Brown & Haley v. Commissioner

BROWN & HALEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Brown & Haley v. Commissioner Docket No. 31521. United States Board of Tax Appeals 21 B.T.A. 752; 1930 BTA LEXIS 1793; December 17, 1930, Promulgated *1793 Deductions from income on account of salaries regularly authorized disallowed in the absence of any proof of reasonableness. W. C. Broenkow, Esq., for the petitioner. Arthur H. Murray, Esq., for the respondent. LANSDON *753 The respondent has asserted a deficiency in income tax for the year 1923 in the amount of $2,538.06. For his causes of action the petitioner alleges that the respondent has erroneously refused to reduce its taxable income for the taxable year by deducting therefrom certain amounts alleged to represent net losses sustained in 1921 and 1922, and officers' salaries incurred in the taxable year. FINDINGS OF FACT. The petitioner is a Washington corporation with its principal office in Tacoma, where it is engaged in the manufacturing and sale of candy. It was incorporated in 1909 with authorized capital in the amount of $10,000, evidenced by the issue of 1,000 shares of stock in equal amounts to its organizers, H. L. Brown and J. C. Haley. Later the authorized capital was increased to the amounts of $120,000 and $160,000 on March 14, 1921, and July 13, 1922, respectively. At all times the incorporators held stock in*1794 equal amounts, but prior to the taxable year each sold 10 shares to an employee of the petitioner. On July 2, 1920, the trustees of the petitioner adopted the following resolution: The annual meeting of the Trustees of Oriole Candy Company was held at the office of the Company on the 2nd day of July, 1920, immediately upon the adjournment of the annual meeting of the stockholders. All of the Trustees were present and having taken the oath, the meeting was called to order by President Haley and Secretary Brown recorded the minutes. The minutes of the previous Trustees' meeting of January 6th, 1919, were read and unanimously approved. The meeting thereupon proceeded to the election of officers for the coming year. The following nominations were made: President, J. C. Haley Secretary, H. L. Brown Treasurer, H. L. Brown Upon motion duly made, seconded, and unanimously carried, the nominations were closed and the secretary was ordered to cast the unanimous ballot of the meeting for the election of the above-named officers. The secretary cast the ballot as directed and announced the election of the officers above-named to serve for one year and until their successors*1795 are duly elected and qualified. The meeting then took up the question of salaries for the current and further years and the adoption of the following resolution was thereupon moved, seconded, and unanimously carried: RESOLVED that the respective salaries of President J. C. Haley, in charge of distribution and sales, and of Secretary Treasurer H. L. Brown, in charge of plant and production, shall be $15,000 each for the current year 1920, effective January 1, 1920, and that the salaries of said officers shall continue at the said rate of $15,000 per annum each, efter the expiration of the current year and until such time as this resolution shall be rescinded or modified by appropriate resolution of the Board; said salaries of $15,000 per annum to each of said officers shall be payable *754 monthly in such installments as the said Haley and Brown may require for their respective living expenses and individual purposes, and the balance, if any, shall be paid or credited at the end of each calendar year while this resolution remains in force. There being no further business, the meeting thereupon adjourned. During the years 1921, 1922, and 1923 and officers of the petitioner*1796 were paid on account of salaries the respective amounts of $21,000, $12,500 and $12,500. In its income and profits-tax return for those years petitioner deducted such amounts from its gross income reported respectively for each year and upon audit the said deductions were allowed. The amounts so paid and allowed as deductions from income in the respective years were in the aggregate $44,500 less than the salaries authorized by the resolution of July 2, 1920. In the years in question the officers' salaries accounts were credited and petitioner's expense account was charged only with amounts of salaries actually paid. On December 31, 1924, pursuant to resolutions of the board of trustees of petitioner dated July 10 and October 20, 1924, the differences between the amounts authorized as salaries by the resolution of July 2, 1920, for H. L. Brown and J. C. Haley, and the amounts credited and paid to them, amounting to $9,000 for the year 1921, $17,500 for the year 1922, and $18,000 for the year 1923, a total of $44,500, were credited to the respective personal accounts of Brown and Haley, and petitioner's surplus account was correspondingly charged with the sum of $44,500. On*1797 December 31, 1924, the personal accounts of Brown and Haley were charged with the sum of $22,250 each; and on the same date the stock subscription accounts of Brown and Haley were credited with the sum of $19,000 each, a total of $38,000; and on December 31, 1924, the balance of $6,500 was donated back to the petitioner by Brown and Haley and credited to petitioner's surplus account. In 1927 the petitioner filed an amended return for 1923 in which it deducted the unpaid salaries alleged to have been incurred in that year and the net losses which ti now claims for 1921 and 1922. Its books were kept and its income-tax return was rendered on the accrual basis. OPINION. LANSDON: The petitioner, a small corporation engaged in the manufacture of candy, defends itself against the determination of the respondent on the theory that it was entitled to deduct the amount of $30,000 annually from its income for the years 1921, 1922, and 1923, on account of liabilities incurred for two officers' salaries. Such salaries were authorized by appropriate corporate action and were paid in part in cash. The petitioner was on an accrual basis and, upon proof of reasonableness, is entitled to*1798 include the unpaid *755 amount of salaries as dedictions from income in the several years here involved. The courts and this Board have held that in all controversies over the allowance of salaries as deductions from gross income as ordinary and necessary expenses the taxpayer must show that the amounts claimed are necessary expenses, that they represent salaries only, and that they are reasonable compensation for services rendered. ; ; . In the instant proceeding there are only two stockholders to be considered and each owns the same stock interest. The salaries authorized for each are the same. Apparently it is not material to either officer whether the earnings of the petitioner are distributed as dividends or salaries, except as to the matter of income-tax liability. In such circumstances we have held that the salaries should be carefully scrutinized to determine whether the amounts thereof are a reasonable compensation for services rendered or excessive, and, in effect, a distribution*1799 of profits. . In determining the reasonableness of salaries the Board has considered duties discharged, responsibilities assumed, volume of business handled, capital employed, gross income, and net income. The petitioner has offered no proof that the salaries claimed are reasonable. In its brief it contends that reasonableness is not in issue, since it was not pleaded by the respondent. From the cases cited above, it is obvious that the question of reasonableness is inherent in all controversies over salary deductions. No proof having been offered that the amounts claimed as salaries are reasonable compensation for services rendered in the several years involved, we must hold that the petitioner has failed to sustain the burden of proof necessary to overcome the presumption that the determination of the Commissioner is correct. Having reached this conclusion, it is not necessary to discuss the other issues raised and argued by the petitioner. Decision will be entered for the respondent.