Anderson v. Comm'r of Internal Revenue

• Decision Date: 27 September 1971
• Docket Number: Docket No. 1533-70.
• Citation: 56 T.C. 1370
• Parties: JAMES E. ANDERSON AND ALICE ANDERSON, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

56 T.C. 1370

JAMES E. ANDERSON AND ALICE ANDERSON, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 1533-70.

United States Tax Court

Filed September 27, 1971.

David J. Creagan, Jr., and John H. Overbeck, Jr., for the petitioners.

James F. Hanley, Jr., for the respondent.

Petitioner paid certain sums to his employer because his sale and purchase of stock constituted an apparent violation of section 16(b) of the Securities Exchange Act of 1934. Held, petitioner's payment constituted ordinary and necessary business expense. William L. Mitchell, 52 T.C. 170 (1969), revd. 428 F.2d 259 (C.A. 6, 1970), reaffirmed.

TANNENWALD, Judge:

Respondent determined a deficiency of $21,897.64 in the petitioner's income tax for the taxable year ending December 31, 1966. The only issue for our consideration is whether payments made by petitioner James E. Anderson to his employer, pursuant to an alleged violation of section 16(b) of the Securities Exchange Act of 1934, constitute an ordinary and necessary expense of petitioner James E. Anderson's business.

FINDINGS OF FACT

A stipulation of facts filed by the parties is incorporated herein as part of our findings of fact.

Petitioners James E. Anderson and Alice Anderson, husband and wife, filed their 1966 joint Federal income tax return with the district director of internal revenue at Chicago, Ill. They resided in Elmwood Park, Ill., at the time the petition herein was filed. Alice Anderson is a petitioner herein only by virtue of having joined in filing the aforesaid joint return. All references herein to petitioners shall be deemed to refer to James E. Anderson.

In 1942, petitioner joined Zenith Radio Crop. (hereinafter referred to as Zenith) as a purchasing agent. He became vice president, director of purchasing, in 1947 and continued in that capacity until his retirement on September 1, 1968. He was responsible for the procurement of the raw materials, machinery, and labor necessary for the manufacture of Zenith's products, including radios, television sets, and hearing aids. In 1966, purchases made by petitioner on behalf of Zenith totaled approximately $350 million.

On January 30, 1956, petitioner entered into an employment agreement which covered the period from January 1, 1955, through December 31, 1964. This agreement was extended by mutual consent through December 31, 1965. It provided, in part, that, upon its expiration, Zenith agreed to employ petitioner in an advisory capacity for a length of time equal to his full-time employment since January 1, 1955, at an annual salary of $20,000, in return for which petitioner agreed to perform services for Zenith for no more than 60 days per year. As of December 31, 1965, petitioner had accrued 11 years of full-time employment.

On May 11, 1966, petitioner and Zenith executed a second employment contract, confirming their agreement that petitioner would be employed on a full-time basis effective January 1, 1966, through December 31, 1968. Under this agreement, petitioner received an annual salary of $50,000 plus a bonus based upon Zenith's annual net income. Zenith retained the right to terminate petitioner's employment at any time, in which case petitioner would commence serving Zenith in the aforementioned advisory capacity. In 1966, petitioner reported income of $173,332.14 as a result of his employment with Zenith.

In 1962 and 1963, petitioner, pursuant to an employee stock purchase agreement dated November 25, 1958, purchased a total of 1,000 shares of Zenith common stock for $14,038.90. In April of 1966, petitioner sold these shares on the open market for $162,923.21 and reported a long-term capital gain of $148,884.31. On April 11, 1966, following the sale of the aforementioned shares and pursuant to a second employee stock purchase agreement, dated August 5, 1964, petitioner purchased 750 shares of Zenith common stock for $49,312.50.

On May 2, 1966, petitioner filed a ‘Statement of Charges of Beneficial Ownership of Securities' with the Securities and Exchange Commission (SEC), reporting the details of the aforementioned sale and purchase of Zenith stock. Prior to May 11, 1966, petitioner was advised by Zenith that the aforementioned sale and subsequent purchase of Zenith stock violated section 16(b) of the Securities Exchange Act of 1934.¹ Petitioner responded that he did not think this was the case and, upon receiving a demand for payment from Zenith's legal department, referred the matter to his attorneys. They informed him that Zenith had no alternative but to demand payment from him.

Although he believed (and still believes) that he had done nothing wrong, petitioner reasonably assumed that if he failed to comply with Zenith's demand, his position would be in jeopardy and his business reputation would be damaged. On May 19, 1966, petitioner's attorneys, acting on his behalf, informed Zenith of petitioner's intent to comply with its demand. Accordingly, petitioner paid Zenith $51,259.14, exclusive of interest, in connection with the alleged section 16(b) violation and deducted this sum as an ordinary and necessary business expense.

Petitioner remained a full-time employee of Zenith until September 1, 1968, at which time he refused an offer of 3 additional years of full-time employment and voluntarily retired. Zenith had no mandatory retirement age for its employees and it was not until July of 1968 that petitioner decided to retire.

In his notice of deficiency, respondent determined that the payments made to Zenith should be treated as long-term capital losses and recalculated the petitioner's tax for 1966 accordingly.

ULTIMATE FINDING OF FACT

Petitioner's payment of $51,259.14 to Zenith was made to preserve his employment with Zenith and avoid injury to his business reputation.

OPINION

In April of 1966, petitioner sold 1,000 shares of Zenith stock, from which he realized a long-term capital gain of $148,884.31. Several days later, in apparent violation of section 16(b) of the Securities Exchange Act of 1934, petitioner purchased 750 shares of Zenith stock for $49,312.50. In response to Zenith's demand for payment under section 16(b), petitioner paid Zenith $51,259.14 during 1966.

The sole issue herein relates to the deductibility of such amount. Petitioner urges us to adhere to our decision in William L. Mitchell, 52 T.C. 170 (1969), rev. 428 F.2d 259 (C.A. 6, 1970), and to hold that he is entitled to a deduction as an ordinary and necessary business expense under section 162(a). ² Respondent counters with a two-pronged argument for the proposition that petitioner is entitled only to treat the payment as a long-term capital loss: (1) Petitioner has not satisfied the requirement of section 162(a), in that he has failed to establish that his belief that his status and reputation as a corporate executive would be jeopardized by nonpayment was reasonable, and (2) we should, in any event, follow the reversal of our decision in Mitchell and hold that the tax treatment of the payment in question should be controlled by the capital gain coloration of the profit from the sale of the Zenith shares. For the reasons hereafter stated, we hold for petitioner.

We deal first with the question whether, aside from the impact of the Mitchell reversal, petitioner has satisfied the requirements of section 162(a). It is clear that, if a violation of section 16(b) of the Securities Exchange Act of 1934 occurred, it was unintentional on petitioner's part. Respondent does not challenge petitioner's assertion that he was in the trade or business of being a corporate executive. Nor does he seriously contest the fact that petitioner personally believed that his position as a corporate executive of Zenith would be in jeopardy if he did not make the payment. Rather, his argument is directed to the reasonableness of petitioner's belief and is based primarily on the fact that the second employment contract between petitioner and Zenith was executed at a time subsequent to Zenith's demand but before petitioner had agreed to make the payment in satisfaction thereof. We think that respondent takes too narrow a view of the circumstances in which petitioner found himself. Our Findings of Fact set forth in detail those circumstances and we see no need to repeat them here. We note, however, two significant facts, without in any way indicated, that, in their absence, we would have sustained respondent's contention. First, it is apparent that, although the second employment agreement was not formally signed until May 11, 1966, it clearly represented confirmation of a prior agreement between petitioner and Zenith for a continuation of his employment from January 1, 1966. Second, Zenith had the right to terminate that agreement at will, in which event petitioner would have suffered a substantial decrease in income. Upon the basis of the entire record herein, we have found that petitioner's belief was reasonable and consequently hold that he has satisfied the usual test of deductibility under section 162(a).³ William L. Mitchell, supra; Laurence M. Marks, 27 T.C. 464 (1956).

We now turn to the critical issue herein. Under substantially identical circumstances, we held in William L. Mitchell, supra, that a payment by a corporate executive in discharge of his apparent obligation to his employer under section 16(b) of the Securities Exchange Act of 1934 was a deductible expense under section 162(a). In so holding, we refused to apply the principle of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and thereby limit the taxpayer to a deduction for a capital loss. The Sixth Circuit reversed us on the grounds that (1) the character of the payment was controlled by the underlying sale-purchase which gave rise to the apparent violation of section 16(b) and (2) the right of deduction under section 162(a) was subordinary to the principles of Arrowsmith and its progeny. In so holding the Court of Appeals relied heavily on ...