DocketNumber： Docket Nos. 3088-71, 3089-71, 3090-71, 3205-71
Citation Numbers： 61 T.C. 727, 1974 U.S. Tax Ct. LEXIS 143, 61 T.C. No. 78
Judges： Goffe
Filed Date： 3/13/1974
Status： Precedential
Modified Date： 11/14/2024
1974 U.S. Tax Ct. LEXIS 143">*143
Contributions were made by an electing subch. S corporation to the trust for a profit-sharing plan based on regular salary plus shares of the "undistributed net profits" of the corporation of shareholder-employees pursuant to a profit-sharing employment contract which existed before adoption of the profit-sharing plan. The plan prescribed that allocations under the plan were to be based on annual compensation, defined as the "regular salary or commission of a participant, exclusive of all special payments of every nature." Allocations under the profit-sharing plan were made to the accounts of the nonshareholder employees based solely upon regular salary alone, as they received no share of the profits.
61 T.C. 727">*728 The respondent determined deficiencies in Federal income taxes of the petitioners as follows:
| Docket No. | Year | Amount |
| 3088-71 | 1967 | $ 3,283.98 |
| 3089-71 | 1967 | 2,438.55 |
| 3090-71 | 1967 | 3,105.26 |
| 3205-71 | 1967 | 1,957.53 |
Upon joint motion by the parties, these cases were consolidated for trial, briefs, and opinion.
Certain concessions have been made by the petitioners. The two remaining issues presented for decision are: (1) Whether the profit-sharing plan created by Elgin B. Robertson, Inc., was a qualified plan under
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated by this reference.
The petitioners in each of the cases are husband and wife. The joint Federal income tax returns of all of the petitioners for the taxable year 1967 were filed with the district director of internal revenue at Dallas, Tex. All of the petitioners except George B. LaLonde and Patsy LaLonde (docket No. 3205-71) resided in Dallas, Tex., at the time of filing the petition herein. The LaLondes resided in Mason City, Iowa, at that time.
Paul S. Neblett, Max C. Jordan, Elgin B. Robertson, Jr., and George B. LaLonde were shareholders and employees of Elgin B. Robertson, Inc. (hereinafter sometimes1974 U.S. Tax Ct. LEXIS 143">*147 referred to as Robertson, Inc., or the corporation), throughout its fiscal year ended June 30, 1967, and through December 31, 1967. The corporation was organized under the laws of the State of Texas and had its principal office in Dallas, Tex. It was a manufacturers' sales representative in Texas, Kansas, and Oklahoma for electrical manufacturers who sold industrial, electronic, and utility equipment to electronic and aircraft businesses. The corporation was an electing subchapter S corporation for its taxable year ended June 30, 1967. The percentage of stock owned by each shareholder from July 1, 1961, through June 30, 1967, was as follows: 61 T.C. 727">*729
| Petitioner | Percentage |
| Elgin B. Robertson, Jr. | 18.18 |
| Paul S. Neblett | 18.18 |
| Chester M. Davis | 18.18 |
| George B. LaLonde | 15.05 |
| Max C. Jordan | 15.05 |
| E. L. Snyder | 15.05 |
| Gilbert E. Robertson | .31 |
On July 1, 1961, all of the shareholders, except Gilbert E. Robertson, entered into a "Profit Sharing Employment Contract" (contract) with the corporation. The contract provided in pertinent part as follows:
1.
2.
| Name of employee | Percentage |
| Elgin B. Robertson, Jr. | 18.29 |
| Paul S. Neblett | 18.28 |
| Chester M. Davis | 18.28 |
| George B. LaLonde | 15.05 |
| Max C. Jordan | 15.05 |
| E. L. Snyder | 15.05 |
The "undistributed net profits" of the corporation are determined by deducting from the undistributed taxable income all compensation, including bonuses, payable to employees1974 U.S. Tax Ct. LEXIS 143">*149 and premiums paid during the year on life insurance policies covering the lives of its officers, directors, or employees.
On May 5, 1965, the corporation established a profit-sharing plan and trust (plan). The plan provided that on the annual anniversary date each participant was entitled to one unit for each $ 100 of annual compensation in excess of $ 4,800 paid to him or accruing to him during the year for which the contribution was made. The value of each unit under the plan was to be determined by dividing the employer's contributions and the forfeitures by the total number of all participants. Each participant's account was then to be computed by multiplying the unit value by the number of his units. The maximum permissible employer contribution, including forfeitures, to be allocated to the account of any participant was 9 3/8 percent of such participant's annual compensation in excess of $ 4,800 for the year. The plan defined 61 T.C. 727">*730 "annual compensation" as "the regular salary or commission of a participant, exclusive of all special payments of every nature."
In the case of shareholder-employee participants, the allocations to the participants' accounts were made upon1974 U.S. Tax Ct. LEXIS 143">*150 the bases of the total of the fixed annual salary of each and his respective share of undistributed net profits as defined in the profit-sharing employment contract. Allocations to the other participants were based solely upon the annual salary of each. The number of units each participant was entitled to and the amounts from which his units were derived for the fiscal year ended June 30, 1967, were as follows:
| Annual | Share of | ||
| Employee | salary | undistributed | Units |
| net profits | |||
| Shareholders | |||
| Elgin B. Robertson, Jr. | $ 17,017.99 | $ 32,910.02 | 451 |
| Paul S. Neblett | 17,000.00 | 32,910.02 | 451 |
| Chester M. Davis | 17,000.00 | 32,910.02 | 451 |
| George B. LaLonde | 14,016.00 | 27,094.95 | 363 |
| Max C. Jordan | 14,016.00 | 27,094.95 | 363 |
| E. L. Snyder | 14,016.00 | 27,094.95 | 363 |
| Nonshareholders | |||
| Ronnie G. Smith | 10,980.00 | 62 | |
| W. S. Walters | 7,800.00 | 30 | |
| Jim D. Humphrey | 6,775.00 | 20 | |
| Louise G. Winerich | 5,565.00 | 8 | |
| Eddie L. Stimson | 5,125,00 | 3 | |
| James H. Clay | 5,085.00 | 3 | |
| Shirley Wright | 4,930.00 | 1 |
The positions held and duties performed by the shareholder- employees, who were full-time employees of the corporation during the fiscal year ended June 30, 1967, were as 1974 U.S. Tax Ct. LEXIS 143">*151 follows: Elgin B. Robertson, Jr., was the secretary-treasurer and was involved in outside sales in Dallas; Paul S. Neblett was vice president and general manager of the corporation at Dallas; Chester M. Davis was vice president and manager of outside sales in Houston; George B. LaLonde was an outside salesman who directed the industrial sales effort in Dallas; Max C. Jordan was an outside salesman directing the electronics sales effort in Dallas; and E. L. Snyder was an outside salesman in Houston. Outside sales positions comparable to that held by E. L. Snyder were occupied by three nonshareholder employees of the corporation. Contributions and allocations made under the profit-sharing plan had been made on the same basis in years prior to the corporation's fiscal year ended June 30, 1967. The minutes of the corporation's annual board of directors meetings held in July 1965, July 1966, and July 1967, reflect that the salaries of all officers except Gilbert Robertson, Sr., and Elgin Robertson, Jr., were to remain the same as in the preceding year.
The employer contribution to the fund and the allocation to the 61 T.C. 727">*731 participants' accounts for the fiscal year ended June 30, 1967, 1974 U.S. Tax Ct. LEXIS 143">*152 and the amounts vested and forfeitable were as follows:
| Name | Vested | Forfeitable |
| Elgin B. Robertson, Jr. | $ 2,527.99 | $ 1,685.32 |
| Paul S. Neblett | 2,527.99 | 1,685.32 |
| Chester M. Davis | 2,527.99 | 1,685.33 |
| George B. LaLonde | 2,034.72 | 1,356.48 |
| Max C. Jordan | 2,034.72 | 1,356.48 |
| E. L. Snyder | 2,034.72 | 1,356.48 |
| W. S. Walters | 168.16 | 112.10 |
| Ronnie G. Smith | 115.84 | 463.38 |
| Jim D. Humphrey | 74.74 | 112.10 |
| Louise G. Winerich | 44.84 | 29.90 |
| James H. Clay | 16.82 | 11.21 |
| Eddie Lee Stimson | 5.60 | 22.43 |
| Shirley Wright | 1.87 | 7.47 |
| Total | 14,116.00 | 9,884.00 |
The corporation claimed a deduction in the amount of $ 24,000 in its U.S. corporation income tax return, taxable year ended June 30, 1967, for its contribution made to the profit-sharing plan. In his statutory notice of deficiency the Commissioner disallowed as a deduction the portion of the corporation's contribution which was forfeitable thus increasing its taxable income in that amount and taxing to the shareholders their respective shares of the deduction disallowed. The Commissioner also increased the gross income of each petitioner in the amount of the respective vested portions of the employer's contribution. The Commissioner1974 U.S. Tax Ct. LEXIS 143">*153 explained the adjustments as follows: "that in operation, the basic compensation used in allocating contributions to the Elgin B. Robertson, Inc. Profit Sharing Plan and Trust included undistributed net profits payable to shareholder-employees which did not constitute compensation and was not otherwise consistently and uniformly available to all participants and therefore resulted in discrimination in allocation of benefits in favor of highly paid shareholder-employees and the plan is not qualified."
The corporation's largest account during its fiscal year ended June 30, 1967, was Burndy of Texas, Inc. (Burndy), a manufacturer whom the corporation represented under an exclusive sales contract since 1928 in Texas and in parts of Louisiana. Burndy was represented in electronics sales in Oklahoma by Penzner Associates, Inc. (Penzner). In June 1967, Robertson, Inc., and Penzner reached an agreement whereby Penzner was to terminate its representation of Burndy in Oklahoma and Robertson, Inc., was to expand its sales representation of the manufacturer in that State so as to be able to more nearly represent Burndy in a sales territory corresponding to the boundaries of 61 T.C. 727">*732 the electronics1974 U.S. Tax Ct. LEXIS 143">*154 industry association, which included the States of Texas, Oklahoma, Arkansas, and Louisiana.
The following letter dated June 9, 1967, was sent to Penzner by Neblett, as vice president of Robertson, Inc., to confirm such oral agreement:
Mr. Jerry S. Penzner
Subject: Oklahoma territory for Burndy electronic products.
Dear Jerry:
This letter is to confirm the telephone conversation of June 2, 1967, between you and Max Jordan, in which we agreed to pay you $ 8,500.00. This money is to be your fee to consult with us in our taking over the responsibility for the sale of Burndy electronic products in Oklahoma, effective July 1, 1967.
For us to do an effective job in serving Burndy's customers in Oklahoma, we will need your customer correspondence file, your customer order file, and your customer mailing list and mailing list plates for Burndy electronic customers in the state of Oklahoma.
We hope that you can find the time to make at least one trip through the Oklahoma territory with our Glen Smith to introduce him to the customers you are now servicing in the Oklahoma territory.
Judd Clark tells me that you have 1974 U.S. Tax Ct. LEXIS 143">*155 notified him that we had come to an agreement about this change in territorial responsibility and he is issuing an addendum to the contract we now have with Burndy for the sale of electronic products to expand our territory coverage to include Oklahoma. I presume that he will also amend your contract with Burndy to delete your coverage in Oklahoma on Burndy electronics products.
Jerry, I am sending this letter in duplicate so you can sign one copy of it and return it to us for our files. I feel that we will both benefit from this agreement in the years to come and want to thank you for your cooperation in working out this exchange of territory responsibility.
Yours very truly,
Elgin B. Robertson, Inc.,
(S) Paul S. Neblett
6/12/67
(S) J. S. Penzner
The payment referred to in the letter was made by check dated June 9, 1967. In a cover letter enclosed with the returned confirmation letter bearing his signature, Jerry S. Penzner, president of Penzner, stated that he would leave the customer list in Oklahoma City on a Burndy demonstration unit. He added:
I would like to suggest that someone from your office come up here to Kansas City so that we might1974 U.S. Tax Ct. LEXIS 143">*156 go over the customers with the available correspondence that is here in our office. I don't think this should take more than a day.
I will certainly do everything possible to make a trip through the area.
61 T.C. 727">*733 Effective on July 1, 1967, the exclusive sales agency contract between Robertson, Inc., and Burndy was amended so as to provide that the territory served by Robertson, Inc., was to include the electronics business in the State of Oklahoma and was terminable at will by either of the parties upon 30 days' written notice.
The corporation claimed a business expense deduction for the payment of $ 8,500 made to Penzner as a consulting fee during the taxable year ended June 30, 1967. The respondent in his statutory notice of deficiency disallowed the deduction with the explanation that the petitioner had not established that the amount constituted an ordinary and necessary business expense.
OPINION
The first issue presented to us for decision is whether the profit-sharing plan of the petitioners' electing small business corporation constitutes a qualified plan for purposes of
1974 U.S. Tax Ct. LEXIS 143">*158 In order for a profit-sharing trust to qualify under
The threshold question which must be resolved is whether the amounts received by petitioners as their share of the undistributed net profits of the corporation constituted compensation for purposes of
The only evidence presented by petitioners was a list containing the names and positions of all the employees in the corporation and a very skimpy description of several of the shareholder-employee's duties. Based upon the evidence presented, it appears that at least three nonshareholder employees occupied positions comparable to those held by one of the shareholders (E. L. Snyder) but were not compensated by means of a percentage share of the net profits of the corporation.
The employment contract contained only the bare recital that the percentage of net profits payable to the employees was to comprise a portion of his "annual compensation." However, we cannot attach much significance to the label "compensation" as it relates to the corporation because it is unimportant to a subchapter S corporation and 61 T.C. 727">*735 its shareholder-employees whether payments to them represent salary or dividends.
Moreover, it is obvious that this corporation could1974 U.S. Tax Ct. LEXIS 143">*162 not enter into such an employment contract with nonshareholders because 100 percent of the net profits were already siphoned off to the shareholder-employees by use of the employment contract. We, therefore, conclude that the petitioners' respective shares of the undistributed net profits of the corporation did not constitute compensation for purposes of
The profit-sharing plan before us is not on its face discriminatory with respect to the allocation of employer contributions. The plan provides that each participant is entitled to one unit of contributions for each $ 100 of annual compensation paid him or accrued for him in excess of $ 4,800. The prohibited discrimination exists by reason of the operation of the plan. While the plan provides for allocations to be made on the basis of a percentage of annual compensation, defined in the plan as "the regular salary or commission of a participant, exclusive of all special payments of every nature," the actual allocations herein have been based upon regular salary
Respondent's determination must, therefore, be sustained.
61 T.C. 727">*736 The second issue involves the deduction under section 162 as an ordinary and necessary business expense of the amount of $ 8,500 which was paid by the corporation to Penzner Associates when the corporation replaced Penzner as the exclusive sales agent for Burndy in marketing electronics equipment in Oklahoma. Petitioners assert that the payment was in the nature of a consultant's fee paid to Penzner for introducing Robertson, Inc., to the customers in the Oklahoma market area and for acquainting it with the products being manufactured in that area. Respondent contends that the payment was for the purchase of customer lists and the right to represent Burndy in Oklahoma, both of which are intangible capital assets the acquisition of which is a nonductible capital expenditure under section 263.
We agree with respondent on this issue. Petitioners have not met their burden of proving that the expenditure was made for consultation services provided by Penzner relating to Robertson, Inc.'s replacement of Penzner in Oklahoma. On1974 U.S. Tax Ct. LEXIS 143">*164 the contrary, the evidence presented by petitioners clearly indicates that the payment was made for two purposes: (1) To acquire the customer mailing list, the customer correspondence file, the customer order file, and the customer mailing list plates held by Penzner; and (2) to obtain the right to represent Burndy in Oklahoma by securing the relinquishment of Penzner's exclusive sales agency in that State. As to the customer mailing list and related items, there is no doubt that these materials are capital assets.
Purchasing the right to represent Burndy in Oklahoma constituted an expenditure made in the acquisition of business which was also of a capital nature.
The correspondence exchanged between Robertson, Inc., and Penzner supports the conclusion that the payment was made for customer 61 T.C. 727">*737 lists and the right to represent Burndy. Consultation and introduction of Oklahoma customers were not part of the agreement. In a letter written to Jerry S. Penzner, the president of Penzner, Paul Neblett indicated that Robertson, Inc., would need Penzner's customer correspondence1974 U.S. Tax Ct. LEXIS 143">*166 file, order file, mailing list, and mailing list plates covering the Burndy customers in the State of Oklahoma. The letter did not specify the nature of any consultation which was to be extended the successor representative and merely expressed the "hope that [Jerry Penzner] can find the time to make at least one trip through the Oklahoma territory with our Glen Smith to introduce him to the customers you are now servicing in the Oklahoma territory." Penzner's response that he would "certainly do everything possible to make a trip through the area" makes it obvious that the introduction of Robertson, Inc., to Oklahoma customers was not one of the items for which Robertson, Inc., paid $ 8,500. Moreover, it was at
The $ 8,500 expenditure to Penzner is clearly not deductible1974 U.S. Tax Ct. LEXIS 143">*167 as a business expense.
1. Cases of the following petitioners are consolidated herewith: Max C. Jordan and Margaret A. Jordan, docket No. 3089-71; Paul S. Neblett and Mary F. Neblett, docket No. 3090-71; and George B. LaLonde and Patsy LaLonde, docket No. 3205-71.↩
2. All statutory references are to the Internal Revenue Code of 1954 as in effect during the taxable year at issue.↩
3.
(a) Requirements for Qualification. -- A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section --
* * * * (4) if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.↩
Falstaff Beer, Inc. v. Commissioner of Internal Revenue , 322 F.2d 744 ( 1963 )
Richard M. Boe and Mary Lots Boe v. Commissioner of ... , 307 F.2d 339 ( 1962 )
Bramlette Building Corporation, Inc. v. Commissioner of ... , 424 F.2d 751 ( 1970 )
Carl Reimers Co., Inc. v. Commissioner of Internal Revenue , 211 F.2d 66 ( 1954 )