Wiggin v. Commissioner

HARRY H. WIGGIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Wiggin v. Commissioner Docket Nos. 25071, 32539, 41272. United States Board of Tax Appeals 19 B.T.A. 282; 1930 BTA LEXIS 2436; March 14, 1930, Promulgated *2436 Where the principal stockholder of a corporation enters into an agreement with the corporation to serve it as president upon the basis that the net profits of the corporation shall be paid to him as compensation and the net losses of the corporation shall be sustained by such principal stockholder, and net losses are sustained, such net losses are not deductible from gross income in the individual's income-tax returns. Robert H. Montgomery, Esq., and Melville F. Weston, Esq., for the petitioner. John D. Kiley, Esq., for the respondent. SMITH *283 These proceedings consolidated for hearing involve deficiencies in income tax as follows: [1922] $6,126.52 [1923] 7,893.53 [1924] 3,905.00 [1925] 3,635.56 Deficiency taxes result solely from the Commissioner's disallowance of the deductions taken by the petitioner in his individual returns on account of losses alleged to have been sustained pursuant to the terms of a written contract or contracts. FINDINGS OF FACT. Petitioner is a resident of Brookline, Mass. During the years 1922 to 1925, inclusive, and for several years prior thereto, he was president and treasurer of*2437 the H. H. Wiggin Lumber Co. He was also president of two warehouse companies and of a fumigating company. His principal occupation during the taxable years involved was that of executive of these various companies. He devoted his entire time between them giving to each whatever time was necessary. Approximately one-third of his time was given to the service of the H. H. Wiggin Lumber Co. His income-tax returns for 1922 to 1925, inclusive, show income from salaries of the fumigating and warehouse companies of $50,000 for each of the years 1922 and 1923, $46,000 for 1924, and $40,166.66 for 1925. They also show income from rents and royalties of $45,275 for 1922, $58,518.33 for 1923, $44,275 for 1924, and $30,900 for 1925. These constituted his principal items of income. The H. H. Wiggin Lumber Co. was a Massachusetts corporation with a capital stock consisting of 1,500 shares. Its plant and properties were located at Plaquemine, La. The ownership of this stock during the years in question was divided as follows: Shares Harry H. Wiggin 1,015 Gertrude S. Wiggin [415] H. Sherburne Wiggin [30] Morrill Wiggin [25] George H. Damon [15] Total 1,500 The*2438 stock of George H. Damon was held by his estate at the time of a stockholders' meeting of January 28, 1925, he having deceased prior to that date. *284 Gertrude S. Wiggin is the wife of the petitioner and H. Sherburne Wiggin and Morrill Wiggin are sons. George H. Damon was not a member of the Wiggin family but was an employee of the company holding the position of manager of the Louisiana mill. The wife and the sons of the petitioner had acquired their interests in the H. H. Wiggin Lumber Co. by purchasing stock in that company with funds which had not been given to them by the petitioner. The H. H. Wiggin Lumber Co. operated at a profit in some years prior to 1921 and the petitioner received a salary from it of $9,000 per year. Immediately prior to 1922 the Lumber Co. was operating at a loss. The petitioner had faith in the company and believed that ultimately it would operate at a profit. On or about November 2, 1922, the petitioner and the H. H. Wiggin Lumber Co. entered into the following written agreement: Agreement between H. H. WIGGIN LUMBER COMPANY, a Massachusetts corporation having its principal place of business in Boston, Massachusetts, party of the*2439 first part, and HARRY H. WIGGIN of Brookline, Massachusetts, party of the second part: WHEREAS said Company desires to employ said Wiggin as its President, Treasurer and General Manager for a term of two (2) years, beginning January 1, 1922, and is willing to pay to said Wiggin for his services all profits made by the Company during said two years if he will indemnify and hold the Company harmless against all losses made during said years, which said Wiggin is willing to do. Now, THEREFORE, in consideration of the premises and the mutual agreements hereinafter contained, and in further consideration of One Dollar by each of the parties to the other in hand paid, the receipt whereof is hereby acknowledged, this agreement. WITNESSETH: 1. Said Wiggin agrees that he will act as President, Treasurer and General Manager of said Company and give to it his best efforts and as much of his time as is necessary to carry out his duties for a period of two years from January 1, 1922, without compensation or salary except as hereinafter provided. 2. Said Company agrees that it will during the term of this agreement upon the thirty-first day of December in each year pay to said Wiggin*2440 as compensation for his services all its net profits, said profits to be computed in accordance with the method used in the Federal Income Tax Law, less, however, the amount of the Federal income tax thereon. 3. Said Wiggin agrees that he will during the term of this agreement upon the thirty-first day of December in each year pay to said Company any loss incurred by it in its operations, such loss to be computed by the method used in calculating net income for purposes of the Federal income tax; Said Wiggin shall not be obliged to pay said Company under this obligation more than the entire amount of the debt owed by said Company to said Wiggin. 4. If at the end of said period of two years the losses paid by said Wiggin to said Company exceed the compensation he has received hereunder, said Wiggin shall have the right at his option to extend this agreement for a period of one year. *285 Dated as of the third day of January, 1922, and executed upon the part of the Company by said Harry H. Wiggin as Treasurer, hereunto specially authorized by votes of the Directors and stockholders of the Company. (Signed) H. H. WIGGIN LUMBER COMPANY. (Corporate seal) By H. *2441 H. WIGGIN, Treasurer. HARRY H. WIGGIN. This agreement on the part of the corporation was authorized by unanimous vote of the board of directors and unanimous vote of the stockholders. The petitioner was the only stockholder of the company personally present at the aforementioned stockholders' meeting, the remaining stockholders being represented by proxy to J. Colby Bassett and Robert H. Montgomery, who were attorneys for both the petitioner personally and for the corporation. Gertrude S. Wiggin never attended a stockholders' meeting of the Wiggin Lumber Co. On January 3, 1924, the petitioner exercised the option conferred upon him by paragraph 4 of the agreement of November 2, 1922, to extend the same over the calendar year 1924. On or about January 28, 1925, an agreement similar in all material respects to the one of November 2, 1922, was entered into between the petitioner and the company for a period of one year from January 1, 1925. This agreement was also authorized by unanimous vote of the stockholders and board of directors of the company. Like agreements were entered into covering operations of the company for the years 1926 and 1927. The agreement was*2442 not in effect after 1927, the Wiggin Lumber Co. having by that time been put on a paying basis. At the time the agreement of November 2, 1922, was entered into the corporation was then indebted to the petitioner on notes and open account to the extent of approximately $250,000. The H. H. Wiggin Lumber Co. sustained operating losses as follows: [1922] $86,547.06 [1923] 62,306.90 [1924] 37,264.36 [1925] 67,823.27 In each of those years the petitioner discharged his obligations to the company under the agreements by canceling each year a portion of the indebtedness owed him by the corporation in an amount equal to the company's loss of that year, corresponding deductions in the indebtedness being made on the company's books and the transaction being closed on December 31 of each year by final adjustment. *286 The amounts paid by the petitioner were claimed as deductions in his income-tax returns for the years in question. The Commissioner has disallowed these deductions and the proposed deficiencies arise solely from such disallowances. OPINION. SMITH: The sole question presented by these proceedings is the right of the petitioner to deduct from*2443 gross income in his income-tax returns for the years 1922 to 1925, inclusive, the net losses of the H. H. Wiggin Lumber Co., which the petitioner was required to make good and did make good to the H. H. Wiggin Lumber Co. under his agreements with that company. The petitioner claims the deductions as losses sustained by him under the provisions of section 214(a) of the Revenue Acts of 1921, 1924, and 1926, which provide, in so far as material, as follows: (a) That in computing net income there shall be allowed as deductions: * * * (4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business; (5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * * The respondent has disallowed the deductions upon the ground that they represent additional investments of capital on the part of the petitioner in the corporation and are therefore not deductible losses. At the hearing of these proceedings the petitioner was asked what the reason was for entering into the agreement*2444 dated November 2, 1922. He replied: Well, the first was the fact that my stockholders could not or would not advance any more money to carry along the business during this depression and therefore feeling as they did about it, about dividends, I knowing what I supposed was much more than anybody else about the lumber business, having had experience in cost accounting and knew how lumber was bought and was manufactured, I had perfect faith in the business and felt that I would be able to pull it out with a profit each and every year. I therefore decided that it would be better for me, as I was very active in it to advance money to take care of it. Now, I might say there were two objects; the other object would be if I made money I would have a chance to pay tax, and if I didn't, why I would not. I suppose that was the two motives I had. I hoped, however, to pay taxes rather than lose money as I did. In the first place, it is contended by the petitioner that the loss sustained by him during the taxable years was a loss "incurred in trade or business." He contends that a compensation agreement between a corporation and one who makes his living as a paid executive is entered*2445 into in the course of the latter's trade or business; *287 and, if under its terms a loss is sustained the loss is incurred in trade or business. In support of this contention the petitioner cites . The facts in that case were that the president of a corporation, whose directors declined to authorize expenditures upon a certain project in the corporation's behalf, agreed to advance the money himself, the same to be repaid to him if the project was successful. The project was not successful and he was held entitled to deduct as a loss over $5,000 which he had spent and for which he was not reimbursed. In our opinion we stated: * * * We are further of the opinion that the loss was "incurred in trade or business" in that the furtherance of the business of the company of which he was president was legally and logically his business. Petitioner also cites , and . The facts in the Lloyd case were substantially different from those which obtained in the instant proceedings. The petitioner had reason to expect that the project for*2446 which he had advanced the money would be successful and that the corporation would reimburse him for the money advanced. The Jones and Washer cases are distinguishable upon their facts and the decisions therein are not controlling in the proceedings at bar. Quite clearly the business of the H. H. Wiggin Lumber Co. was not the business of the taxpayer. The losses in the first instance were sustained by the H. H. Wiggin Lumber Co. By the agreement of November 2, 1922, the petitioner seeks to have the losses of that company deducted from gross income in his individual tax return. If the losses are deductible they are deductible by virtue of the agreement of November 2, 1922, and succeeding agreements covering the years 1924 and 1925. We think that in no proper sense were the losses claimed as deductions by the petitioner losses incurred by him in a trade or business carried on by himself. Petitioner further makes the contention that the losses were incurred in a transaction or transactions entered into for profit. The facts are that the corporation was operating at a heavy loss. It had operated at a loss for 1921, and by November 2, 1922, it was apparent that it would*2447 operate at a loss in 1922. The agreement which was entered into on November 2, 1922, was apparently for the purpose of enabling the petitioner to deduct from his gross income the losses of the corporation. It is to be noted that the agreement covered a period of only two years. There is no reason to believe that the agreement was one from which the petitioner expected to realize a profit. It was rather to enable him to deduct from his own gross income the losses of the corporation. We are therefore of the opinion *288 that the losses sustained for the years 1922 and 1923 did not result from a transaction entered into for profit. We are likewise of the opinion that the extensions of that agreement to cover the years 1924 and 1925 were made merely to enable the petitioner to deduct from his gross income the losses of the corporation. We are led to this conclusion in part by the fact that as soon as the H. H. Wiggin Lumber Co. began to operate at a reasonable profit the agreements were not further extended. It is further to be borne in mind that the petitioner owned a large majority of the stock of the corporation and that he and his immediate family owned over 98 per*2448 cent of the stock of the corporation. The corporation was entirely dominated by the petitioner and the agreements were not arm's-length transactions. In , we had before us the case of a stockholder who owned one-half of the stock of the taxpayer corporation and who, acting for himself and the owner of the remainder of the stock, acquired stock in another corporation and transferred it to the petitioner corporation, which credited the accounts of both stockholders with the par value of such stock. During the same year the petitioner corporation acquired directly additional shares of such stock and sold all of the stock to one of its stockholders for an amount much less than the cost thereof, who in turn delivered one-half of the stock to his co-stockholder. We held that this was not a bona fide sale upon which the taxpayer was entitled to claim a deductible loss. We said: * * * In the case of corporations sales to stockholders in all cases are subject to special scrutiny and their good faith must be unquestioned. The principle of corporate entity can not be used to cloak a transaction which is essentially a fraud upon the*2449 public revenue. We are of the opinion that the same principle controls the issue in the proceedings at bar. Reviewed by the Board. Judgment will be entered for the respondent. STERNHAGEN and MATTHEWS concur in the result only.