Paula Constr. Co. v. Comm'r of Internal Revenue

• Decision Date: 28 September 1972
• Docket Number: Docket No. 1058-70.
• Citation: 58 T.C. 1055
• Parties: PAULA CONSTRUCTION COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

58 T.C. 1055

PAULA CONSTRUCTION COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 1058-70.

United States Tax Court

Filed September 28, 1972.

Louis G. Shushan, for the petitioner.

A. A. Simpson, Jr., for the respondent.

1. P had its status as a subch. S involuntarily terminated for the years 1965 and 1966. During such years, P made distribution to its stockholders, but no amounts were treated by P or the stockholders as payments of compensation. Two of its stockholder-officers performed substantial and valuable services in prior years for which no compensation was received. Held, because no amounts were paid out as compensation, P is not entitled to claim a deduction for compensation under sec. 162, I.R.C. 1954.

2. P filed late returns for the years 1965 and 1966 on Form 1120-S. Held, there has been no showing of reasonable cause for the failure of P to file its returns timely, as required by sec. 6651, I.R.C. 1954.

SIMPSON, Judge:

The respondent determined deficiencies in the petitioner's Federal income tax of $14,606.34 for 1965 and $14,9865.76 for 1966. He has also determined additions to the tax under section 6651(a), I.R.C. 1954,¹ of $2,190.95 for 1965 and $749.29 for 1966. Two issues remain for our decision:

(1) Whether a corporation, whose status as a small business corporation has terminated, is entitled to deduct as compensation portions of distributions made to shareholders, even though such distributions were not treated as payments of compensation; and (2) whether the petitioner is liable for additions to the tax for failing to file timely returns.

FINDINGS OF FACT

Some of the facts were stipulated, and those facts are so found.

The petitioner, Paula Construction Co. (PCC), had its principal office in New Orleans, La., at the time of filing the petition in this case. For the years 1965 and 1966, PCC filed U.S. Small Business Corporation Return of Income (Form 1120-S) with the district director of internal revenue, New Orleans, La. PCC maintained its books and records and filed its income tax returns according to the cash method of accounting based on the calendar year.

PCC, a Louisiana corporation, was organized in 1958 for the principal purpose of engaging in the construction business. Throughout its history, its stock has been owned as follows:

+--------------------------------------------------------------------+
                ¦                              ¦                       ¦Percent of   ¦
                +------------------------------+-----------------------+-------------¦
                ¦Stockholder                   ¦Offices held           ¦stock owned  ¦
                +------------------------------+-----------------------+-------------¦
                ¦                              ¦                       ¦             ¦
                +------------------------------+-----------------------+-------------¦
                ¦Anthony P. Abraham (Anthony)  ¦President              ¦50           ¦
                +------------------------------+-----------------------+-------------¦
                ¦Wilson P. Abraham (Wilson)    ¦Vice President         ¦45           ¦
                +------------------------------+-----------------------+-------------¦
                ¦Margaret H. Abraham (Margaret)¦Secretary and treasurer¦5            ¦
                +--------------------------------------------------------------------+
                

On November 28, 1958, PCC elected to be taxed as a small business corporation (a subchapter S corporation) under section 1372. From such time through 1967, John Wooten has been the certified public accountant for PCC, Anthony, and Wilson. Prior to the election, Mr. Wooten, Anthony, and Wilson discussed the advantages and disadvantages of subchapter S treatment. These discussions were continued on and off through 1965 and 1966. Mr. Wooten advised them that as long as PCC remained eligible under subchapter S, the tax treatment of a payment of a dividend or a payment of compensation would be the same— a shareholder of PCC was taxable on any dividends he received and his share of the undistributed taxable income of PCC, and although a payment of compensation would reduce the taxable income of PCC, such a payment would be taxable to him as compensation.

On June 12, 1964, PCC sold its interest in the Chateau Carre Apartments, an apartment building it had erected, for $1,816,964.19. The purchaser assumed a mortgage on the property, and for its equity, PCC was to be paid in installments that bore interest. On March 1, 1965, PCC received payments totaling $46,720, including $9,720 as interest. Such amounts constituted PCC's total gross receipts for 1965; therefore, more than 20 percent of its gross receipts in that year were derived from the interest, and it no longer qualified as an electing small business corporation for 1965 and succeeding years.

In 1965, PCC distributed $29,700.97 to its stockholders. Of such amount, Anthony received $14,850.48; Wilson received $13,365.45; and Margaret received $1,485.04. For 1965, PCC's taxable income was $43,971.55, of which $21,985.77 was includable in the income of Anthony, $19,073.69 in the income of Wilson, and $2,912.09 in the income of Margaret.

In 1966, PCC distributed its entire taxable income of $44,762.01 to its stockholders. Anthony received $22,381.01, Wilson received $20,142.90, and Margaret received $2,238.10.

Anthony and Wilson performed substantial and valuable services for and on behalf of PCC in connection with the construction, financing, and sale of the Chateau Carre Apartments. Neither the petitioner's books and records nor its corporate minutes contain any reference to salaries, or the possibility of salaries, being paid to Anthony, Wilson, or Margaret from the time of its incorporation up to and including the year 1966. Also, the small business corporation returns, prepared by Mr. Wooten and filed by the petitioner for 1965 and 1966, contain no reference to any deductions for salaries and wages. Nor do these returns contain any reference to any deductions for compensation paid to officers. The petitioner's 1965 and 1966 State of Louisiana Domestic Corporation returns, also prepared by Mr. Wooten, contain no deduction for salaries, wages, or compensation of officers.

The individual income tax returns filed by Anthony and Wilson for the years 1965 and 1966 indicate no salary was received from the petitioner. The distributions received by them in those years were reported as distributions from a subchapter S corporation.

The parties have agreed that if portions of the distributions made to Anthony, Wilson, and Margaret may be treated as compensations for services rendered, PCC is entitled to salary deductions of $27,000 for each of the years 1965 and 1966— $15,000 for Anthony and $12,000 for Wilson.

For the years 1965 and 1966, PCC filed returns on Form 1120-S as a small business corporation, which were prepared by Mr. Wooten. The officers of PCC and Mr. Wooten were unaware at that time that the corporation no longer qualified as a subchapter S corporation. There is no evidence as to when PCC delivered its books and records and other necessary information to Mr. Wooten for the preparation of such returns. It was his practice, after the preparation of the returns, to return them, within 1 to 6 days after he approved them, to PCC to be signed by the corporate officers and filed by them. The return for 1965 was signed by Mr. Wooten on April 6, 1966, signed by Wilson on May 16, 1966, mailed by him on the same day, and received by the respondent on May 17, 1966. The return of 1966 was signed by Mr. Wooten on March 1, 1967, signed by Wilson on March 15, 1966, mailed by him on March 21, 1967, and received by the respondent on March 24, 1967.

OPINION

Two issues are presented for decision: (1) Is PCC entitled to deduct as compensation portions of the distributions made to its stockholder-officers during years for which its status as a subchapter S corporation was involuntarily terminated? (2) Is PCC liable for additions to the tax under section 6651(a) for its failure to file timely corporate income tax returns?

The petitioner claims deductions for the payment of compensation with respect to portions of disbursements made to its two major stockholder-officers in the years 1965 and 1966. The burden of proof rests upon the petitioner. Rule 32, Tax Court Rules of Practice; Botany Mills v. United States, 278 U.S. 282, 292 (1929); Electric & Neon, Inc., 56 T.C. 1324, 1340 (1971). Because Anthony and Wilson, with respect to whom the deductions are claimed, were in complete control of the corporation's affairs, close scrutiny must be given to the relevant facts in order that we may determine whether the disbursements were payments of compensation or distributions of earnings. Northlich, Stolley, Inc. v. United States, 368 F.2d 272, 278 (Ct. Cl. 1966); Anthony Mennuto, 56 T.C. 910, 921 (1971); Ben Perlmutter, 44 T.C. 382, 401 (1965), affd. 373 F.2d 45 (C.A. 10, 1967).

Section 162(a)(1) allows a deduction for the payment of reasonable compensation for services when incurred as an ordinary or necessary business expense during the taxable year. The regulations further provide that ‘The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services.’ Sec. 1.162-7(a), Income Tax Regs. The parties have agreed that Anthony and Wilson performed substantial services for PCC prior to 1965 and that if PCC is entitled to treat any amount as compensation for the years 1965 and 1966, $27,000 would be a reasonable deduction for each of such years. Therefore, the issue is limited to whether parts of the distributions in 1965 and 1966 were made purely for services rendered.

It is now settled law that only if payment is made with the intent to compensate is it deductible as compensation. Charles McCandless Tile Service v.United States, 422 F.2d 1336, 1339 (Ct. Cl. 1970); Northlich, Stolley, Inc. v. United States, supra at 278; Irby Construction Co. v. United States, 290 F.2d 824, 826 (Ct. Cl. 1961); Electric &...