Smith Ins. Service, Inc. v. Commissioner

SMITH INSURANCE SERVICE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Smith Ins. Service, Inc. v. Commissioner

Docket No. 10901.

United States Board of Tax Appeals

9 B.T.A. 284; 1927 BTA LEXIS 2630;

November 23, 1927, Promulgated

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The cancellation of indebtedness of the petitioner to a principal stockholder held not to constitute income of the petitioner under the provisions of the Revenue Act of 1921.

W. Chester Gray, C.P.A., H. E. Dennision, Esq., and R. D. Campbell, C.P.A., for the petitioner.

L. C. Mitchell, Esq., for the respondent.

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SMITH

This is a proceeding for the redetermination of deficiencies in income and profits tax for the years 1920 and 1921 of $913.19 and $2,388.57, respectively. Petitioner alleges error on the part of the Commissioner in disallowing as a deduction from gross income of 1920, $5,000 of the amount paid the president for salary. This error is conceded by the Commissioner. The question in issue for the year 1921 is whether the petitioner derived income from the cancellation of indebtedness of the petitioner to a stockholder in the circumstances herein stated.

FINDINGS OF FACT.

The petitioner is a Massachusetts corporation organized in 1919. It is engaged in rendering insurance service and appraisals to its clients. The president, Fred S. Smith, is an expert in insurance matters and in the placing of insurance, especially casualty insurance. During the taxable years 1920 and 1921 the president secured all of the business of the company and supervised the conduct of the work and generally ran the business. The outstanding capital stock of the company at January 31, 1920, and January 31, 1921, was as follows:

	1920	1921
Preferred capital stock	$9,230	$13,930
Common capital stock	7,030	7,290

At the close of 1920 and 1921 the president held 650 shares and 628 shares, respectively, of common stock of a par value of $10 per share. Upon the organization of the corporation the St. Croix Paper Co. subscribed and paid for at par 500 shares (par value of $5,000) of the preferred stock which it owned during the taxable years 1920 and 1921. This company placed all of its insurance through Smith Insurance Service, Inc., and paid the company an annual retainer for such service. It was particularly interested in the success of the petitioner and whenever the petitioner was in need of funds for operation the St. Croix Paper Co. made advances to it. Up to January 19, 1921, the St. Croix Paper Co. had advanced to the petitioner $14,250 receiving demand notes for same. From April 2 to October 1, 1921, it advanced, by checks on National Union Bank, $7,141.58 additional. Its total advances to the company amounted to $21,391.58.

Fred S. Smith, as president of the company, had borrowed from the petitioner up to October 31, 1921, $6,063.25.

Under date of October 27, 1921, the St. Croix Paper Co. addressed a letter to the petitioner reading as follows:

We hereby agree with your President, Mr. Fred S. Smith, to assign to us insurance policies on his life amounting to $20,000 and on receipt of said life insurance policies duly assigned, to cancel all indebtedness of the Smith Insurance Service, Inc. to us amounting to $21,391.58 and to surrender to said Smith Insurance Service, Inc. all notes or other evidence of said indebtedness.

At a meeting of the board of directors of the petitioner, on October 31, 1921, the following transpired:

It was reported by the President to the meeting that the St. Croix Paper Co. was willing to cancel its claim against Smith Insurance Service, Inc., in the sum of $21,391.58, in consideration of the personal assignment of Fred S. Smith of insurance policies on his life amounting to $20,000, and Mr. Smith further reported that he was prepared to make the assignment in consideration of Smith Insurance Service, Inc., canceling all claims against himself consisting of his notes of $6063.25 and all salary and advancement withdrawals up to and including October 3, 1921, be and hereby are canceled.

The President explained that in line of curtailment, he felt it encumbent upon himself to materially reduce his salary until such time as the business might warrant the Directors in increasing it.

Upon motion duly made, and seconded, it was unanimously

VOTED: Commencing November 1, 1921, that the President's salary should be at the rate of $5,000 a year to which is to be added a bonus at the rate of 10% of the income derived from all new business not before registered, new business (not meaning renewals of expiring contracts) which may be transacted in future, first deducting in each individual case, any commissions paid to other parties.

The offer of the St. Croix Paper Co. to cancel its claim against the petitioner in the amount of $21,391.58 in consideration of insurance policies on the life of Fred S. Smith being assigned to it was accepted by the petitioner. Fred S. Smith assigned the life insurance policies to the Paper Company and the Paper Company relinquished its claim against the petitioner. Likewise, the petitioner relinquished its claim against Fred S. Smith for the $6,063.25 owed to it by him. In November, 1921, entry was made in the company's journal, charging notes payable and crediting service income and appraisal department income with the $21,391.58, owed by it to the St. Croix Paper Co. This account was in turn credited to profit and loss and the $21,391.58 was reported as gross income in petitioner's income-tax return for 1921. The $6,063.25 owed by Fred S. Smith to the petitioner was in turn credited to notes receivable and charged to salary account. Five thousand dollars of the amount claimed as salary deduction on the return for 1921 was disallowed by the Commissioner in determining the deficiency for that year.

OPINION.

SMITH: The only allegation of error so far as the year 1920 is concerned is that the respondent improperly disallowed $5,000 of the amount paid as salary to the president of the company. At the hearing of this appeal the respondent admitted error with respect to this disallowance.

Although the petitioner reported in its gross income for 1921, $21,391.58 of indebtedness canceled by the St. Croix Paper Co., the petitioner now contends that it was in error in doing so; also that if this amount is to be included in gross income the respondent was in error in disallowing $5,000 of the amount claimed as salary deduction for 1921.

The net result of the transaction by which the St. Croix Paper Co. released the petitioner from indebtedness of $21,391.58 and by which the petitioner canceled a debt owing to it by Fred S. Smith of $6,063.25 increased the petitioner's assets to the extent of $15,328.33. This enrichment of the petitioner was at the expense of two principal stockholders. It, in effect, was a contribution to the corporation by those stockholders and constituted a gift to it. Section 213(b) of the Revenue Act of 1921 specifically provides that the term "income" shall not include the following items, which shall be exempt from taxation under this title:

(3) The value of property acquired by gift, bequest, devise, or descent (but the income from such property shall be included in gross income).

Section 233(a) of the Revenue Act of 1921 provides:

That in the case of a corporation subject to the tax imposed by section 230 the term "gross income" means the gross income as defined in sections 213 and 217 * * *.

In the light of these provisions of the Revenue Act of 1921 we are of the opinion that the petitioner was in error in including in the gross income reported in its tax return $21,391.58 of indebtedness canceled by the St. Croix Paper Co. and that it likewise was in error in claiming as a deduction from gross income $6,063.25 indebtedness owed by it to Fred S. Smith, which was canceled in the circumstances herein stated.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.