528 F.2d 176 (10th Cir. 1975), 74--1388, Pepsi-Cola Bottling Co. of Salina, Inc. v. C. I. R.

Docket Nº:74--1388.
Citation:528 F.2d 176
Case Date:December 08, 1975
Court:United States Courts of Appeals, Court of Appeals for the Tenth Circuit

Page 176

528 F.2d 176 (10th Cir. 1975)




No. 74--1388.

United States Court of Appeals, Tenth Circuit

December 8, 1975

Submitted Jan. 23, 1975.

As Amended on Denial of Rehearing

Jan. 21, 1976.

Page 177

Thomas J. Kennedy, Salina, Kan. (Robert B. Berkley, Salina, Kan., on the brief), for petitioner-appellant.

F. Arnold Heller, Atty., Dept. of Justice, Washington, D.C. (Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Elmer J. Kelsey, Daniel F. Ross, Attys., Tax Div., Dept. of Justice, Washington, D.C., on the brief), for respondent-appellee.

Before HOLLOWAY, McWILLIMAS and DOYLE, Circuit Judges.

HOLLOWAY, Circuit Judge.

This appeal challenges a determination made by the Commissioner of Internal Revenue that compensation paid to the executive officer of a closely held corporation was unreasonably high in three tax years, deductions for the full amount of the compensation should be denied, and that deficiencies existed. The Tax Court sustained the findings of unreasonableness of compensation, allowing however more deductions than the Commissioner. 61 T.C. 564.

Page 178

The taxpayer is the Pepsi-Cola Bottling Co. of Salina, Inc., a Kansas corporation engaged in the manufacture, packaging and distribution of particular name brand soft drinks within an exclusive franchise area. The company began as a sole proprietorship in 1941, operated by R. W. Nesbitt and his wife, Verla Nesbitt. When Mr. Nesbitt died in 1945, Mrs. Nesbitt continued the business as sole proprietor until July 1, 1955, at which time she caused the business to be incorporated. Mrs. Nesbitt, now Mrs. Joscelyn, has served as president and general manager of the corporation since its inception and has at all times held 248 of the outstanding 250 shares of stock (Tr. 50).

On February 14, 1956, the directors of the company adopted a resolution which has remained continuously in effect since that time and which prescribes a contingent compensation arrangement for Mrs. Joscelyn. 1 Compensation was paid to Mrs. Joscelyn in accordance with the resolution for the years 1956 through 1970. This suit concerns only the compensation which the company deducted on its returns for the calendar years 1968, 1969 and 1970. The compensation to Mrs. Joscelyn in those three years was $67,187, $88,457 and $97,552, respectively, all in accordance with the resolution.

Through the years the company has been highly successful. The national Pepsi Cola Company considers per-capita consumption within a franchise territory to be one of the best measures of a successful franchise holder. By this standard the taxpayer company ranked first in Kansas and in the top 5% of approximately 500 Pepsi Cola bottling plants in the United States. There was undisputed testimony that in the opinion of experienced individuals engaged in the bottling business, the growth and success of the taxpayer company has been due primarily to the managerial attributes and qualities of Mrs. Joscelyn. 2

During the years in issue Mrs. Joscelyn was in good health, was 63, 64 and 65 years of age, and continued to be active in the business. She was the company's only active executive officer for all the years in question. During those years the company employed respectively a total of 56, 60 and 64 persons. Mrs. Joscelyn had no other business activities and the undisputed proof was that she worked 50, 60 or 70 hours a week, working six days a week and on Sundays, if necessary. She performed all types of tasks for the Company (Tr. 24).

The Commissioner determined deficiencies for 1968, 1969 and 1970 in the respective amounts of $35,158.05, $47,859.44 and $50,783.89, concluding that compensation to Mrs. Joscelyn was excessive to the extent that it was in excess of $40,000 for each year in issue (R. 64--65). The taxpayer filed a petition in the Tax Court for a redetermination of the income tax deficiencies.

Page 179

At trial the Tax Court received testimony and written evidence, including a statistical comparison of executive compensation in the soft drink industry (Exhibit 4--D, 1968 Financial Survey of the Soft Drink Industry, published by the National Soft Drink Association). It was shown also that the company had never paid a dividend to shareholders.

The Tax Court concluded that the company had shown the Commissioner's determinations as to reasonable amounts of compensation to be erroneous, but it did not agree that Mrs. Joscelyn's compensation during the years in issue was a reasonable allowance for personal services actually rendered within the meaning of § 162 of the Internal Revenue Code (R. 74). The Court found that $50,000 for 1968, $54,500 for 1969 and $57,500 for 1970 constituted reasonable compensation to Mrs. Joscelyn for the services rendered (R. 78). Since only the company appealed, we address solely the issue whether the Tax Court erred in finding that the compensation paid by Mrs. Joscelyn was unreasonable to the extent that it exceeded the amounts stated above.

Section 162(a)(1) of the Internal Revenue Code of 1954 permits a taxpayer to deduct as ordinary and necessary business expenses 'a reasonable allowance for salaries or other compensation for personal services actually rendered.' 26 U.S.C.A. § 162(a)(1). The controlling principles for review of Tax Court decisions under this section of the Code are clear. No fixed rule applies to determine a reasonable salary. Reasonableness depends on the circumstances of each case and the question is one of fact which must be determined in light of all the evidence. Perlmutter v. C.I.R., 373 F.2d 45, 47 (10th Cir.). The taxpayer has the burden of showing that the amounts deducted were in fact reasonable compensation. Botany Worsted Mills v. United States, 278 U.S. 282, 49 S.Ct. 129, 73 L.Ed. 379 (1929); see also Perlmutter, supra at 47.

The factors to be considered in determining reasonableness of compensation have been stated innumerable times. The Tax Court accepted the formulation found in Mayson Mfg. Co. v. C.I.R., 178 F.2d 115, 119 (6th Cir.), without apparent disagreement from either party. We present these factors in a numerical listing to...

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