per centum or more of whose gross income consists of gains, profits, or income derived from trading as a principal. For the purposes of this subsection, an individual shall be considered as owning, at any time, the stock owned at such time by his spouse or minor child or by any guardian or trustee representing them.↩