Carpinter & Baker, Inc. v. Commissioner

CARPINTER & BAKER, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Carpinter & Baker, Inc. v. Commissioner Docket No. 7295. United States Board of Tax Appeals 9 B.T.A. 165; 1927 BTA LEXIS 2652; November 18, 1927, Promulgated *2652 The evidence fails to establish that certain expenditures were deductible from gross income as ordinary and necessary business expenses within the year. Benjamin Mahler, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. LOVE *165 The Commissioner determined deficiencies in income and profits tax for the years 1920 and 1921 in the amounts of $3,451.92 and *166 $2,646.66, respectively. The issue is whether the amount of $13,750 paid by petitioner under an alleged contract during each of the years 1920 and 1921 to the widow of a former officer and stockholder constitutes an allowable deduction from gross income as an ordinary and necessary business expense. FINDINGS OF FACT. The petitioner is a New York corporation organized in 1903 with its office in New York City. Its business is agent and broker for marine and general insurance. Prior to the formation of the corporation, one Carpinter, and John T. Baker were engaged in the same business, as partners, under the name of Carpinter & Baker. Carpinter died in 1895 and thereafter the partners were John T. Baker and his son, William C. Baker. Upon incorporation*2653 John T. Baker became a stockholder and president of petitioner and continued so until his death on May 17, 1907. Petitioner's income is and has always been derived from commissions on insurance which it places; the commission being the difference between the gross premiums received from the insured and the net premiums remitted to the insurance companies which it represents. As broker it performs certain services for clients whose insurance it handles with respect to the covering of their risks. Among the clients from whom the petitioner derived income were about sixteen large concerns and between one hundred and two hundred smaller ones whose business had been secured by John T. Baker. Accounts with these clients were active in 1907 and during 1920 and 1921 the petitioner received commissions from these accounts in the respective approximate amounts of $42,000 and $37,000. On or about May 7, 1907, an oral agreement was made between John T. Baker and petitioner, under which petitioner agreed to pay to Mrs. John T. Baker the sum of $10,000 a year for a period of ten years and thereafter $13,750 a year so long as she should live. At this time John T. Baker was afflicted with*2654 an illness which resulted in his death ten days later. After his death, petitioner paid to Mrs. John T. Baker annually the sum of $10,000 until 1917, and from thence forward, $13,750 per annum. The latter amount was paid to her by the petitioner in each of the years here in question and charged to expense. At the time the agreement was made, Mrs. John T. Baker was 57 years old. No services have ever been rendered to petitioner by Mrs. John T. Baker. At the time the agreement was entered into by petitioner and Baker with respect to payments to be mace to Mrs. John T. Baker, John T. Baker owned 97 per cent of petitioner's stock. In the years 1920 *167 and 1921 the petitioner had 100 shares of stock outstanding which were held as follows: Shares Howard W. Beebe 33 1/3 J. Whitney Baker 33 1/3 Estate of John T. Baker 32 1/3 Harry P. Winters [1] Howard W. Beebe is a son-in-law, and J. Whitney Baker, a son of the aforementioned John T. Baker. At the time the agreement of 1907 was entered into John T. Baker was president of the petitioner, Howard W. Beebe was vice president, J. Whitney Baker was secretary, and all were present when the agreement was*2655 made. There exists a custom among insurance brokers under which one broker turns over the insurance of his clients to another broker who is better equipped and organized to perform the required services connected therewith. The second broker performs the service, collects the commissions, and pays the first broker a percentage of the commissions received. Such percentage varies between 40 and 60 per cent. The agreements between the brokers frequently provide that the right to a portion of the commissions shall continue for a limited period after the death of the broker who controls the business and may be disposed of by him. Such an agreement was made between Carpinter and John T. Baker prior to the organization of petitioner corporation and after the death of the former in 1895 John T. Baker continued such payments to Carpinter's heirs until a settlement was finally made by Baker's estate. In 1903 a similar agreement was made between petitioner and William C. Baker, its then vice president, and after his death in 1905 petitioner made payments thereunder to his widow until 1917. OPINION. LOVE: The petitioner contends that since the payments in question were made on the*2656 basis of a binding contract entered into prior to the incidence of the income-tax laws, and since the person who negotiated the agreement in her behalf had procured and left with the petitioner clients who were sources of income to the petitioner in the years 1920 and 1921, the payments were proper deductions by petitioner from its gross income as ordinary and necessary expenses. The facts are not clear as to what John T. Baker paid in to the petitioner at its formation; that is, the evidence does not show whether the bringing of certain clients to the petitioner which John T. Baker had previously procured and which became income-producing factors to the petitioner was the consideration for the issuance *168 of stock to John T. Baker. It appears John T. Baker was a member of a partnership prior to 1903; that in 1903 the petitioner was formed to succeed this partnership; that in 1907 a large number of clients, who were a source of income to the petitioner, were clients whom John T. Baker had personally secured, and that in the years involved these clients, or at least many of them, were productive of substantial commissions to the petitioner. The principal witness for the*2657 petitioner stated as a conclusion that these clients could have been taken away from the petitioner in 1907 by John T. Baker, which is inconsistent with the proposition that they were ever paid in to the petitioner. The same witness testified that the payments to Mrs. Baker were for services performed by John T. Baker. On cross-examination the following statements were made by the aforementioned witness: Q. Now, what was said in the agreement with reference to designating that as a pension? A. I do not know whether the word "pension" was used; it was done as a pension, however, that is what we considered it. Q. The reason I asked you that question, Mr. Baker is the fact that in the return of your mother for these two years, signed by you, you designated the payment as a pension from the corporation. A. Yes, that is the way we considered it. Q. Now, when your agreement was made, did you discuss these payments as being a pension? A. For services performed, yes, sir. Q. But your mother never performed any services? A. Oh, no, mother never performed any services. The facts are not clear as to the exact nature of the agreement between Baker and petitioner, *2658 but whatever the facts may be with respect to these clients of John T. Baker, the evidence does not show that the agreement made in 1907 on behalf of Mrs. Baker gave to the petitioner any rights which it did not previously have, or furnish any new security for the retention of these accounts. The most that can be said is that in 1907 the petitioner, through its officers, who were members of the same family as John T. Baker, its president and principal stockholder, agreed to make certain payments to the widow of the principal stockholder, beginning after the death of John T. Baker and continuing throughout the life of Mrs. Baker, in consideration of the insurance business which Baker turned over to petitioner. It would seem that petitioner agreed to make the payments to Mrs. Baker in consideration of the insurance business which Baker had personally secured, the commissions from which, or at least a percentage thereof, belonged to him. We fail to see where it has been shown that the payments in question can be said *169 to come within the category of ordinary and necessary expenses. To say the least, they are extraordinary in their nature and would not seem likely to occur*2659 other than in a family concern, such as the petitioner or in the acquisition of an income-producing asset. It seems to us that the latter was the basis of the payments. There is not present the condition which exists in many corporations where pensions are paid to employees after they have reached a certain age and have performed certain services. Such consideration as ordinarily attaches to the payment of pensions to former employees for faithful services in the past could hardly attach to the payments here in question. Mrs. Baker rendered no services to the petitioner at any time and, therefore, what was paid to her could not be said to have been on this account; and, consequently, it could not be said that its payment would result in more satisfactory services on the part of present employees of petitioner. The petitioner's answer to the foregoing is that the payments are not, in fact, in the nature of a pension, but rather represent payments made on account of clients which John T. Baker left with the petitioner. Even if we concede that such was the consideration for the payments, this would not make them allowable deductions as business expenses, as under such a theory*2660 they would be in the nature of capital expenditures which are being made for the acquisition of income-producing assets, and in our opinion under the facts these payments were made by petitioner in consideration of the insurance business turned over to it by Baker. The mere fact that payments are made under a contract does not make such payments allowable deductions from gross income as ordinary and necessary expenses. Cf. ; . Whether a given expenditure is to be treated as capital or expense is a question of fact to be determined in each instance. . Where the expenditure is for the acquisition of an asset the useful life of which extends beyond the year for which the expenditure is being made, such expenditure is usually to be considered of a capital nature and, therefore, not deductible in its entirety in the year when made. Section 215, Revenue Act of 1918, and . The Board is of the opinion that whatever view is taken of the expenditures, the evidence fails to establish that*2661 they are ordinary and necessary expenses, and, consequently, the action of the Commissioner in disallowing them as a deduction is sustained. Reviewed by the Board. Judgment will be entered for the respondent.