ERNEST, HOLDEMAN & COLLET, INC. v. Commissioner
| Decision Date | 29 January 1960 |
| Docket Number | Docket No. 71250. |
| Citation | 1960 TC Memo 10,19 TCM (CCH) 42 |
| Parties | Ernest, Holdeman & Collet, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Thomas H. Krise, Esq., and John H. O'Hara, Esq., for the petitioner. Bernard J. Boyle, Esq., for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioner's income and excess profits taxes for the taxable years 1952 and 1953 as follows:
Year Deficiency
1952.......... $255,397.28
1953.......... 130,706.84
Several issues have been resolved by agreement of the parties. There remain for our consideration the following questions: (1) Whether salaries paid to petitioner's officers during the taxable years 1952 and 1953 were unreasonable and excessive; (2) whether petitioner correctly valued its inventory at the close of each of the taxable years 1952, 1953, and 1954; (3) whether respondent correctly added freight-in to the value of inventories for each of the taxable years 1952, 1953, and 1954; (4) whether the premiums paid by petitioner during the taxable years 1952 and 1953 on health and accident insurance policies furnished to four of its five officers were deductible expenditures; and (5) whether the sale of a particular punch press was consummated in the taxable year 1954 and petitioner's gross profit on the transaction consequently includible in taxable income for that year.
A net operating loss carry-back from the taxable year 1954 will be computed under Rule 50.
Findings of Fact
Petitioner, a corporation having its principal office in Elkhart, Indiana, was incorporated on December 29, 1947. It filed its Federal income tax returns for the taxable years 1952, 1953, and 1954 with the director of internal revenue at Indianapolis, Indiana.
Petitioner succeeded the Apex Machinery Company, a partnership formed in 1946 by Frederick I., Richard W., and Robert F. Ernest, and S. Vance Holdeman, hereinafter sometimes referred to as Frederick, Richard, Robert, and Holdeman, respectively.
During the years 1948 through 1950 petitioner sold new and used machine tools and did a small amount of rebuilding and tooling of machine tools.
In 1951, with the beginning of the Korean War, new and used machinery both became difficult to obtain, and special tooling for Foster Fastermatics (automatic, hydraulic turret lathes) and similar machines became the bulk of petitioner's business. Frederick, Richard, and Robert Ernest and S. Vance Holdeman had all worked for the manufacturer of the Foster Fastermatic. The special tooling program, which involved the engineering and service of machines for various suppliers, extended through 1952 and into 1953.
Petitioner's customers included Allis-Chalmers, building jet sapphire engines; Chevrolet, building jet engines; Kaiser-Frazer and Nash-Kelvinator, building Wright engines; and Bridgeport-Lycoming and Buick, making accessories for aircraft. Petitioner retooled and reallocated Foster Fastermatics to these customers from the Government machinery pool.
The machines which needed reconditioning were reworked in petitioner's plant so that they conformed to new machine tolerances. Petitioner did the engineering on the standard and special tooling but subcontracted the actual manufacture of the tools. It took the jobs on a firm bid as opposed to a cost-plus basis.
During the years 1948 through 1950 petitioner had an average of approximately 12 employees besides officers. The officers performed multiple functions. In 1951 the number of employees was increased to approximately 50. In 1952 the number was further increased to approximately 60. During the years 1951 through 1953 the officers worked long hours — sometimes seven days a week; the shop employees often worked 65 hours a week.
Frederick I. Ernest, petitioner's president, was 59 years of age in 1952. He was educated at LaSalle Extension University and had considerable night school work in engineering, drafting, and mathematics. He started work as a machine operator for a munitions manufacturer during World War I. In 1920 he worked in the machinery division of the Elkhart Company, which manufactured automobiles. The remainder of the time between 1917 and 1942 he worked for the Foster Machine Company. He started as a machine operator, then became foreman of the turret lathe department, and was later transferred to various departments in the plant to gain wider knowledge of the business.
In 1942 Frederick left the Foster Machine Company and went with C. G. Conn Band Instrument Company to work on their gyroscope program. He studied the manufacturing methods at Sperry Gyroscope and then returned to Conn Company where he helped set up an assembly line for the production of such instruments. He was general manager of the machine division.
Frederick later worked for the International Detrola Corporation (formerly Foster Machine Company), engaging in their various special tooling programs. He remained at that position until he and other of petitioner's officers formed the Apex Machinery Company predecessor of petitioner. He worked part time for Apex and part time for International Detrola and then eventually left International Detrola entirely.
Upon the incorporation of petitioner, Frederick became its president and has continued ever since in that capacity. From 1948 until September 1951 he devoted at least two-thirds of his time to petitioner. During 1952 and 1953 he devoted full time to petitioner. His duties were diversified.
During the time Frederick worked for the Foster Machine Company and its successor, the International Detrola Corporation, he developed a device known as a speed grip chuck. This mechanism is used to chuck parts while they are being machined. International Detrola had no objection to his patenting the device. Petitioner itself sold some of these chucks with their special tooling. Machines were also sold through salesmen. Most of these devices were sold through manufacturers' representatives.
Albert J. Collet, a graduate engineer and petitioner's vice-president until 1954, was approximately 47 years of age in 1952. Prior to his association with petitioner in 1948 he had sold used machinery and had had his own used machinery business.
Collet was instrumental in obtaining new machine tool lines for petitioner. He was also an excellent salesman and set up petitioner's Indianapolis sales office. He was considered one of the better used machinery dealers.
S. Vance Holdeman, petitioner's secretary, was 33 years of age in 1952. He first went to work in 1936 for the Foster Machine Company, where he remained until October 1945. During his first two years with Foster he took extension courses from Purdue University in mechanical engineering. While working for Foster he did detail engineering work, layout and design work, and later was in charge of a special machine design group. After 1945 Holdeman went to work for the Indianapolis Machinery and Supply Company, the largest new and used machinery dealer in Indiana. He acted as buyer of used machinery and assisted the salesmen in the sale of new and used machinery. In 1947 he became a partner in the Apex Machinery Company, and also, for a short time, was in the wholesale plumbing business. Upon petitioner's incorporation in 1947, he became secretary of that organization. During 1952 and 1953, in addition to being officer in charge of sales, he also was officer in charge of engineering products as related to special machinery and tooling. He traveled extensively for petitioner. Holdeman has been very well accepted in his field.
Richard W. Ernest, petitioner's treasurer, was 35 years of age in 1952. He had taken some night school courses in engineering, and in 1938 graduated from International Business College. Thereafter he took a sales position with a local firm. After approximately a year he left that position and took a job with the Foster Machine Company, where he worked on tooling assembly, engineering, and estimating of special equipment.
In 1946 Richard left full-time employment with Foster and became a partner in the Apex Machinery Company. He was occupied with the rebuilding and sale of machinery and was the first partner to devote his full time to Apex. In 1948 he became treasurer and general manager of petitioner and has since continued in that capacity. He has mechanical ability, an understanding of hydraulics, and has had experience with various lines of machine tools. He has spent considerable time estimating special machine tools.
Robert F. Ernest, petitioner's assistant secretary, was 28 years of age in 1952. After graduation from high school in January 1942, he worked for the Foster Machine Company as an apprentice engineer. From February 1943 until December 1945 he served in the Army, attaining the grade of corporal. In 1950 he graduated from Indiana University, receiving a B. S. degree in business administration. During the summers, while he was in college, he worked for petitioner and its predecessor, Apex Machinery Company, in which he was a partner.
In October 1950 Robert became assistant secretary of petitioner. His principal responsibility was the purchase of the special tooling to be mounted on the machines upon which petitioner was working. Petitioner engineered the special tooling but subcontracted the actual manufacture of the tools. Robert was responsible for the allocation of these contracts to outside shops. It was necessary for him to co-ordinate the activities of all the shops so that the work would flow in at the proper time and meet delivery requirements.
At the initial meeting of petitioner's board of directors early in 1948 the salaries of the vice-president, the treasurer, and the secretary were fixed at $5,200 per year. In addition, it was resolved that a bonus was to be paid to the officers and directors. The bonus was to equal 75 per cent of the net profits of the...
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