McEwen v. Commissioner

J. H. McEwen, Petitioner, v. Commissioner of Internal Revenue, Respondent

McEwen v. Commissioner

Docket No. 6151

United States Tax Court

6 T.C. 1018; 1946 U.S. Tax Ct. LEXIS 195;

May 9, 1946, Promulgated

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Decision will be entered for the respondent.

Where, pursuant to an employment contract and trust agreement suggested by petitioner-employee, 5 percent of the net earnings of the employer over and above $ 450,000 for the fiscal year ended November 30, 1941, or $ 43,934.62, was unconditionally paid by the employer in 1941 to the trustee as additional compensation for services rendered to it by the petitioner during such fiscal year, held, the amount of $ 43,934.62 is income to petitioner under section 22 (a) of the Internal Revenue Code.

W. H. Holderness, Esq., for the petitioner.

E. M. Woolf, Esq., for the respondent.

Hill, Judge.

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HILL

The Commissioner determined a deficiency in income tax of $ 30,982.03 for 1941. The deficiency is due to several adjustments made by the Commissioner, only one of which is in controversy, i. e., the inclusion in petitioner's 1941 taxable income of $ 43,934.62 as additional compensation.

FINDINGS OF FACT.

The petitioner is a resident of Burlington, North Carolina. His Federal income tax return for 1941, made on the cash receipts and disbursements basis, was filed with the collector for the district of North Carolina, at Greensboro.

Prior to August 31, 1940, petitioner was vice president and treasurer of McEwen Knitting Co., Burlington, North Carolina. He owned a little over half of the outstanding shares of that company.

On September 1, 1940, the May Hosiery Mills and McEwen Knitting Co. effected a statutory merger, as a result of which the McEwen Knitting Co. went out of existence. On or about January 1, 1941, the surviving company, May Hosiery Mills, changed its name to May McEwen Kaiser Co., hereinafter referred to as the company. The petitioner became the president of the company and of its two wholly owned subsidiaries, Grabur Silk Mills, Burlington, North Carolina, and Dothan Silk Hosiery Co., Dothan, Alabama. He was also a director of the company. The petitioner and his family owned approximately 23 percent of the outstanding shares of the company, 10 percent of which was owned outright by petitioner. Neither petitioner nor any member of his family owned any shares in either of the company's subsidiaries. W. H. May, chairman of the board of directors of the company, and B. V. May and their families controlled approximately 40 percent of the outstanding shares of the company. No other individual or family group owned or controlled a block of shares comparable in size to that held by the May families.

At a special meeting held on August 15, 1940, the board of directors of the company fixed petitioner's compensation, effective as of September 1, 1940, at a salary of $ 30,000 per year, plus a bonus of 7 1/2 percent of the net earnings of the company for the fiscal year ended August 31 over and above $ 450,000. At a regular meeting of the board of directors of the company held on November 15, 1940, its fiscal year was changed to end on November 30 instead of August 31. At the same meeting a resolution was adopted providing that the additional compensation of petitioner provided for by the resolution adopted August 15, 1940, from September 1 to November 30, 1940, the close of the new fiscal year, be based upon the pro rata of the net earnings of the company for such 3-month period and that for the fiscal year beginning December 1, 1940, the petitioner be paid, in addition to his fixed salary of $ 30,000 a year, 7 1/2 percent of the net earnings of the company for the new fiscal year over and above $ 450,000.

On November 27, 1941, an employment contract was entered into and executed by petitioner and the company in which the company agreed to employ or cause one or more of its subsidiaries to employ petitioner and petitioner agreed to serve the company or such of its subsidiaries as designated by it and to devote his entire time, energy and skill during the regular business hours of such employment, for a period commencing as of December 1, 1940, and continuing to and including November 30, 1943, for a compensation as follows:

4. Subject only to the limitations hereinafter set out, the Company agrees to pay, or to cause one or more of its subsidiaries to pay, to McEwen, commencing as of December 1, 1940 and continuing during the term of this contract, as a fixed salary for his services, the sum of Thirty Thousand Dollars ($ 30,000) per annum, payable in equal monthly installments, and also to pay, or to cause one or more of its subsidiaries to pay, as additional compensation for services rendered by McEwen (in addition to his fixed salary).

(a) To McEwen 2 1/2% of the net earnings of the Company, over and above $ 450,000, for each of the fiscal years of the Company ending November 30, 1941, November 30, 1942 and November 30, 1943.

(b) To Security National Bank of Greensboro, as Trustee under the trust agreement, a copy of which is hereto attached as Exhibit A, 5% of the net earnings of the Company, over and above $ 450,000, for each of the fiscal years of the Company ending November 30, 1941, November 30, 1942 and November 30, 1943.

The payments required by sub-paragraphs (a) and (b) above shall accrue as liabilities of the Company as follows, to-wit: the first of such payments on November 30, 1941, the second of such payments on November 30, 1942, and the last of such payments on November 30, 1943, and each such payment shall be paid by the Company as soon as the exact amount of the same has been definitely ascertained.

* * * *

6. If at any time prior to November 30, 1943, McEwen shall die, or shall become physically incapable of performing such services as may be required of him by the Company, or shall for any reason cease to remain in the employ of the Company or of one or more of its subsidiaries, the Company shall not be required to make any further payments whatever under the terms and provisions of this contract and agreement either to McEwen or to his representatives or to the Security National Bank of Greensboro, as Trustee under the trust agreement hereinbefore referred to, except that there shall be paid to McEwen or to his representatives and to the Security National Bank of Greensboro, as Trustee under said trust agreement, a pro rata part of the total compensation which the Company would have had to pay for the services of McEwen for the fiscal year in which his employment is terminated had McEwen remained in the employ of the Company or one of [sic] more of its subsidiaries under the terms and provisions of this contract and agreement for the whole of said fiscal year.

7. It is distinctly understood and agreed that any and all amounts heretofore paid to McEwen by the Company as part of his fixed salary for the fiscal year ending November 30, 1941 shall be deemed to have been paid under this contract and agreement.

* * * *

On the same day a trust agreement was executed by the company, the petitioner, and the Security National Bank of Greensboro, as trustee, which provided in part as follows:

That Whereas, contemporaneously with the execution and delivery of this agreement, the Company and the Employee have entered into a new employment contract, a copy of which is attached hereto and made a part hereof as if fully set out herein, and have canceled and rescinded the employment agreement theretofore existing between them, and all rights and privileges under the same, with the distinct understanding and agreement that any and all amounts heretofore paid to the Employee by the Company, as part of his fixed salary for the fiscal year ending November 30, 1941, shall be deemed to have been paid under said new employment contract;

Now Therefore, for and in consideration of the premises and of the mutual covenants herein contained and of the mutual covenants contained in said new employment contract, it has been and is hereby agreed by and between the Company, the Employee and the Trustee as follows, to-wit:

1. Subject only to the limitations contained in paragraph numbered 6 of said new employment contract, the Company will pay, or cause one or more of its subsidiaries to pay, to the Trustee five per cent (5%) of the net earnings of the Company, over and above $ 450,000, for each of the fiscal years of the Company ending November 30, 1941, November 30, 1942 and November 30, 1943. The amount of such net earnings shall be determined in accordance with sound accounting practices and by the regular auditors or accountants of the Company. Such payment shall accrue as liabilities of the Company as follows, to-wit: the first of such payments on November 30, 1941, the second on November 30, 1942 and the last of such payments on November 30, 1943, and each such payment shall be paid by the Company as soon as the exact amount of the same has been definitely ascertained. The liability and responsibility of the Company under this agreement is limited solely to the payments provided for in this paragraph. The Trustee shall not be obligated or bound to take any action for the collection, or to determine the correctness, of any amounts payable to it under the provisions of this paragraph, and shall be chargeable with and accountable for only such sums as are actually received by it.

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3. Upon receipt of payments from the Company the Trustee shall hold, invest and reinvest the same, collect the income therefrom, and until the time for the distribution of the same, as hereinafter set out, accumulate, invest and reinvest the net income. The terms "trust funds" and "trust estate" as used in this agreement shall be deemed to include accumulated income.

4. The Trustee is authorized to invest the trust funds (a) in bonds and/or other securities issued by or guaranteed by the United States of America, and/or (b) in single premium contracts purchased from one or more legal reserve life insurance companies, to be selected by the Trustee, (hereinafter sometimes referred to as the issuing insurance companies), for the benefit of the Employee; provided that each such contract shall provide for monthly, quarterly, semiannual or annual payments to the Employee for life from and after his sixtieth birthday, with or without a guarantee of a minimum number of payments or other refund provisions, and/or with or without provision for continuing payments for the life of the Employee's wife if she shall survive the Employee; in such proportions as the Trustee in its discretion may determine from time to time; provided, however, that the Trustee in its discretion may keep the trust funds uninvested from time to time.

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6. In order to accomplish the general purpose of this agreement, the Trustee shall be the complete and absolute owner of any annuity contract held in the trust estate and of each and every incident of ownership thereof, and shall have the power to sell or assign any such contract; to receive all dividends on any such contract; to surrender any such contract for cash; to receive all payments of any kind which may be made to it on any contract held in trust; to change the persons named in any contract to receive the proceeds; to designate any mode of settlement of the proceeds that the issuing insurance company may allow; to convert contracts from one form to another and, without limitation of any of the foregoing, to exercise any and all of the rights, options or privileges which belong to the absolute owner of such contracts or which are granted by the terms of any such contracts or by the terms of this agreement.

7. The trustee shall retain physical possession of all annuity contracts purchased by it for the benefit of the Employee, but the Trustee shall direct the issuing insurance companies to make payments directly to the Employee in the manner designated in accordance with the foregoing provisions, and any and all payments so made shall be deemed to be payments under and pursuant to this agreement. Upon the death of the Employee the Trustee shall direct the issuing insurance companies to make payment of the proceeds and avails of all annuity contracts then held by the Trustee in accordance with the terms of the contract; and if any proceeds or avails remain in any annuity contract purchased by the Trustee for the Employee's benefit, with no then living beneficiary other than the Trustee entitled to receive the same, the Trustee shall forthwith collect the proceeds and avails of all such annuity contracts as they become due and payable.

8. When and if the Employee shall attain the age of sixty years, there shall be paid to him by the issuing insurance companies a life income in accordance with the provisions of the annuity contract or contracts, if any, purchased by the Trustee for the benefit of the Employee.

9. If the Employee lives to attain the age of sixty years, then subject to the limitations hereinafter contained the trust estate held by the Trustee at such time, other than that remaining invested in the annuity contracts from time to time, shall be distributed and disbursed by the Trustee as follows, to-wit:

[1/15th on June 27, 1955, 1/14th on June 27, 1956, 1/13th on June 27, 1957, etc., and the balance on June 27, 1969.]

such distributions and disbursements to be made to the Employee if he is living to receive the same, otherwise to the Employee's widow if she is living to receive the same.

10. If the Employee dies before reaching the age of sixty years, then subject to the limitations hereinafter contained the trust estate held by the Trustee at such time, other than that remaining invested in annuity contracts from time to time, shall be distributed and disbursed by the Trustee as follows, to-wit:

[1/10th on the first anniversary of the Employee's death, 1/9th on the second anniversary, etc., and the balance on the tenth anniversary of his death.]

such distributions and disbursements to be made to the Employee's widow if she is living to receive the same; provided, however, that the Employee's widow may, if she so desires and if it meets with the approval of the Trustee for her so to do, postpone in whole or in part any of the distributions and disbursements provided for in this paragraph, and provided further that any distributions or disbursements so postponed, or any part of the same, shall be made available to the Employee's widow at any time thereafter upon her written demand for the same.

11. If any proceeds and avails are collected by the Trustee after the death of the Employee, but during the lifetime of the Employee's widow, from any annuity contract purchased by the Trustee for the Employee's benefit, and if the proceeds and avails so collected are not distributable to the Employee's widow under the provisions of paragraph 9 or paragraph 10 hereof, such proceeds and avails when and as collected shall be distributed and disbursed by the Trustee to the Employee's widow if she is living to receive the same.

12. If the Employee and his wife both die before all of the trust funds and the trust estate have been distributed and disbursed by the Trustee, as hereinbefore provided for, notwithstanding anything herein contained to the contrary, this trust shall be terminated at that time or on June 27, 1955, which ever shall last occur, and the trust estate as constituted at the time of such termination, including any and all annuity contracts then held by the Trustee and the proceeds and avails of the same, shall be transferred, assigned and delivered, freed and discharged of all trusts, to the then living issue of the Employee, in equal shares per stirpes; or if there be no such issue then living, to the then living next of kin of the Employee as determined by the laws of the State of North Carolina in force and effect at that time, in equal shares per stirpes.

13. Any and all taxes of any and every kind that may be imposed upon or in respect of this trust or any funds delivered to or forming a part of this trust shall be charged against such trust and the Trustee shall pay such taxes out of the trust estate.

14. The Trustee shall keep full and complete records of the administration of the trust, which shall be open to inspection at all reasonable times by the Employee or the Employee's wife. Within sixty days following the close of each calendar year, the Trustee shall file with the Employee if he is then living, otherwise with the Employee's widow, a statement of account setting forth all matters affecting the trust estate during such annual period and the condition of the trust estate as of the end of such annual period.

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19. To the extent permitted by law, none of the payments provided for under this agreement, whether in cash or in securities, and whether income or principal and including payments under or proceeds or avails of any annuity contract, shall be subject to any claim of any creditor of the Employee or of any beneficiary, and shall not be subject to attachment or garnishment or other legal process by any creditor of the Employee or beneficiary, nor shall the Employee or beneficiary have any right to alienate, anticipate, commute, pledge, encumber or assign any of such payments or proceeds or avails; and any designation of a beneficiary or contingent beneficiary and any designation of the mode or method of payment of benefits to the Employee or a beneficiary or contingent beneficiary and any annuity contract purchased by the Trustee shall so provide.

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21. This agreement shall be binding upon the beneficiaries, heirs, executors, administrators, distributees and assigns of the individual party hereto and the successors and assigns of the Company and the Trustee.

22. Under no circumstances or conditions whatever shall any part of the trust estate or any income therefrom revert to or in any way inure to the benefit of the Company or any one or more of its subsidiaries.

* * * *

The foregoing employment contract and trust agreement were prepared at the suggestion of petitioner.

The company also had an employment contract and trust agreement with its vice president similar to those entered into with petitioner, which were separate and distinct from petitioner's contracts.

During 1941 the petitioner received from the company as compensation $ 30,000 and a bonus of $ 21,967.31. In addition there was paid $ 43,934.62 by the company as compensation for services rendered by petitioner to it during the year ended November 30, 1941, to the Security National Bank of Greensboro pursuant to the contract and trust agreement of November 27, 1941. The trustee purchased out of such payment an annuity of approximately $ 25,000. No part thereof was paid by the trustee in 1941 to the petitioner or members of his family or used to pay any of their obligations. The petitioner, in his income tax return for 1941, reported the amounts of $ 30,000 and $ 21,967.31 as compensation received, but did not report the amount of $ 43,934.62 as income for 1941.

OPINION.

The Commissioner included in petitioner's taxable income as additional compensation the amount of $ 43,934.62 paid by the May McEwen Kaiser Co. to the Security National Bank of Greensboro, trustee under the agreement of November 27, 1941.

The petitioner does not rely upon section 165 of the Internal Revenue Code. His first contention is that, where a right to receive a designated salary is waived or rescinded for a valid consideration, the unpaid portions of such salary, although due at the time of the rescission, are not income to the employee, since such salary was never received by or made available to him. It is stated that petitioner owned a controlling interest in the McEwen Knitting Co., but that after the merger he became a minority shareholder in the surviving company, in which the May families owned approximately a 40 percent stock interest; that petitioner's employment was for a year and his position with the surviving company, by comparison with his former position in the hosiery industry, was indeed insecure; and that, therefore, to gain the security of a three-year contract of employment he waived his rights under the one-year contract of employment to receive 7 1/2 percent of the net earnings over and above $ 450,000, by accepting in cash only 2 1/2 percent of such earnings. The petitioner concedes that 5 percent of such earnings were transferred in trust in 1941, but argues that the contingencies which would authorize the trustee to make payments of the fund to the petitioner not only did not but could not take place in 1941.

The petitioner's second argument is that he neither personally nor constructively received the amount of $ 43,934.62 in 1941.

The first argument is untenable. The employment contract of November 27, 1941, did not change the rate of salary or bonus payable to petitioner from that fixed by the board of directors at the special meeting of August 15, 1940, and the regular meeting of November 15, 1940. That petitioner's position was insecure is refuted by the statements in the November 27, 1941, contract itself. It specifically states that petitioner "is recognized as a leader in the hosiery industry and is a most valuable officer and employee of the Company and the Company was and is anxious to assure the continuation of his services as such, as a loss of his services would cause irreparable injury to the Company and to its subsidiaries", and "the Company was and is anxious in its own interest and in the interest of its subsidiaries to take such steps as are reasonable to secure the continuation of McEwen's services up to and including November 30, 1943."

Stern-Slegman-Prins Co. v. Commissioner, 79 Fed. (2d) 289; Albert W. Russell, 35 B. T. A. 602; Guy Fulton, 11 B. T. A. 641; and H. C. Couch, 1 B. T. A. 103, cited by the petitioner, are not applicable, because distinguishable on the facts. It was held in such cases that compensation for services of officers of corporations for any period is subject to modification either by corporate action or by agreement at any time and from time to time during the taxable year and the amount at which compensation is finally adjusted at the close of the taxable year is the amount which the officer must report as compensation or the corporation may deduct as ordinary and necessary business expense. In each case the employee either did not receive or returned to the employer in the taxable year a portion of his salary previously authorized. Herein, the amount of the compensation agreed upon was not adjusted downward. The company paid the full amount agreed upon and the trust agreement specifically provides:

22. Under no circumstances or conditions whatever shall any part of the trust estate or any income therefrom revert to or in any way inure to the benefit of the Company or any one or more of its subsidiaries.

In our view the petitioner waived nothing whatever in obtaining the two contracts of November 27, 1941.

That the $ 43,934.62 paid by the company in 1941 to the trustee bank was intended and paid as a part of the compensation which the company agreed to pay for the services rendered to it or its subsidiaries by the petitioner during the fiscal year ended November 30, 1941, is manifested by the contract and trust agreement of November 27, 1941.

In Commissioner v. Smith, 324 U.S. 177">324 U.S. 177, it is stated:

Section 22 (a) of the Revenue Act is broad enough to include in taxable income any economic or financial benefit conferred on the employee as compensation, whatever the form or mode by which it is effected. See Old Colony Trust Co. v. Commissioner, 279 U.S. 716">279 U.S. 716, 729. * * *

The petitioner testified that the contract of November 27, 1941, and the trust arrangement therein provided were suggested by him to the officers of the company. The payment of 5 percent of the net earnings over and above $ 450,000 of the company to the trustee was made in effect at his request and direction. Hence his failure to personally receive that amount was due entirely to his own volition. The payment of such amount to the trustee to be invested and preserved for the benefit of petitioner or his family is clearly an "economic or financial benefit conferred on the employee as compensation." The "form or mode by which it is effected" was at the outset determined by the petitioner, since the establishment of the trust and payment of a part of his compensation thereto were first suggested by him.

While there are some factual differences between this case and Hubbell v. Commissioner, 150 Fed. (2d) 516, affirming 3 T. C. 626; Oberwinder v. Commissioner, 147 Fed. (2d) 255; Richard R. Deupree, 113">1 T. C. 113; and Renton K. Brodie, 1 T. C. 275, in our opinion, the principle of such cases is applicable herein. Whether the employee or a trustee is given the possession of an annuity contract is not determinative of the issue whether the premium paid therefor is income to the employee under section 22 (a). The question is, was "any economic or financial benefit conferred on the employee as compensation" in the taxable year? If it was, then the form or mode by which such benefit is effected is not important. The amount of $ 43,934.62 was unconditionally, and pursuant to the request of petitioner, paid in the taxable year 1941 to the trustee for the benefit of petitioner or his family, and such fund, or the economic or financial benefit flowing therefrom, could not thereafter revert to the employer or be diverted or used for any other purposes. The petitioner herein was the recipient in 1941 of an economic benefit just as much as was the taxpayer in Old Colony Trust Co. v. Commissioner, 279 U.S. 716">279 U.S. 716, wherein, as additional compensation, the employer paid income taxes assessed against his employee; and as the taxpayer in Helvering v. Horst, 311 U.S. 112">311 U.S. 112, who detached interest coupons from bonds and delivered them to his son, who later in the year at their maturity was paid the amount thereof; and as the taxpayer in Lucas v. Earl, 281 U.S. 111">281 U.S. 111, wherein the Court stated:

* * * There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. * * *

Adolph Zukor, 33 B. T. A. 324, cited by the petitioner, is distinguishable on the facts. Under the agreement in that case the trustee bank was to hold a certain percentage of the net earnings of the corporate employer delivered to it in cash or stock in a particular year "until December 31, two years subsequent to the expiration of such calendar year," which was then payable to the employee "unless prior to such December 31" a statement was filed with the bank that the employee had not performed his obligations. In no year was payment made by the trustee until after the beginning of the following year. It was held that additional compensation for 1929 paid to the trustee in 1930, and by it to the employee in 1932, was, under the circumstances, not constructively received by the employee in 1931 and hence was not income to him in that year.

It is our conclusion that the $ 43,934.62 paid to the Security National Bank of Greensboro by the May McEwen Kaiser Co. in 1941 as compensation for services rendered to it or its subsidiaries by the petitioner was income taxable to him under section 22 (a).

Decision will be entered for the respondent.