Moore & Evans v. Commissioner

MOORE & EVANS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Moore & Evans v. Commissioner

Docket No. 29891.

United States Board of Tax Appeals

24 B.T.A. 45; 1931 BTA LEXIS 1704;

September 17, 1931, Promulgated

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An amount credited to an employee who held a qualifying share as a director as additional compensation for the taxable year and two prior taxable years, held to be deductible in the taxable year.

E. B. Wilkinson, Esq., M. F. Gallagher, Esq., S. M. Rinaker, Esq., for the petitioner.

J. E. Marshall, Esq., for the respondent.

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TRAMMELL

This is a proceeding for the redetermination of a deficiency in income tax for the taxable year 1924 in the amount of $1,875. The error assigned is the disallowance by the Commissioner of a deduction claimed of $15,000 as additional compensation to the vice president and general manager.

FINDINGS OF FACT.

Moore & Evans, Inc., Nestor-Johnson Manufacturing Company, and S. E. Morse Company, affiliated corporations, filed a consolidated income-tax return for the fiscal year period ending January 31, 1924, in October, 1924. In said return a deduction of $21,000 for compensation to C. A. Ritter, vice president of the Nestor-Johnson Manufacturing Company and general manager of its factory, was claimed. The Commissioner allowed $6,000 and disallowed $15,000 of this deduction. Upon the disallowance of said deduction from $15,000 the Commissioner determined additional income tax due from petitioner for said fiscal year ending January 31, 1924, in the amount of $1,875.

James W. Clark, president and treasurer of all three companies, owned all of the stock, both preferred and common of all three companies, with the exception of one or two shares of common stock of each company owned by, Ritter and Morse to qualify them as directors.

The books of account of the Nestor-Johnson Manufacturing Company were kept on an accrual basis of accounting.

C. A. Ritter was manager of the factory of Nestor-Johnson Manufacturing Company from May, 1917, continuously until his death in June, 1924.

James W. Clark hired Ritter as manager of the factory of Nestor-Johnson Manufacturing Company in 1917. For the first two years Ritter was paid a salary of $5,000. In 1919 his salary was increased to $6,000 a year, which amount was paid him every year thereafter, including the fiscal year ending January 31, 1924. In addition to his salary Ritter was paid a bonus for the years ending in 1920, 1921 and 1922. The amount of such bonus was customarily determined by Clark at the end of each fiscal year and was credited to Ritter on the books of the company at the direction of Clark, and subsequently formally approved by the board of directors. The approval of the board of directors was usually two or three or sometimes six months later.

In the year 1922 Nestor-Johnson Manufacturing Company loaned Ritter the sum of $15,000 on the understanding that it would be repaid to the company out of his bonus during the next two or three years. Ritter gave the company his note for this amount at the time of the loan. The loan was entered on the books of the company in 1922, charged to J. W. Clark, special loan. The loan was charged to Clark instead of Ritter at the direction of Ritter, without Clark's knowledge or consent. Ritter was not credited with any bonus on the books of the company for the fiscal years ending in 1922, 1923 and 1924 until January 31, 1924. The amount of bonus to be paid to Ritter for those years was determined by Clark at the time of the entry on the books of the company in Janurary 1924. The bonus of $15,000 determined by Clark in January, 1924, and entered on the books of the company at that time at his direction, was for the year then ending and the two previous years. No determination of the amount of bonus to be paid Ritter for the two previous years was made prior to that time because of the outstanding loan of $15,000 made to Ritter in 1922.

On January 31, 1924, at the direction of Clark that Ritter be credited with a bonus of $15,000, the following entry was made on the books of the company by the auditor:

	JANUARY 31, 1924
Officers' Salaries Adjusting	$15,000
Journal Entries
J. W. Clark (Special loan		$15,000
to C. A. Ritter)
To set up additional
compensation for the year
per authorization of Board
of Directors.

Subsequently, on January 20, 1925, the board of directors approved the allowance of such bonus to Ritter authorized by Clark and entered on the books of the company in January, 1924. It was customary for the board of directors to meet and approve any action previously authorized by Clark as a matter of form.

The business of the Nestor-Johnson Manufacturing Company was financially successful in the years 1922 and 1923. The success of the business depended entirely upon Ritter's management. The total compensation paid or credited to Ritter during the fiscal years ending in 1922, 1923, and 1924 was reasonable compensation for his services during those years.

The bonus of $15,000 credited to Ritter on the books of the company in January, 1924, was paid to his estate after his death in June, 1924, by delivery to the representative of his estate of the note to the company evidencing the $15,000 loan to him in 1922, canceled.

OPINION.

TRAMMELL: We think that this case is controlled by the case of . The Commissioner undertook to distinguish this case upon the ground that the additional compensation was not authorized by the board of directors during the taxable year. He also takes the position that it is not shown that the additional compensation was reasonable in amount for services rendered.

We think from the evidence that Clark was in every substantial sense of the word authorized by the corporation to determine and fix the amount of compensation paid to Ritter. The usual practice and manner of conducting the affairs of the corporation indicate that Clark had this implied authority. The corporation had uniformly, merely as a formality, approved his action. He owned substantially all of the stock of the corporation. The shares not owned by him were merely qualifying shares. The amount was not only determined, but credited on the books of the corporation in 1924. The action in 1924 was in pursuance of the regular course of conduct of corporate affairs. We think this action was sufficient to create an obligation in 1924 to pay the additional compensation. This conclusion is supported by previous decisions. See ; ; .

In any event, the formal ratification of the board of directors, which consisted of the petitioner and those directors who merely held qualifying shares, relates back to the time of the act which was ratified, and this was in 1924. See Fletcher Cyc. Corporations, vol. 4, p. 3425; ; .

On the question of the reasonableness of the compensation, we think that the evidence is sufficient to show that it was reasonable compensation for services rendered for 1924 and the two previous years. Ritter owned only qualifying shares in the corporation and it could, in no sense, have been said that it was a distribution of profits. He was general manager of the corporation and the success of the business depended upon his management. It was financially successful and we believe that the amount was reasonable. It was so considered by Clark, who owned substantially all of the stock, and by the board of directors.

In view of the foregoing, we are of the opinion that the amount is a proper deduction in computing net income for 1924.

Judgment will be entered under Rule 50.