William C. Atwater & Co. v. Comm'r of Internal Revenue
| Decision Date | 04 February 1948 |
| Docket Number | Docket No. 8999. |
| Citation | 10 T.C. 218 |
| Parties | WILLIAM C. ATWATER & COMPANY, INCORPORATED, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. S, an employee of petitioner, had in prior years acquired 100 shares of petitioner's stock, which were subsequently increased to 1,500 shares by a stock dividend, under an employment arrangement by which petitioner's services. S resigned April 23, 1936, and demanded that petitioner purchase his share at ‘book value,‘ plus two years or earnings. Petitioner refused. S brought suit and in 1943 the Court of Appeals of New York affirmed the lower court's decision in favor of S. Petitioner paid this judgment in 1943, together with interest and certain court costs, and thus reacquired S's 1,500 shares of stock. It also paid some legal fees and litigation expenses in connection with the suit in 1942. Held, the stock plan petitioner had with S was an employment arrangement, rather than an outright sale and repurchase of stock, and under section 23(a)(1)(A), I.R.C., petitioner is entitled to deduct in 1943 the part of the judgment paid which represented additional compensation to the employee rather than a capital expenditure; held, further, petitioner is also entitled to deduct in 1942, under the same section, the legal fees and litigation expenses paid in 1942 in connection with the suit.
2. The respondent, in examining petitioner's return for 1942, determined that he had allowed an excessive deduction for capital stock tax in determining petitioner's net income for 1941. Upon the basis of this determination the respondent included the determined excessive deduction for 1941 in petitioner's income for 1942. Held, the respondent erred in so doing.
3. The respondent determined that the capital stock tax liability accrues at the beginning of the capital stock tax period rather than at the close of the period and adjusted petitioner's capital stock deductions for 1942 and 1943 accordingly. Held, this determination was correct, petitioner being on the accrual basis.
4. During the year 1942 petitioner's business required large sums of cash and its cash resources were needed in the business. There was pending at the end of the year the possibility that the Court of Appeals would affirm the large judgment awarded against petitioner in the suit brought by S. Petitioner's directors had been advised by reputable certified public accountants and lawyers that petitioner was in no position to declare and pay a dividend in 1942. Held, petitioner was neither formed nor availed of in the taxable year for the purpose of preventing the imposition of surtax upon its stockholders and is not subject to the surtax on corporations imposed by section 102 of the Internal Revenue Code. Charles B. McInnis, Esq., and G. Kibby Munson, Esq., for the petitioner.
William A. Schmitt, Esq., for the respondent.
The respondent determined deficiencies as follows:
+-------------------------------------------------------------+
¦Tax ¦Year ended ¦Year ended ¦
+---------------------------------+-------------+-------------¦
¦ ¦Dec. 31, 1942¦Dec. 31, 1943¦
+---------------------------------+-------------+-------------¦
¦Declared value excess profits tax¦None ¦$3,204.83 ¦
+---------------------------------+-------------+-------------¦
¦Income tax ¦$9,589.12 ¦5,647.77 ¦
+---------------------------------+-------------+-------------¦
¦Surtax under section 102 ¦42,261.96 ¦24,155.91 ¦
+-------------------------------------------------------------+
The deficiencies in declared value excess profits tax and income tax are due to certain adjustments set out and explained in the statement attached to the deficiency notice as follows:
Taxable Year Ended December 31, 1942
(a) and (b) It is held that legal fees of $296.17 and expenses of litigation of $20,975.37, representing the cost of the defense of a suit by John L. Steinbugler to enforce the purchase by you, under an agreement, of his stock in your company, do not constitute an ordinary and necessary business expense which is deductible under section 23 of the Internal Revenue Code, but represent a capital expenditure which is not deductible under the provisions of section 24 of the Internal Revenue Code.
(c) Inasmuch as your income is reported on the accrual basis, it is held that you are entitled to a deduction for capital stock tax of $1.25, whereas you claimed a deduction of $2,500.00. The difference of $2,498.75 has accordingly been disallowed as a deduction. It is further held that the amount of $202.50 which represents and overaccrual of capital stock tax for the taxable year 1941, constitutes taxable income in the current year. Your taxable income for the current year has accordingly been increased by a total of $2,701.25.
(a) It is held that you are not entitled to a deduction for a bad debt of $17,536.22 due from John L. Steinbugler under the provisions of section 23(k) of the Internal Revenue Code.
(b) It is held that the amount of $308,909.00 deducted as ‘judgment awarded in litigation‘ constitutes a capital expenditure for the purchase of your stock from John L. Steinbugler under the provisions of section 24 of the Internal Revenue Code and is not deductible from income.
(c) It is held that the amount of $3,392.10 deducted as ‘court costs awarded in termination of litigation‘ constitutes additional cost of stock purchased from John L. Steinbugler and his not deductible from income under the provisions of section 23 of the Internal Revenue Code.
(d) Inasmuch as your income is reported on the accrual basis, your deduction for capital stock tax has been increased by $2,498.75 in order to reflect the proper accrual of such tax.
The deficiencies in surtax under section 102 are due to the above mentioned adjustments to net income for each of the taxable years and to the respondent's holding set out in the said statement for each of the taxable years as follows:
It is held that your earnings or profits have been accumulated for the purpose of avoiding surtax by your stockholders and that you are subject to the surtax computed at the rate prescribed by section 102 of the Internal Revenue Code.
Petitioner by appropriate assignments of error contests each of the above mentioned adjustments to net income and also the holding relative to the determination of the deficiencies in surtax under section 102.
The issues thus raised fall into three main divisions, namely, the Steinbugler litigation issues, the capital stock tax issues, and the section 102 issues.
Petitioner is a corporation, organized under the laws of the State of New York in 1909, with its principal office in New York City. At the time of organization petitioner took over the business of a predecessor company that had existed since 1900. Since the time of its incorporation petitioner has been engaged continuously in the business of selling coal on a commission basis for various coal mines in the Pocahontas coal field of southern West Virginia. It also received some income from trading in coal, mine management, dividends, and interest. Its returns for the calendar years 1942 and 1943 were filed with the collector for the third district of New York.
Petitioner at the time it was incorporated in 1909 employed one John L. Steinbugler, who had been in the employ of petitioner's predecessor. Steinbugler remained in petitioner's employ continously from 1909 until he resigned April 23, 1936. He was made a director in 1909 and was secretary of petitioner from 1909 until 1932 and president from 1932 until the date of his resignation. He also acted as general counsel for petitioner and supervised its accounting.
At the time of incorporation petitioner's capital stock consisted of 1,000 shares of the par value of $100 per share. William C. Atwater, Sr., owned 712 shares and Charles P. Hutchins owned 280 shares. Both Atwater and Hutchins were directors. Atwater was president and Hutchins was treasurer. Atwater remained president until 1932, when he was succeeded by Steinbugler. Atwater died February 22, 1940. William C. Atwater, Jr., has been president since the date of Steinbugler's resignation.
Beginning January 1, 1912, and continuing through the month of October 1915, petitioner paid to Steinbugler and another employees, David W. Allen, each a monthly bonus of 2 1/2 per cent of its net profits. The bonuses were in addition to their regular compensation.
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