White v. Commissioner

Carl L. White, Petitioner, v. Commissioner of Internal Revenue, Respondent

White v. Commissioner

Docket No. 28984

United States Tax Court

17 T.C. 1562; 1952 U.S. Tax Ct. LEXIS 240;

March 21, 1952, Promulgated

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Decision will be entered for the petitioner.

Prior to and during the taxable year, petitioner withdrew, from a corporation in which he was an officer and a stockholder, amounts which exceeded his salary, bonus, and travel allowance. Held, such excessive withdrawals were loans and were not dividends within the meaning of section 115 (a) of the Internal Revenue Code.

J. G. Williamson, Esq., and Glenn A. Railsback, C. P. A., for the petitioner.

F. S. Gettle, Esq., and W. B. Riley, Esq., for the respondent.

Rice, Judge.

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RICE

This case involves an income tax deficiency of $ 42,399.18 for the calendar year 1944. The issues are (1) whether certain withdrawals by petitioner from a corporation constituted dividend distributions to the extent of the corporation's surplus at the end of the taxable year, or represented loans by the corporation to the petitioner; and (2) whether that portion of petitioner's total withdrawals over a three-year period, which exceeded the corporation's surplus at December 31, 1944, constituted a return of capital and, to the extent it exceeded the basis of petitioner's corporate stock, constituted a long term capital gain taxable in 1944. In the event that such withdrawals are determined to be taxable either as dividends or as capital gains, petitioner contends that his withdrawals during 1942 and 1943 should not be taxed to him in 1944.

FINDINGS OF FACT.

The petitioner is a resident of Eudora, Arkansas. His income tax return for the taxable year 1944 was filed with the collector of internal revenue for the district of Arkansas.

The Breece-White Manufacturing Company is an Arkansas corporation, sometimes referred to herein as the company, which was organized in or about January 1936 for the purpose of manufacturing lumber and wood products. The company continued the lumber business formerly conducted by petitioner and A. B. Vaughters, as partners; and it has been continuously engaged in the lumber business from the date of its organization. The authorized and outstanding capital stock of the company during 1944 was 500 shares of $ 100 par value common stock which was owned by the officers of the company as follows:

Carl L. White -- President	200 shares
Robert G. White -- Vice-President	100 shares
A. B. Vaughters -- Secretary-Treasurer	200 shares

Robert G. White is petitioner's son. He acquired his 100 shares of stock in the company on or about January 1, 1942. He has remained the owner of such shares at all times material hereto.

The petitioner was experienced in buying and selling timber and lumber, and he was largely responsible for the conduct of the company's business outside of the office. Vaughters operated the office, kept the records, and consulted with petitioner regarding the conduct of the business. Robert G. White participated very little in the conduct of the company's business during the taxable year.

At all times material hereto, petitioner and Vaughters were authorized to and did separately draw checks on the company's funds. No counter signature was required on company checks drawn by either petitioner or Vaughters. Both officers drew checks on the company to pay their personal obligations. The company carried personal accounts for petitioner and Vaughters on its books of account. Their respective personal accounts were charged with their withdrawals and credited with salary, bonus, and traveling expenses. The debit or credit balances of these personal accounts were carried on the books of the company as an account receivable or an account payable, as the case might be. The company paid no interest on the credit balances in these personal accounts and charged no interest on the debit balances therein. During the taxable year and the two preceding years, no notes were given by petitioner to evidence any indebtedness for the debit balance in his personal account, and no notes were given by the company to evidence any indebtedness to Vaughters for the credit balance in his personal account.

During 1939, 1940, and part of 1941, petitioner's withdrawals from the company exceeded the amounts credited to his account for salary, expenses, and bonus. During these three years the largest debit balance in petitioner's personal account was $ 16,593.47 on May 31, 1941. By the end of 1941, credits to petitioner's personal account had wiped out this debit balance, so that on December 31, 1941, his account was in balance.

For the calendar years 1942 to 1944, inclusive, petitioner's total withdrawals, credits, and the debit balances in his personal account at December 31 are reflected in the following table:

	Total debit	Total credit	Dec. 31 debit
Year	entries	entries	balance
1942	$ 37,750.97	$ 27,000	$ 10,750.97
1943	83,852.09	27,000	67,603.06
1944	69,177.16	22,739	114,041.22

Petitioner's withdrawals and credits in 1944, and subsequent thereto, were handled in the same manner as his withdrawals and credits prior thereto. The principal debit entries in his personal account for each of the years 1942 to 1944, inclusive, were cash and tax payments, while his credit entries were his monthly salary of $ 500, his bonuses, and one credit entry in 1944 for expenses. A breakdown of petitioner's 1944 withdrawals shows: Cash -- $ 62,885; local, state, and Federal taxes -- $ 5,918.44; miscellaneous personal items consisting largely of payments for water, gas, electricity, etc. -- $ 373.72. A breakdown of petitioner's total credit entries for 1944 shows: Salary -- $ 6,000; bonus -- $ 15,739; and expense -- $ 1,000.

The net worth of the company on December 31, 1944, was between $ 400,000 and $ 500,000. Petitioner's 200 shares of stock in the company at that date were worth approximately $ 180,000. Petitioner's personal assets were insufficient to pay the debit balances in his personal account with the company on December 31, 1943, or 1944, without borrowing on his 200 shares of stock.

During the period 1942 to 1944, inclusive, neither A. B. Vaughters nor Robert G. White, who together owned three-fifths of the stock of the company, received any dividends from the company or borrowed any money from it. During this period the company owed Vaughters for undrawn compensation consisting of salary and bonuses credited to his personal account. On December 31, 1943, and 1944, Vaughters' personal account with the company showed credit balances of $ 22,883.97 and $ 34,773.37, respectively. The company needed money for its operations and Vaughters left his credit balances with the company. Vaughters could not have withdrawn all the money due him in 1944; his withdrawals normally were his $ 300 a month salary and such part of his bonus as he needed.

Petitioner lost the bulk of the money which he withdrew from the company in gambling. Vaughters and petitioner's son knew that petitioner was using the excessive withdrawals for gambling. Vaughters objected before, during, and after the taxable year to petitioner's excessive withdrawals. Petitioner would promise to and would quit (his excessive withdrawals) for a time, but sooner or later would resume his excessive withdrawals. Petitioner continued his gambling with the hope that he could recoup some of his losses and put the money back into the company.

Prior to 1950 Vaughters and Robert G. White took no action to stop petitioner's excessive withdrawals. Vaughters discussed the situation with petitioner's son, but not too much, as it was a ticklish question; and he did not know, in case of a showdown, whether the son would vote with him to stop his father's excessive withdrawals. Vaughters feared that positive action would wreck the business, which he preferred to continue, objecting from time to time as petitioner's withdrawals became excessive, in the hope that petitioner would eventually balance his personal account as he had done at December 31, 1941.

By December 31, 1949, the debit balance in petitioner's personal account had reached $ 268,769.23. Vaughters again discussed the matter with petitioner and advised him that something should be done about his excessive withdrawals. Petitioner agreed, and, at Vaughters' request, he assigned his 200 shares of stock to the company as security for the debit balance in his personal account. This assignment of stock, dated January 21, 1950, was recorded with the recorder of Chicot County, Arkansas, on January 24, 1950. Petitioner's stock certificates No. 6 for 30 shares and No. 7 for 170 shares, were duly endorsed by petitioner and delivered to the company. A notation of petitioner's assignment was also made on the stock-certificate stubs in the company's stock-record book.

After the assignment of his stock certificates, petitioner continued his excessive withdrawals. The debit entries in his personal account for February and March, 1950, included cash withdrawals of $ 8,100 while his credit entries were only for his monthly salary of $ 500. When these further withdrawals came to his attention, Vaughters began seriously to consider retiring from the company; and within a few months thereafter, he did retire. In June 1950 Vaughters transferred his 200 shares of stock to the company in exchange for certain of its assets and resigned as an officer of the company. At the time he retired, Vaughters' personal account had a credit balance of about $ 34,000. The company satisfied this obligation by giving Vaughters a series of notes totaling $ 33,000, and permitted Vaughters to use the remainder of the credit balance in paying various bills and commissary accounts. The first note in the aforementioned series was for $ 3,000, due in January 1951, and the remaining notes were for $ 2,000 each, due monthly until the $ 33,000 was paid. Payment by the company of these notes was current at the time of the hearing herein on April 28, 1951.

The notice of deficiency herein was mailed to petitioner on or about March 14, 1950. Petitioner and Vaughters had no notice at the time petitioner pledged his stock with the company that respondent proposed to treat petitioner's withdrawals as taxable distributions by the company.

Prior to April 2, 1951, the company sued petitioner in the Chancery Court of Chicot County, Arkansas, for the sum of $ 298,648.09, representing funds withdrawn by petitioner in excess of his salary, bonus, and traveling expenses from January 1, 1942, through March 2, 1951. Under date of April 2, 1951, the Chancery Court entered its decree in favor of the company for the above sum after considering the pleadings and "the oral testimony of A. B. Vaughters, Robert M. Breland and Carl L. White, and upon other evidence, written and oral, * * *." The decree provided that the judgment should constitute a first and exclusive lien against the 200 shares of stock owned by petitioner but assigned by him to the company. The decree further provided that if the judgment was not discharged within 10 days the clerk of the court, who was appointed a commissioner, should sell the 200 shares of stock at public auction and apply the proceeds against the expenses of the sale, the judgment awarded to the company, and any sum remaining in the hands of the court's commissioner was to be paid to petitioner. At the time of the hearing herein, the stock had been advertised for sale on May 14, 1951.

During 1951 petitioner received a dividend from the company on his stock in the amount of $ 20,000. This dividend was credited to petitioner's personal account with the company. At the same time, Robert G. White received a dividend of $ 10,000 on his stock. Robert G. White used his $ 10,000 dividend, as a payment on the purchase price of a home from petitioner by having his dividend credited to petitioner's personal account. Petitioner had sold his home to his son and the deed thereto had been recorded. Prior to 1951 the company had paid no dividends on its stock.

In determining the deficiency for 1944, respondent held that petitioner's net withdrawals for that year, $ 46,438.16, constituted dividend distributions to the extent of the surplus available at December 31, 1944, which he determined to be $ 42,586.05, and that the remainder of petitioner's debit balance in his personal account at December 31, 1944, constituted a return of capital on which petitioner realized a long term capital gain computed as follows:

Withdrawals by petitioner	$ 114,041.22
Surplus available Dec. 31, 1944	42,586.05
Return of capital	$ 71,455.17
Basis of capital stock	20,000.00
Long term capital gain	$ 51,455.17
Portion taxable -- 50%	$ 25,727.59

The company and the petitioner intended that his excessive withdrawals should be loans. Petitioner intended to repay his excessive withdrawals, and continuously made repayments thereon with his salary, bonus, and traveling expense allowance. Petitioner's excessive withdrawals during the taxable year and prior thereto were loans and were not taxable distributions.

OPINION.

Section 115 (a) of the Internal Revenue Code defines a dividend as any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year.

Respondent contends that petitioner, who was president of the company, siphoned off its earnings for his pleasure and benefit, and that such withdrawals of earnings constituted dividends within the meaning of section 115 (a) of the Code and are taxable to him. Respondent takes the position that petitioner was in complete control of the company, dictated its policies, and otherwise used it for his personal convenience.

We examine first the question of whether petitioner had complete control of and dictated the policies of the company. Our findings show that he was not the majority stockholder at any time material hereto, owning only 40 per cent of the capital stock. The company's operations were conducted outside of the office by petitioner and inside the office by Vaughters, who also owned 40 per cent of the capital stock. Both Vaughters and petitioner testified that policy matters were settled and decided after discussions between them. Vaughters recognized and respected petitioner's ability and experience as a timber and lumber man, but such recognition and respect are not the equivalent of complete control of the company or dictation of its policies. These facts indicate cooperation in the conduct of the business, rather than control and dictation by the petitioner.

In our opinion the record shows, and we have found, that Vaughters constantly objected over a period of years to petitioner's practice of excessive withdrawals. Time and again he secured an agreement from petitioner that he would stop withdrawals in excess of his salary, bonus, and traveling expenses, only to have petitioner break his promise and renew his excessive withdrawals. Vaughters' testimony, a portion of which is hereinafter set forth, reveals his deep concern over petitioner's practice of withdrawing large sums of cash from the company and the turmoil in his own mind as to what he should do to solve the problem.

The Court: He didn't have control of the other stockholders, did he?

The witness: No.

The Court: Why didn't the rest of the stockholders get together and stop it?

The witness: Well, that is a thing that is hard for me to explain. A person has got to get into the circumstances, the fact that you have got to go ahead from then on here, and when you know that sickness is there, you try to get along the best you can with it without getting out of bounds. Now, that is all I can say. That is the only way I can explain it, but I know in my own mind what it is. I know it shouldn't be countenanced, I will agree with you, but if you are put in my position you might see it differently. [Emphasis added.]

We cannot agree that these facts and the testimony of record establish complete control of the company by petitioner or dictation of its policies. The facts indicate tolerance on the part of Vaughters and an unwillingness to force the matter to an issue until long after the taxable year.

The important fact is not petitioner's measure of control over the company, but whether the withdrawals were in fact loans at the time they were paid out. Wiese v. Commissioner (C. A. 8, 1938), 93 F. 2d 921, 923, certiorari denied 304 U.S. 562">304 U.S. 562, rehearing denied 304 U.S. 589">304 U.S. 589 (1938). The character of the withdrawals depends upon petitioner's intent and whether he took the company's money for permanent use in lieu of dividends or whether he was then only borrowing. Id. In this case we have affirmative statements from witnesses, plus documentary evidence, all of which is corroborated by subsequent events, that petitioner's withdrawals were intended to be loans. There was no agreement, tacit or otherwise, among the company's stockholders authorizing petitioner's withdrawals, a fact which distinguishes this case from cases like Regensburg v. Commissioner (C. A. 2, 1944) 144 F.2d 41">144 F. 2d 41, certiorari denied 323 U.S. 783">323 U.S. 783 (1944); Ben R. Meyer, 45 B. T. A. 228 (1941); and Roy J. Kinnear, 36 B. T. A. 153 (1937). Nor do we have a situation where withdrawals during prior years were canceled out by corporate resolution in the taxable year, as in Cohen v. Commissioner (C. A. 6, 1935), 77 F. 2d 184, certiorari denied 296 U.S. 610">296 U.S. 610 (1935), or were charged off by appropriate entries in the corporate books of account, as in Allen v. Commissioner (C. A. 1, 1941), 117 F. 2d 364, and Cohen v. Commissioner (C. A. 6, 1935), 77 F.2d 184">77 F. 2d 184, certiorari denied 296 U.S. 610">296 U.S. 610 (1935).

Moreover, the facts show that petitioner considered the withdrawals loans and was constantly applying his salary, bonus, and traveling expense allowance against his withdrawals. While it must be admitted that his debit balances increased steadily after December 31, 1941, it must also be recognized that thousands of dollars were credited annually to his personal account in partial satisfaction of his withdrawals. If the company and the stockholders had intended that petitioner's withdrawals were permanent appropriations of corporate profits, there would be no point in his repaying almost $ 75,000 during the 3-year period ending with the taxable year. The manner in which the withdrawals were made, the book entries reflecting the withdrawals, the repayments made on account, and the uncontradicted testimony of petitioner and Vaughters that the withdrawals were intended and were considered to be loans, strongly support petitioner's contention that he was only borrowing from the company.

Furthermore, we have in this case the corroborating facts that subsequent to the taxable year Vaughters forced the issue, the company acquired petitioner's stock as a pledge for his indebtedness to it, and thereafter obtained judgment against petitioner and established a lien against his stock, which was to be sold subsequent to the date of the hearing of this cause in satisfaction of the judgment.

In view of the foregoing, we hold that petitioner's excessive withdrawals during the taxable year were loans and were not dividends within the meaning of section 115 (a) of the Code. Rollin C. Reynolds, 44 B. T. A. 342 (1941) and cases there cited. In so holding we have carefully considered all the facts and circumstances herein, including the fact that no notes were given or interest charged on the indebtedness to the company or the indebtedness owed by the company, and that no dividends were declared by the company during or prior to the taxable year.

Our holding on the first issue disposes of respondent's second issue with respect to capital gain, as our findings show that petitioner's withdrawals and credits were treated the same by all parties during, prior, and subsequent to the taxable year. Disposition of these issues in favor of petitioner's theory makes it unnecessary to consider his alternative contention.

Decision will be entered for the petitioner.