Erskine v. Commissioner

JAMES C. ERSKINE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Erskine v. Commissioner

Docket No. 17493.

United States Board of Tax Appeals

16 B.T.A. 1080; 1929 BTA LEXIS 2455;

June 18, 1929, Promulgated

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1. Petitioner was the principal stockholder of a corporation which suffered a net loss in 1920. The petitioner contends that said corporation was, during the taxable years, a personal service corporation, and that he is entitled to deduct from his personal net income for 1920 a proportionate part of the corporation's net loss, allocated on the basis of stock ownership. The petitioner also claims as deductions from his 1921 income his proportionate part of the net loss sustained by the corporation in that year, and the excess of his proportionate part of the corporation's net loss for 1920 over his personal net income for the latter year.

2. On the facts, held that the corporation was not entitled to personal service classification in the taxable years, and that the petitioner is not entitled to the deductions claimed.

3. Held, further, that the claimed deductions based upon the corporation's net loss for 1920 must be denied also, for the reason that there is no statutory net loss provision applicable to said year. Keystone Table Co.,1 B.T.A. 382">1 B.T.A. 382.

John S. Myers, Esq., for the petitioner.

W. Frank Gibbs, Esq., for the respondent.

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TRAMMELL

In this proceeding the petitioner seeks a redetermination of his income tax for the years 1920 and 1921, for which years the respondent has determined deficiencies of $1,033.73 and $887.69, respectively.

The petitioner alleges that the respondent erred (1) in refusing to permit as a deduction from his net income for the year 1920 the amount of $35,045.37, representing his proportionate part, based upon stock ownership, of a net loss of $43,806.71 sustained by the Ostrander-Erskine Corporation during that year, and in holding that said corporation in said year was not a personal service corporation; (2) in refusing to allow, as a deduction from income for the year 1921, the amount of $1,577.70, representing petitioner's proportionate part, based upon stock ownership, of a net loss of $1,632.10 suffered by said corporation in 1921, and in holding that the said corporation in said year was not a personal service corporation; and (3) in disallowing as a deduction from petitioner's 1921 income the amount of $21,109.03, representing the excess of the petitioner's proportionate part of the corporation's 1920 net loss over the net income of the petitioner for said year.

FINDINGS OF FACT.

The petitioner is an individual, who resided in Brooklyn, N.Y., during the taxable years and until June 1, 1926, when he removed to Bronxville, N.Y.

The petitioner is the principal stockholder of the James C. Erskine Corporation, which was organized under the laws of the State of New York in March, 1920, under the name of the Ostrander-Erskine Corporation. In 1921, the name of the corporation was legally changed to James C. Erskine Corporation, and is hereinafter sometimes referred to as the Erskine Corporation. Its authorized capital consisted of 300 shares of preferred stock, of the par value of $100 per share, and 300 shares of no par value common stock, having a nominal value of $5 per share.

During 1920 the stock of the corporation was owned as follows:

Stockholders	Shares
	Preferred	Common
James C. Erskine, president and treasurer	228	252
Guy C. Fleming, vice president	60	40
J. F. Hopper, assistant treasurer	12	8
Total	300	300

The stock held by Guy C. Fleming was sold to the petitioner in 1921, so that the entire stock of the corporation in 1921 was owned by the petitioner and J. F. Hopper.

The business in which the Erskine Corporation was engaged was originally carried on by Ostrander & Co., Inc., which was a corporation organized in 1909 and dissolved in 1920, when its business as a going concern was taken over by its successor, the Ostrander-Erskine Corporation. The Erskine Corporation acted as agents in selling on commission the products of a number of mills producing cotton goods and other textiles. Orders would be obtained by the corporation and forwarded to the mills. The finished product would be consigned by the mills to the selling agent, which would receive a commission on the sales for its services.

The Erskine Corporation did not merchandise nor trade directly or indirectly as a principal. It assumed no risks of market fluctuations, bad debts, or failures of customers to accept shipments. It did not guarantee the accounts of the purchasers, nor was it in any way responsible to the mills for the payment of the purchase price. It did not realize a profit on the sale of the products, nor base its fee or commission upon any difference in the price at which the seller sold or the buyer bought.

The petitioner was president of the Erskine Corporation, its principal stockholder, and the only person in the corporation who was in direct touch with the mills it represented. All the manufacturing orders and styling were attended to by him personally. Fleming, who was vice president, was the sales manager of the corporation, and Hopper, the assistant treasurer, was essentially a salesman, who had a large clientele in the South, and who made trips regularly to that region.

Of the gross income of the corporation in the taxable years, approximately 50 per cent resulted from the sales made by Erskine personally, 20 per cent or less from the sales made by Fleming, and about 10 per cent from the sales made by Hopper. The balance of 20 per cent or more was contributed by the salesmen, who received monthly salaries as follows: Downing, $208.33; Fowler, $162.50; Corsa, $129.17; Farrow,$100; Sievwright, $87.50; and Nixon, $100.

In addition to the six salesmen, the corporation employed an office force consisting of order and record clerks, cashier, and bookkeepers, stenopraphers, office boys, etc. The corporation had in all about 18 or 19 employees. Of the salesmen employed, Fowler made occasional trips to the Middle West, and Nixon was local representative on the Pacific Coast.

The Erskine Corporation represented about 9 mills, located principally in Massachusetts and Rhode Island, including the Bolton-Barnsley Mills Corporation. The latter was a converting company which purchased grey goods in the market and converted them into finished products. Its stock was owned by the same individuals who owned the stock of the Erskine Corporation and in approximately the same proportions.

Erskine was president of the Bolton-Barnsley Mills Corporation, and the other stockholders held corresponding offices. The Erskine Corporation performed the same services at the same rates for the Bolton-Barnsley Mills as it did for the other mills.

The Erskine Corporation sold goods for the accounts of the mills, took care of the detailed charges and overhead expenses and kept the records of sales for the accounts of the mills.

During the year 1920, the Erskine Corporation made gross sales amounting to $1,000,000, of which $450,000 was for the account of the Bolton-Barnsley Mills. In 1921 its gross sales amounted to $1,530,000, of which $291,000 was for the account of said last mentioned mills. Erskine, Fleming and Hooper attened stockholders' and directors' meetings of the Bolton-Barnsley Mills Corporation, but devoted very little time in addition to the affairs of that company. Its offices were located in the same building as those of the Erskine Corporation.

The respondent held that the Erskine Corporation was not a personal service corporation in either of the taxable years, and that said corporation and the Bolton-Barnsley Mills Corporation were affiliated.

The Erskine Corporation suffered a net loss of $43,806.71 for the year 1920 and a net loss of $1,632.10 for the year 1921.

OPINION.

TRAMMELL: The Erskine Corporation sustained a loss for the year 1920 in the amount of $43,806.71, and for the year 1921 in the amount of $1,632.10. The petitioner claims that this corporation was entitled to personal service classification in both taxable years, and that being a personal service corporation, the individual stockholders are entitled to deduct from their personal income the losses sustained by the corporation, such losses to be allocated in proportion to stock ownership. Accordingly, the petitioner asserts that he is entitled to a deduction from his 1920 income of the amount of $35,045.37 as representing his proportionate part of the corporation's loss for that year, and that he is entitled to deduct from his 1921 income the amount of $1,577.70, as representing his proportionate part of the corporation's loss in 1921. The petitioner also claims that after applying his proportionate share of the corporation's loss for 1920 against his personal net income for that year, there remained an excess of $21,109.03, which constitutes a personal net loss deductible from his personal net income for 1921.

A corporation which is subject to tax under the revenue laws is a taxable entity separate and distinct from its stockholders, and a stockholder of such a corporation is not entitled to deduct from his personal income any portion of a net loss sustained by the corporation. This principle is too well settled to require discussion, nor is any contrary contention made in this proceeding. The petitioner asserts his right to the claimed deductions solely on the ground that the Erskine Corporation was, during the taxable years, a personal service corporation not subject to taxation, and that its stockholders are, therefore, entitled to the benefit of its net losses under section 218 of the Revenue Acts of 1918 and 1921, which provides in pertinent part as follows:

Personal service corporations shall not be subject to taxation under this title, but the individual stockholders thereof shall be taxed in the same manner as the members of partnerships. All the provisions of this title relating to partnerships and the members thereof shall so far as applicable apply to personal service corporations and the stockholders thereof * * *.

The respondent has denied personal service classification to the Erskine Corporation for the years 1920 and 1921. The corporation is not a party to this proceeding, and the correctness of the respondent's determination in that regard will be considered by us only in so far as it affects the tax liability of the petitioner herein.

The petitioner has attempted to show by his evidence that the respondent erred and that said corporation was during the taxable years in fact a personal service corporation. If the evidence does not establish this fact, the petitioner's contention must fail, irrespective of whether or not the stockholder of a personal service corporation is entitled to deduct from his personal income a proportionate part of the net loss of such a corporation.

The Revenue Acts of 1918 and 1921, in section 200, define the term "personal service corporation" as meaning, among other things, "a corporation whose income is to be ascribed primarily to the activities of the principal owners or stockholders." There is no contention that the Erskine Corporation did not meet the statutory requirements for personal service classification in all other particulars. We must, therefore, examine the record before us to determine whether or not its "income is to be ascribed primarily to the activities of the principal owners or stockholders."

The evidence shows that during the taxable years the corporation's income consisted entirely of commissions received for its services in selling the products of certain textile mills. Its three stockholders, Erskine, Fleming, and Hopper, effected between 75 per cent and 80 per cent of the sales, and only a corresponding percentage of its gross income is attributable to their activities. At least 20 per cent or more of the sales were made by the 6 salesmen, who were non-stockholders and whose activities thus contributed to the production of a corresponding portion of the gross income. During the years in question the corporation had about 18 or 19 employees who were not stockholders, or 6 times as many employees in one year as stockholders, and 9 times as many employees in the other year. Under similar facts, we have held that a corporation is not entitled to personal service classification.

In , we had before us the question whether the income of the corporation there involved was to be ascribed primarily to the activities of the principal owners or stockholders. In that connection, we said:

In our opinion this clause means more than that the stockholders shall obtain the clients and supervise the work, or that clients shall look to their experience; it means, among other things, that the corporation may not rely upon non-stockholders to do a substantial amount of the work which produces the income whether such work be detailed or supervisory. Just as another clause excludes from personal service classification those corporations where capital contributes materially to the income, so does this clause exclude corporations where the services of the employees so contribute.

In the instant case, the Erskine Corporation relied upon its non-stockholding employees to do a substantial amount of the work which produced its income. Not less than 20 per cent of its gross income was derived directly from the activities of its 6 salesmen, who rendered substantially the same income-producing services as the three stockholders in the first year and the two stockholders in the second. In these circumstances, we can not say that the Erskine Corporation was entitled to personal service classification. See ; ; ; .

In addition to the foregoing reason which impels us to deny the petitioner's contentions, the claimed deductions based upon the corporation's net loss for 1920 must be disallowed on another ground also. The corporation sustained a loss in 1920 of $43,806.71. Of this amount, the petitioner's proportionate part, based upon stock ownership, would be $35,045.37, which he seeks to apply first against his 1920 income, and the excess of $21,190.03 against his income for 1921. Even if the petitioner had himself directly suffered a net loss in 1920, there is no provision of law which authorizes the allowance of any part thereof as a deduction from income for any year. .

Reviewed by the Board.

Judgment will be entered for the respondent.