Charles Schneider & Co., Inc. v. C.I.R., s. 73-1798

• Citation: 500 F.2d 148
• Decision Date: 19 August 1974
• Docket Number: Nos. 73-1798,s. 73-1798
• Parties: 74-2 USTC P 9563 CHARLES SCHNEIDER & CO., INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. FUTURE FOAM, INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. CHARLES, INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. CENTRAL WOODWORKING CO. INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. to 73-1802.
• Court: United States Courts of Appeals. United States Court of Appeals (8th Circuit)

Page 148

500 F.2d 148

74-2 USTC P 9563

CHARLES SCHNEIDER & CO., INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

FUTURE FOAM, INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

CHARLES, INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

CENTRAL WOODWORKING CO. INC., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

Nos. 73-1798 to 73-1802.

United States Court of Appeals, Eighth Circuit.

Submitted May 13, 1974.

Decided July 10, 1974, Rehearing Denied Aug. 19, 1974.

Joel Davis, Omaha, Neb., for appellants.

Louis A. Bradbury, Atty. Tax Div., Dept. of Justice, Washington D.C., for appellee.

Before JOHNSEN and VAN OOSTERHOUT, Senior Circuit Judges, and TALBOT SMITH, Senior District Judge. ^*

VAN OOSTERHOUT, Senior Circuit Judge.

The taxpayer corporations in the above-entitled cases, which were consolidated in the Tax Court and here, have taken timely appeals from the decision of the Tax Court determining deficiency income tax liability against Charles Schneider & Co., Inc. (C.S. & Co.), for the taxable years ending June 30, 1966, 1967 and 1968, in the amounts of $23,512.40, $15,333.42 and $21,721.05 respectively, and determining income tax deficiency against Future Foam, Inc., for the taxable years ending August 31, 1966, 1967 and 1968, in the amounts of $18,130.17, $3,475.46 and $7,365.58 respectively. The Tax Court's opinion filed June 18, 1973 is reported at 31 TCM 553 (1973). Decision was entered in accordance with the opinion on August 22,1973. This appeal followed.

Many issues involved in this litigation have been resolved and are no longer in controversy. Taxpayers in their brief challenge the Tax Court's determination that under the facts of this case Charles, Inc., was not entitled to file a consolidated return with its subsidiary Chemical Corporation of America. Such issue was specifically abandoned by taxpayers on oral argument. In any event, the decision of the Tax Court on the issue is entitled to be affirmed on the basis of the Tax Court's opinion.

The issue before us is whether taxpayers C.S. & Co. and Future Foam, Inc., are entitled to ordinary and necessary business expense deductions under 162(a)(1) I.R.C. 1954 for the compensation paid their chief executive officers for the years ending in 1966, 1967 and 1968, in excess of the amount which the Tax Court found to be reasonable compensation for services rendered to the corporations. ¹ More specifically, the issue is whether the Tax Court's determination of the amount of executive compensation paid by C.S. & Co. and Future Foam, Inc., which is deductible as a reasonable expense, is clearly erroneous. We hold that the Tax Court's decision is supported by substantial evidence and is not clearly erroneous and affirm the judgment.

The record in this case is long. Much of the evidence is stipulated. Evidence was offered in the Tax Court by both parties. Many exhibits were received in evidence. The pertinent evidence is fairly set out in considerable detail in the Tax Court's opinion. An attempt to set out all of the facts would unduly prolong this opinion. We shall briefly summarize the basic facts. Taxpayers C.S. & Co., Future Foam, Inc., Charles, Inc., and Central Woodworking Co., Inc., are all active in various aspects of the furniture and upholstering manufacturing business at Council Bluffs, Iowa. Charles Schneider played the principal part in organizing and developing such corporations. His efforts contributed significantly to the successful operation of the corporations. During the tax years here in controversy all of the stock in C.S. & Co., 60% Of the stock in Future Foam, Inc., 50% Of the stock in Central Woodworking Co., Inc., and possibly all of the stock in Charles, Inc. ² was owned by Charles Schneider. Schneider, after substantially completing a law school course and serving in World War II, started a furniture and upholstery business about 1946. In 1954 this business was incorporated as C.S. & Co. with Schneider as president and his brother-in-law, Leon Summer, as vicepresident. Summer became president in 1963 and assumed active management. Summer had an option to purchase C.S. & Co. stock which he never exercised. Schneider at all times owned all of the corporate stock and maintained an active role in the company's affairs. In 1963 an agreement was entered into providing a basic salary of $351.00 per week for Summer and $230.00 per week for Schneider, plus bonuses to be computed as follows:

Bonus No. 1.

If there was sufficient net income

Three-fourths of 1% Of annual net sales divided equally between Schneider and Summer. Bonus No.2.

After deductions from net profits for: (a) Schneider's and Summer's salaries and No. 1 bonuses. (b) 2% Of net sales for retained earnings (c) federal income taxes; (d) state income taxes; remainder to be divided equally between Schneider and Summer.

The amount of compensation paid by C.S. & Co. based on basic salaries and bonuses No. 1 and No. 2 for the fiscal years ending in 1966, 1967 and 1968 was $65,104.94, $59,052.98 and $65,000.00 to Schneider and $74,414.50, $66,357.95 and $74,089.36 to Summer. Bonus No. 2 provided the major portion of the compensation paid to the executives. It is undisputed that C.S. & Co. has never paid a dividend. With respect to each of the taxable years here involved, the Commissioner disallowed deductions to C.S. & Co. for compensation paid Schneider in excess of $35,000 and for compensation paid Summer in excess of $50,000. The Tax Court found and determined that for each of the years involved salaries paid by C.S. & Co. to Schneider in excess of $40,000 and to Summer in excess of $60,000 would be unreasonable and hence not allowable as a business expense deduction.

Future Foam was organized by Schneider who held all of its stock until 1965 when he sold 20% Of the stock to Grassman and a similar amount to Friedman, all pursuant to a stock option. Grassman and Friedman had been with Future Foam since about 1960 and had put in long hours and capable services in building up the company. Grassman played a major part in developing a successful foam which the company manufactured and sold. Friedman was president of the company and Grassman was vice-president. In 1963 an agreement was entered into to pay Schneider a basic salary of $150.00 per week and Grassman and Friedman each $175.00 per week. Additionally, under Bonus No. 1 Friedman and Grassman were to divide 3/4 of 1% Of net sales. Bonus No. 2 was in substance the same as the C.S. & Co. Bonus No. 2 with division to be made equally among Schneider, Friedman and Grassman.

Pursuant to this arrangement for the fiscal year ending August 31, 1966, Friedman and Grassman each received compensation of $80,176.00 ($61,807.00 of which was based on Bonus No. 2), and Schneider received $45,000.00. Schneider received $45,780.00 in the fiscal year 1967. The Commissioner disallowed Future Foam a deduction for compensation paid Grassman and Friedman in excess of $50,000 during the fiscal year ending August 31, 1966, and compensation paid Schneider for the fiscal years 1966 and 1967 in excess of $35,000.00 per year. The Tax Court raised the allowable deduction for compensation paid Grassman and Friedman to $65,000.00 and reised the allowable deduction for salary paid Schneider to $40,000.00 for the years 1966 and 1967.

Section 162(a)(1) of the Internal Revenue Code of 1954 permits a taxpayer to deduct 'a reasonable allowance for salaries or other compensation for personal services actually rendered' as ordinary and necessary business expenses. The determination of what is reasonable compensation is a factual one to be ascertained from all the facts and circumstances of a case, to which the clearly erroneous standard applies. Charles McCandless Tile Serv. v. United States, 191 Ct.Cl. 108, 422 F.2d 1336. 1338 (1970); Pacific Grains, Inc. v. Commissioner, 399 F.2d 603, 605 (9th Cir. 1968). Decisions of the Tax Court are reviewable in the same manner and to the same extent as decisions of the district courts sitting in civil actions without a jury. This court is bound by the factual determinations of the Tax Court unless they are found to be clearly erroneous or are unsupported by substantial evidence upon the record as a whole. 26 U.S.C. 7482(a); Commissioner v. Duberstein, 363 U.S. 278, 290-291, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960); Byrne v. Commissioner, 449 F.2d 759, 760 (8th Cir. 1971); Commissioner v. Riss, 374 F.2d 161, 166 (8th Cir. 1967).

Several factors to be considered in determining reasonableness of compensation have been mentioned by the courts.

Such factors include the employee's qualifications; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with the gross income and the net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years. Mayson Mfg. Co. v. Commissioner, 178 F.2d 115, 119 (6th Cir. 1949).

See also Hammond Lead Products, Inc. v. Commissioner, 425 F.2d 31, 33 (7th Cir. 1970), quoting 4A Mertens, Law of Federal Income Taxation, 25.69 at 282 (1966); Irby Constr. Co. v. United States, 154 Ct.Cl. 342, 290 F.2d 824, 826 (1961).

In the instant case, the petitioners strenuously advocate that because the compensation paid to their employees was paid pursuant to contingent compensation agreements, the reasonableness of which must be measured by conditions existing at the time of their execution, the compensation must necessarily have been reasonable. Such agreements were incentives to the officers to increase the profits, as shown by the later...