Omaha Nat'l Bank v. Commissioner

OMAHA NATIONAL BANK, JOHN CLAPPER AND KATIE FARRINGTON, EXECUTORS OF THE ESTATE OF F. J. FARRINGTON, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Omaha Nat'l Bank v. Commissioner Docket No. 53237. United States Board of Tax Appeals 29 B.T.A. 817; 1934 BTA LEXIS 1475; January 18, 1934, Promulgated *1475 Prior to 1918 the decedent was employed under contracts which, in addition to cash salary, gave him the right to purchase stock of his corporate employer at $50 per share. The contracts were modified in 1918 to provide that decedent's account in respect of the stock should be credited with dividends declared thereon and if such dividends did not amount to $50 per share by stated times his account should be arbitrarily credited with sufficient amounts to make up the $50 on specified blocks of stock which would then be issued. In 1928, as the result of dividends and an arbitrary credit, 150 shares of stock were delivered to decedent. Held, the several contracts were essentially contracts of employment and the stock represented compensation received in 1928 to the extent of its fair market value. Karl Reimer, Esq., for the petitioners. R. W. Wilson, Esq., for the respondent. ARUNDELL *817 The petition herein was originally filed by F. J. Farrington, now deceased. Upon suggestion of the death of the petitioner and motion for substitution of parties, the executors of his estate were substituted as petitioners. The deficiency in income*1476 tax of $10,928.07 for the year 1928 arises out of respondent's inclusion in income, as additional compensation, the value of corporate stock received by the decedent in the taxable year. Whether the stock was received as additional compensation *818 for services rendered is the only issue. Petitioners contend that the stock was acquired by purchase under a contract entered into in 1918. The facts were stipulated. FINDINGS OF FACT. The decedent, F. J. Farrington, from October 6, 1903, until his death in 1932 was continuously in the employ of Deere & Co., an Illinois corporation. On November 1, 1911, Farrington, Deere & Co., and a subsidiary company of the latter entered into a contract, in which it was recited in the preamble that "the parties are mutually desirous that" Farrington "shall continue in the employ of" the company "for a period of three years." The contract then provided: (1) that Farrington would "remain in the service" of the company for the three-year period; (2) that the company would pay him an annual salary of $5,000; (3) that "in further consideration of the services so to be rendered by" Farrington, the company "agrees to sell" and Farrington "agrees*1477 to buy * * * 500 shares of the Common Capital Stock of" the company "at an agreed price of $50.00 per share, payable according to the tenor and effect of a certain promissory note of even date herewith." The note referred to was executed by Farrington in favor of the company in the amount of $25,000 payable in installments over the period from June 1, 1914, to June 1, 1919. It was recited therein that Farrington had deposited as collateral security 500 shares of the common stock of the company, represented by a "common stock trust certificate." On April 8, 1914, the same parties entered into a contract by which the term of Farrington's employment was extended for one year, and which provided that payment for the common stock should be in accordance with the terms of the original contract except "as modified by the terms of a certain promissory note of even date herewith." The new note was in the amount of $25,000 and contained provisions as to the time of payment but slightly different from the original. Like the original, it recited the deposit of 500 shares of common stock as collateral security. Farrington's employment by the company during the period November 1, 1915, to*1478 October 3, 1919, was governed by the terms of the contract of November 1, 1911, as modified by the contract of April 8, 1914. On April 8, 1918, Deere & Co., as first party, and Farrington, as second party, entered into a contract, the terms of which, in so far as material here, were as follows: 1. All agreements in such contract [the contract of 1911, as modified in 1914], or any modification thereof, respecting the purchase to be made by the *819 second party of the first party's common stock (or voting common stock), are hereby canceled. 2. The stock referred to in said contract, viz: 500 shares of Deere & Company's Common Stock, is hereby transferred to the first party. 3. The first party now agrees to sell and the second party to buy 500 shares of said Deere & Company's Common Stock of the par value of $100.00 per share, at $50.00 per share, upon the following terms and conditions: (a) Said stock shall be paid for (except as hereinafter provided) by first party crediting upon the purchase price thereof, a sum equivalent to the dividends which may be declared upon a like number of shares of Deere & Company's outstanding Common Stock. (b) When the credits*1479 so to be made shall equal the sum of $25,000.00, the said stock shall be delivered to the second party, but if the credits do not amount to $25,000.00 by June 1, 1925, the second party shall be entitled to receive, and there shall be delivered to him, 100 shares of said stock; and if by June 1, 1928, the said credits do not amount to the purchase price of the remainder of the stock covered by said contract, the second party shall be entitled to receive, and there shall be delivered to him, 150 shares of said stock, in addition to the 100 shares previously delivered, as herein provided. In either or both cases, i.e., on stock delivered in 1925 or 1928, the first party shall credit the second party with the difference between the sum of $50.00 per share and the credits actually made thereon. This contract, as to any stock not delivered in 1925 or 1928, as aforesaid, shall not be affected by such deliveries, and any stock remaining undelivered after June 1, 1928, will be delivered when paid for, as hereinabove provided. (c) The second party shall have the option at any time of paying any part or all of the unpaid balance on the Common Stock so purchased, and upon final or complete*1480 payment, certificates for the same shall be delivered to second party. 4. In the event of the second party discontinuing the service of the first party or of any subsidiary or allied company prior to the time that the Common Stock purchased hereunder is fully paid for, as herein provided, the second party shall have the option as to the stock undelivered: (A) To pay the balance due to first party in cash and receive the Common Stock purchased hereunder or (B) To receive from first party in cash the amount actually credited on account of such purchase, with 5% interest annually on any cash payments made by second party from the time such payments were made. In event that such discontinuance of service is occasioned by death or retirement on account of age or physical disability which, in the judgment of the first party, necessitates discontinuance of active work, said second party (or his personal representative in case of death) shall have the option, as to stock then undelivered; (a) To pay the balance due to first party in cash and receive said Common Stock: or (b) To continue to have the credits herein provided made on such Common Stock until the same is paid for, *1481 as though such discontinuance of service had not occurred; (c) In case of second party's decease, to receive from first party in cash the book value of said stock, less all intangible assets, according to the November 1st statement preceding said second party's death, and less any unpaid balance of the purchase price of said Common Stock so provided herein; the amount to be paid hereunder shall not exceed $100,000 per share, less such unpaid balance. *820 On the dates of September 24, 1919, May 16, 1921, and October 31, 1924, Farrington entered into additional contracts with the company, which, so far as material here, provided that he would remain in the employ of the company until November 1, 1929, and would receive a cash salary in stated amounts, plus a percentage of the company's earnings if they exceeded certain amounts. These contracts made no mention of the stock of the company with which we are here concerned. Between April 8, 1918, and June 1, 1925, the company declared no dividends and Farrington made no payments under the 1918 contract. On June 1, 1925, pursuant to the 1918 contract, the company credited Farrington's account with $5,000 and delivered to*1482 him 100 shares of stock. On April 1, 1928, the company paid a dividend of $1.50 per share on its common stock, and pursuant to the 1918 contract the company credited Farrington's account with $600. That dividend was the only dividend declared or paid by the company on its common stock between June 1, 1925, and June 1, 1928. Pursuant to the 1918 contract, the company on June 1, 1928, credited the account of Farrington with $7,275 and delivered to him 150 shares of common stock. The market price and fair market value of the stock on that date was $397.125 per share. Of the $600 credited on April 1, 1928, the amount of $225 was credited on account of the 150 shares delivered on June 1, 1928. In his return for 1928 Farrington included $7,500 as compensation realized upon the receipt of the 150 shares of stock. The respondent determined that the fair market value of the stock in the amount of $59,568.75 represented compensation and increased the reported income accordingly. OPINION. ARUNDELL: The petitioners contend that the delivery of the stock to Farrington in 1928 was in fulfillment of a right of purchase that he acquired in 1918, and that since that right was property*1483 no income resulted from its exercise. The appreciation in the value of the right, it is argued, is not income until realized by sale or exchange of the stock acquired by virtue of the right. The respondent, in the other hand, points to the several contracts and argues that they were essentially contracts of employment under which the stock was received by Farrington as compensation for services rendered. We think there can be no doubt that the plan under which Farington acquired the stock in its inception was one based on his employment by the company. The transaction did not start with *821 the contract of April 8, 1918. The contract refers to the one of 1911, as modified in 1914, and cancels the earlier agreements only in respect of "the purchase" of the stock. It left the prior agreements in effect in so far as they pertained to other matters. The 1911 contract, after stating the cash salary to be paid provided that "in further consideration of the services to be rendered" by Farrington, the company "agrees to sell" and Farrington "agrees to buy" 500 shares of stock of the company. When in 1914 the period of employment was extended for a year, and a new note was*1484 executed by Farrington, the continuing existence of the original contract was recognized by a provision in the new note that: This note is given in modification of a personal service and stock purchase contract heretofore made with the undersigned, and is subject to the provisions of the original contract - except as so modified. In the 1918 contract, as pointed out above, only the provisions of the earlier contracts relating to the so-called purchase of stock were modified. Thus at all times from 1911 the parties to the agreements recognized that the stock was to be issued "in further consideration of services to be rendered." The only difference in substance between the 1911 and 1914 contracts and that of 1918 was that under the earlier ones it was contemplated that Farrington would pay $50 per share, while under the last one it would not be necessary for him to pay anything if he waited until dividends and arbitrary credits to his account were sufficient to make up the $50. The consideration for the stock was still the same, namely, services of Farrington plus $50 per share. In order for him to receive the stock without himself paying the $50 per share it was necessary, *1485 under the 1918 contract, for him to remain in the service of the company. An option existed under the contract whereby, in the event of death or discontinuance of services on account of age or disability, arbitrary credits and dividends could be allowed to accumulate until the stock was paid for. There is no provision, however, in the contract under which credits would accumulate and the stock be issued without payment by Farrington if he voluntarily left the employ of the company. Hence, if he lived and was able to continue in the employ of the company he had a choice of two methods of acquiring the stock, either by paying cash of $50 per share or remaining in the service of the company until the credits to his account were sufficient to permit him to withdraw the stock without payment. He chose the latter method and during the succeeding years of his employment entered into several contracts with the company under which he agreed to continue in its service until November 1, 1929. In view of the original intent of the parties that Farrington was to be permitted to acquire the stock at the specified figure in consideration of his services, and that when later it was decided to*1486 issue it to him without cost but only on condition *822 that his employment continued, the conclusion is inescapable that the stock was received as compensation for services. Petitioners do not challenge the long established holding that stock received as compensation is income. See ; ; . It is immaterial that the stock is received for services rendered in the past. See ; ; affd., . Granting that Farrington acquired a valuable right in 1918 under the contract of that year, it does not follow that that represented income then realized. Cf. . The promise in this case - to deliver stock - was not unconditional. Something remained to be done before the employee could draw down the stock. He had either to pay $50 per share or remain in the service of the company until credits to that amount had accumulated. Under such circumstances it seems*1487 clear that to one one the cash basis no income is realized until payment is actually received, which in this case was in 1928. The case of Durkee v. Welch, 49 Fed+(2d) 339, cited by petitioners is not in point. There it was necessary for the recipients of the stock to pay for it by means of permitting deductions from their salary checks. We conclude that the stock received in 1928 was income to the extent of its value at the time of receipt. Cf. . Reviewed by the Board. Decision will be entered for the respondent.