Hall v. Commissioner , 15 T.C. 195 ( 1950 )

Fred C. Hall, Petitioner, v. Commissioner of Internal Revenue, Respondent

Hall v. Commissioner

Docket No. 21027

United States Tax Court

15 T.C. 195; 1950 U.S. Tax Ct. LEXIS 101;

August 31, 1950, Promulgated

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Decision will be entered for the respondent.

Petitioner, who reported his income on the cash receipts and disbursements basis, was one of the organizers of a corporation in November 1942. In November 1942, he entered into an employment contract with the corporation under which he agreed to render services to it during the years 1943 and 1944. As part of his compensation, the corporation issued two certificates of stock in his name, each for 25 shares. He endorsed the certificates in blank and gave them to the treasurer of the corporation. Upon the satisfactory performance of the required services and pursuant to an order of the board of directors, the treasurer was to deliver one of the share certificates to petitioner at the end of each of the years 1943 and 1944. Held, the fair market value of 25 shares is includible in petitioner's income for each of the years 1943 and 1944, in which years they were delivered to him without restriction in consideration of services performed.

Eli Freed, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

Harron, Judge.

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HARRON

The Commissioner determined deficiencies in the petitioner's income and victory tax liability for the year 1943 in the amount of $ 614.96, and a deficiency in petitioner's income tax liability for the year 1944 in the amount of $ 952.67. The year 1942 is also involved because of the provisions of the Current Tax Payment Act.

The issue in this proceeding is whether the fair market value of 50 shares of stock issued in petitioner's name in 1942 is includible in his gross income for that year, or whether the fair market value of 25 shares is includible in his gross income for each of the years 1943 and 1944 in which they were delivered to him without restriction.

The petitioner filed his returns for the years in question with the collector for the eighteenth district of Ohio. He is now a resident of Oakland, California.

The record in this proceeding consists of the testimony of the petitioner and a copy of the employment contract between the petitioner and the Ohio Aircraft Fixture Co. which was introduced into evidence at the trial.

FINDINGS OF FACT.

Petitioner was a resident of Cleveland, Ohio, from 1936 to 1945. During the years in question, he reported his income on the cash receipts and disbursement basis. From 1936 to November 1942, he was employed by the American Coach & Body Co. in Cleveland. Prior to leaving the company in November 1942, he was the manager of its jig and fixture division.

In November 1942, the Ohio Aircraft Fixture Co. (hereinafter referred to as "Company") was incorporated under the laws of Ohio for the purpose of acquiring and operating the jig and fixture division of the American Coach & Body Co. The Company was organized by petitioner and three associates, Warnsman, Fortney, and Wilson. Petitioner purchased one share of stock from the Company at this time, and each of the other three organizers purchased ten shares of stock. The price paid for the stock was $ 100 per share. The $ 3,100 thus raised was adequate working capital for the needs of the Company which was organized to take over and operate a business which had valuable war production contracts and other assets sufficient for its operations.

The purchase of the jig and fixture division was consummated in November 1942, and the Company thereby acquired, on very lenient terms, a going concern, including its personnel, equipment, and valuable war production contracts.

On November 25, 1942, petitioner entered into an employment contract with the Company. This contract provided:

EMPLOYMENT CONTRACT

* * * *

The Parties hereto mutually agree as follows:

1. That the First Party [the Company] hereby hires the Second Party [petitioner] and the Second Party agrees to work for First Party in the capacity of Manager of the Service Engineering Department, in charge and responsible for all sales and advertising, formulating and figuring all selling prices in co-operation with the shop engineering and cost departments and to assist the factory manager in scheduling and planning production in First Party's business of general manufacturing, particularly aircraft, jigs and fixtures for a period of two (2) years, commencing on the 15th day of November, 1942 and ending on the 14th day of November, 1944.

2. Said Second Party shall at all times during such term of employment give his full attendance and to his best endeavors and to the utmost of his skill and abilities exert himself for the profit, benefit and advantage of said business and perform such duties in said capacities as shall be required of him from time to time by First Party.

3. First Party shall pay the Second Party for his services hereunder as salary and compensation at the rate of One Hundred and Twenty-five ( $ 125.00) per week in addition to ten percent (10%) of the profits over $ 5,000.00 before Federal Taxes and after providing for all known reserves for contingencies; of the salary $ 100.00 is to be paid in cash each week, $ 25.00 and the said ten percent, at the option of the Directors of the Company, may be paid in cash or in stock of the Company and shall be payable on or before January 15th of each year and shall cover the preceding year.

4. It is agreed by and between the parties that in case of illness, the base salary shall continue at full rate for six (6) months, half rate for a consecutive six (6) months and quarter rate for the balance of the term of the contract in excess of two six months periods, the additional salary, if any remaining the same. First Party through its Boards of Directors, if it deems advisable, may demand Certificate of Inability to perform on account of illness from one or more reputable physicians.

5. First Party shall issue fifty (50) shares of stock of the Company in consideration of the signing of this employment contract and to carry out certain contracts necessary in the prosecution of the war. Two certificates are to be issued. Each to be for twenty-five shares and endorsed in blank. They are to be deposited with the Treasurer of the Company for the faithful performance of his contract. One certificate for twenty-five shares to be delivered on December 1, 1943 and the other certificate for twenty-five shares to be delivered on December 1, 1944 on the order of the Board of Directors.

6. Second Party agrees that during the life of this contract he will not engage in any manner either directly or indirectly engage [sic] in any other gainful occupation without consent of the Board of Directors; and shall further be directly responsible to the Board of Directors of the Company for the operation of his departments and said Directors shall from time to time determine the operating policies of these departments.

7. It is agreed by and between the parties that this contract will be considered performed on death of the Second Party.

Each of the other three organizers entered into similar employment contracts with the Company.

Pursuant to the employment contract, two stock certificates, each representing 25 shares of no-par value stock, were issued in petitioner's name in the latter part of 1942. He endorsed each stock certificate in blank and deposited it with the treasurer of the Company. Certificates representing 50 shares of stock similarly were issued in the names of each of the other three organizers who endorsed the certificates and deposited them with the treasurer of the Company.

Prior to the issuance of the stock, the board of directors of the Company placed a value of $ 100 per share upon each of the shares of no-par value stock, which represented the fair market value of each share. The total number of shares of stock originally issued by the Company was 231. Of this number, 200 shares were issued to the organizers upon their execution of the employment contracts, and 31 were issued to the organizers upon the payment of $ 100 per share.

Petitioner began work for the Company on November 15, 1942. During 1943, petitioner received $ 6,500 as his base salary from the Company for his services as manager of its service engineering department, and additional compensation of $ 3,515 as his share of the profits above $ 5,000. In December 1943, one of the stock certificates representing 25 shares of stock which had been issued in petitioner's name was delivered to him by the treasurer of the Company on the order of the board of directors.

During 1944, petitioner received $ 6,500 as his base salary from the Company and additional compensation of $ 3,290 as his share of the profits above $ 5,000. In December 1944, the second stock certificate representing 25 shares of stock which had been issued in petitioner's name was delivered to him by the treasurer of the Company on the order of the board of directors.

In September 1945, petitioner severed his connection with the Company and sold his shares of stock for $ 150 per share.

Petitioner became the unrestricted owner of 25 shares of stock in the Company in 1943 in exchange for services which he rendered to the Company in that year.

Petitioner became the unrestricted owner of 25 shares of stock in the Company in 1944 in exchange for services which he rendered to the Company in that year.

In the notice of deficiency, respondent gave the following explanation of the adjustments here in dispute:

Included in your salary for the year 1942 is the fair market value of $ 5,000.00 for 50 shares of Ohio Aircraft Fixture Company Stock.

Pursuant to an agreement made November 25, 1942, by and between Ohio Aircraft Fixture Company and you, fifty shares of the capital stock of that company were to be delivered to you in consideration of the signing of the employment contract and to carry out certain contracts necessary in the prosecution of the war. Two certificates were to be issued, each for twenty-five shares, endorsed in blank, and deposited with the treasurer of the company for faithful performance of the contract. One of the said certificates was delivered to you on December 1, 1943, and the second was delivered on December 1, 1944. It is held that the fair market value of each certificate constituted income to you in the year in which it was delivered on the order of the Board of Directors of the said Ohio Aircraft Fixture Company.

OPINION.

The issue in this proceeding is whether petitioner is taxable in 1942 on the value of shares of stock issued in his name in that year, or in 1943 and 1944 when the shares were delivered to him upon his performance of personal services pursuant to an executory contract with the Company.

Petitioner contends that he became the owner of the 50 shares in question in 1942 when the contract was signed by the parties and the shares were issued in his name; that the consideration for their issuance was the signing by him of the employment contract of November 25, 1942; and that the fair market value of the shares was income to him at that time.

Respondent contends that petitioner is taxable in 1943 and 1944 on the fair market value of the shares of stock received by him in those years and not in 1942 when the contract was entered into. He argues that the shares were only provisionally delivered to petitioner in 1942 and that petitioner did not become the unrestricted owner of any of the shares until 1943 and 1944, in each of which years 25 shares were delivered to him without restriction.

Petitioner reported his income during the years in question on the cash receipts and disbursements basis. Section 42 of the Internal Revenue Code provides that "the amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer." A taxpayer on the cash basis normally reports income in the year in which the cash or property in lieu thereof is received, even though services for which the cash or property represents payment are rendered in either an earlier or a later year. Jackson v. Smietanka, 272 Fed. 970; S. P. Freeling, 7 B. T. A. 1238; Edwin B. DeGolia, 40 B. T. A. 845; cf. Brown v. Helvering, 291 U.S. 193">291 U.S. 193; Astor Holding Corp. v. Commissioner, 135 Fed. (2d) 47; Your Health Club, Inc., 4 T.C. 385">4 T. C. 385.

Although actual receipts remain the touchstone of the cash basis of reporting income, both decisions and regulations include constructive as well as actual receipts as income. E. g., Corliss v. Bowers, 281 U.S. 376">281 U.S. 376; Ross v. Commissioner, 169 Fed. (2d) 483; Warren E. Burns, 11 B. T. A. 524, affd., 31 Fed. (2d) 399, certiorari denied, 280 U.S. 564">280 U.S. 564. Regulations 111, section 29.42-3, which enunciates the doctrine of constructive receipt includes as taxable income all amounts owing to the taxpayer on the cash basis, whether actually received or not, which are unqualifiedly made subject to his demand in the taxable year.

Conversely, where cash or a chose in action, such as a stock certificate or a note, is not received free and clear but is subject to a restriction, the usual effect of the restraint is to postpone the inclusion of the item in taxable income until such time as the restriction is removed. E. g., International Mortgage & Investment Corp., 36 B. T. A. 187; Benjamin F. Patterson, 21 B. T. A. 8; Marion H. McArdle, 11 T. C. 961; Charles F. Mitchell, 45 B. T. A. 300; E. P. Madigan, 43 B. T. A. 549.

There is no evidence in this proceeding on such matters as who dictated the policies of the Company, what its capital structure was, what assets and liabilities comprised its balance sheet, whether any of the shares held by the treasurer were ever voted, whether dividends were ever declared by the Company, and, if so, whether dividends were ever paid by the Company upon the shares which were being held by the treasurer.

Upon our examination of the limited facts which have been made available to us, we must conclude that petitioner did not receive the 50 shares in question in 1942 free and clear from restrictions which would make them subject to his unfettered command. Instead, it is held that respondent was correct in his determination that it was not until 1943 and 1944 that the shares were subjected to petitioner's control, and that the fair market value of the shares delivered in each of those years was includible in petitioner's income for the year in which they were delivered.

The petitioner had no dominion or control over the shares until they were delivered to him by the treasurer of the Company in 1943 and 1944 upon the order of the board of directors. There is no evidence that the petitioner was entitled to vote the shares prior to that time or that he was entitled to share in any dividends which might be declared by the Company. The petitioner could not sell the shares which were being held by the treasurer until they were delivered to him, and the unfettered right of sale is one of the most important attributes of ownership.

The facts which are before us in this proceeding are similar to those in other cases in which formal restrictive devices have resulted in tax postponement until the year in which the property was unrestrictedly delivered into the possession of the taxpayer. Thus, in Phillip W. Haberman, 31 B. T. A. 75, affd., 79 Fed. (2d) 995, the taxpayer agreed with a corporation to remain in the employ of one of its subsidiaries for 3 years for a compensation consisting of a stated cash salary and the right to purchase a stated number of shares of the parent's stock. Stock certificates for fully issued and paid-up shares were issued to the taxpayer, immediately endorsed by him, and deposited with the parent to secure a loan for the full purchase price of the shares. Upon repayment of the loan in installments, in subsequent years, the taxpayer was entitled to receive the shares of stock. Upon these facts, it was held that the taxpayer, who was on the cash basis, received income in the years in which the stock was finally received by him rather than in the year in which the stock was issued.

In Lyle H. Olson, 24 B. T. A. 702, affd., 67 Fed. (2d) 726, certiorari denied, 292 U.S. 637">292 U.S. 637, a corporate employer agreed to issue 200 shares of its stock to Olson in consideration of his continuous performance of services for the next 5 years. Each year from 1918 through 1922 a certificate for 40 shares was issued in Olson's name and delivered to a trustee designated by him. In 1922 at the end of the 5 years, the shares of stock were delivered to Olson. It was held that, since Olson reported his income on the cash basis, the entire 200 shares were includible in his income in 1922 in the amount of their fair market value. Cf. Adolph Zukor, 33 B. T. A. 324.

In Marion H. McArale, supra, the taxpayer sold stock and as part of his consideration received a cashier's check which he endorsed and deposited with the buyer in order to guarantee the buyer against loss from accounts receivable and contingent liabilities of the corporation whose stock was being purchased. It was held that the profit represented by the portion of the sales price so deposited was not income to the cash basis seller in the year of sale, but only in the following year when received unconditionally. See, also, Preston R. Bassett, 33 B. T. A. 182, affd., 90 Fed. (2d) 1004.

And in Roscoe H. Aldrich, 3 B. T. A. 911, where a corporation agreed to compensate a taxpayer for entering into a contract with another corporation and becoming its general manager for a period of 5 years by depositing in escrow 500 shares of stock to be delivered to the taxpayer at the expiration of 5 years, the dividends declared on the stock during the escrow period to be paid to the taxpayer, it was held that the taxpayer did not become the owner of the stock until the expiration of the 5 years and its fair market value was includible in his income at that time. See, also, Charles F. Pearce, Jr., 6 B. T. A. 450; James R. Lister, 3 B. T. A. 475.

It seems clear that in exchange for his services for the next 2 years, the Company agreed to deliver to petitioner 25 shares of stock at the end of each year when the services had been performed. Performance of the services was a condition precedent to the delivery of the stock to petitioner. Petitioner argues that the signing of the contract to perform services in the future was sufficient consideration to make him the owner of the stock in 1942. But the Company was contracting for petitioner's services, not for his promise. The bare promise without the services had no value. The services called for by the contract were not performed until 1943 and 1944, in each of which years a certificate for 25 shares was delivered to petitioner for the services which he had rendered.

Moreover, petitioner's contention that the mere signing of the contract was sufficient consideration for the transfer to him of ownership of the 50 shares is clearly contrary to the laws of the State of Ohio which were in effect at the time the parties entered into the contract. Section 8623-22, Page's Ohio Gen. Code Ann., in effect in 1943, reads as follows:

Payment for shares. -- * * * Shares shall be issued only for money, or for other property, real or personal, tangible or intangible, actually conveyed or transferred to the corporation for its use and lawful purposes, or in its possession as surplus, or for labor or services actually rendered to the corporation. [Emphasis added.]

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Every person who shall subscribe for shares without par value, or to whom such shares are to be issued, except as a share dividend, shall be obligated to pay the corporation therefor, in money or such other property or labor or services, such amount of consideration for each share as may have been determined as hereinbefore in this act provided.

Thus, under the laws of Ohio, petitioner could become the owner of the shares only upon the actual performance of the required services. See, also, Fletcher, Cyclopedia of the Law of Private Corporations (Perm. ed.), section 5187, pp. 424 et seq. And the laws in effect at the time shares of a corporation are issued become a part of the contract between the corporation and its shareholders and the parties to such agreement are presumed to know the extent of the authority granted the corporation by the applicable statutes then in effect. Schaffner v. Standard Boiler & Plate Iron Co., 150 Ohio St. 454">150 Ohio St. 454, 83 N. E. (2d) 192.

Petitioner places considerable reliance upon the case of Schneider v. Duffy, 43 Fed. (2d) 642. However, the facts in Schneider v. Duffy are distinguishable from the facts in this proceeding. In the Schneider case, the employment agreement provided that the corporation would assign "an equitable ownership" in 1,500 shares of stock to Schneider; that he was "entitled to receive and enjoy all of said 1,500 shares", and that all dividends declared on the 1,500 shares would be transmitted immediately to Schneider. Schneider also had the right to vote all 1,500 shares. As a basis for its decision that the fair market value of all 1,500 shares was income in the year in which the contract was executed, the district court of New Jersey emphasized the fact that the stock agreement was not a contract for additional salary, but that it was an incentive given to Schneider, who had no ownership in the company, to remain with the business after he had expressed an intention to sever his connection therewith and organize a competitive company.

In this proceeding, however, petitioner needed no incentive in the form of stock to work for the Company. His former job as manager of the jig and fixture division of the American Coach & Body Co. no longer existed upon the sale of that division outright to the Company. The Company did not agree to deliver a total of 50 shares of its stock to petitioner in order to persuade him to leave his employment with another corporation or to influence him to remain with the Company after he had expressed his intention to leave. Petitioner already had sufficient incentive as one of the organizers of the Company. In addition, under the employment contract, petitioner was entitled to 10 per cent of the profits earned each year by the Company above $ 5,000.

The facts in this proceeding are more closely akin to those relied upon by the Board of Tax Appeals in Anthony Schneider, 3 B. T. A. 920, where, upon consideration of the same fact situation as that present in Schneider v. Duffy, supra, it was held that income was taxable in the years subsequent to the issuance of stock. In the Board's view of the evidence, the agreement was entered into by the company in exchange for the services of Schneider and his agreement to remain with the company for the next 5 years. On these facts, the Board held that "performance of the agreements was the quid pro quo to the delivery of the absolute title to the stock," rather than the issuance of the stock, and that the fair market value of the stock was includible in Schneider's income in the years in which the certificates therefor were delivered to him without restriction. In subsequent cases, we have cited this decision of the Board with approval. Charles F. Pearce, supra;K. E. Merren, 18 B. T. A. 159; Lyle H. Olson, supra;Albert R. Erskine, 26 B. T. A. 155; Charles Chaplin, 46 B. T. A. 385, reversed on another issue, 136 Fed. (2d) 298.

Petitioner also relies upon Chaplin v. Commissioner, 136 Fed. (2d) 298, reversing in part 46 B. T. A. 385. We fail to see how that decision is authority for the contentions made by the petitioner. In the Chaplin case, the stock was issued in consideration of property in the form of photoplays to be delivered by Chaplin to the corporation, rather than for services to be rendered in the future. The stock was placed in escrow until such time as Chaplin delivered the photoplays. In reversing the decision of the Board of Tax Appeals that the fair market value of the stock was includible in Chaplin's income in the year in which he delivered the photoplays and the stock was returned to him, the Court of Appeals relied upon the fact that the agreement specifically provided that Chaplin was the owner of the stock; that Chaplin had at all times the right to vote the stock, and that dividends on the stock were declared and paid to the escrow agent who held them for Chaplin's benefit. These facts are not present in the instant proceeding. Moreover, on the issue of whether the dividends which had been declared on the stock and paid to the escrow agent for Chaplin's benefit in prior years were includible in Chaplin's income in the year in which they were released to him upon delivery of the photoplays, the Court of Appeals held that the dividends were properly includible in Chaplin's income in the year of their release when they were unqualifiedly made subject to his demand, rather than in the years in which they were paid to the escrow agent. The decision on this issue supports the contention of respondent that the fair market value of the shares of stock was not includible in petitioner's income until the years 1943 and 1944, in each of which years 25 shares were delivered to petitioner without restriction.

It is held that the fair market value of the 25 shares delivered to petitioner in the year 1943 is includible in his gross income for that year, and the fair market value of the 25 shares delivered to petitioner in the year 1944 is includible in his gross income for that year.

Decision will be entered for the respondent.