Becker Bros. v. United States, 151.

• Decision Date: 01 June 1925
• Docket Number: No. 151.,151.
• Citation: 7 F.2d 3
• Parties: BECKER BROS. v. UNITED STATES.
• Court: U.S. Court of Appeals — Second Circuit

7 F.2d 3 (1925)

BECKER BROS. v. UNITED STATES.

No. 151.

Circuit Court of Appeals, Second Circuit.

June 1, 1925.

John McCormick, of New York City, for plaintiff in error.

William Hayward, U. S. Atty., of New York City (Thomas J. Crawford, Asst. U. S. Atty., of New York City, and Chester A. Gwinn, Sp. Atty., Bureau of Internal Revenue, of Washington, D. C., of counsel), for the United States.

Before ROGERS, HOUGH, and MANTON, Circuit Judges.

ROGERS, Circuit Judge (after stating the facts as above).

This action, as disclosed in the preliminary statement, was brought to recover additional taxes claimed to be due to the United States under the provisions of the corporation Excise Tax Act of August 5, 1909, and the Revenue Act of 1913, in amounts totaling $1,267.67. The defendant corporation took over the business of Jacob H. Becker as a manufacturer of pianos. Its capital stock was fixed at $25,000, divided into 250 shares, of the par value of $100 each. Jacob H. Becker held 240 shares, his wife held 5 shares, and John McCormick held the remaining 5 shares, and these three persons constituted the board of directors. At the meeting for organization Jacob H. Becker was elected president and treasurer, and his wife was made vice president, and John McCormick was chosen secretary of the corporation. Later, and in 1911, Rudolph C. Becker, the son of Jacob H. Becker, was elected secretary. At the first meeting by-laws were adopted permitting the board of directors to employ one of their number as general manager, with power to fix his salary and the salary of the secretary.

The directors, at the first meeting of the board, adopted the following resolution:

"Resolution made and carried at the meeting of the board of directors of Becker Bros., held at the office of Becker Bros., 527 Tenth avenue, New York City, November, 1902. The president was authorized to act as general manager of the corporation in the management of its business; to make any and all contracts necessary in the management thereof; to discount any and all of the negotiable paper of said corporation; and given discretion to fix the price of sale and terms of sale of all pianos, and to make any and all contracts which he deems necessary, and which contracts shall stand as contracts of the corporation, unless expressly rescinded by the board of directors.

"On the motion of John McCormick, it was ordered that the salary of Jacob H. Becker, as manager of the business, be fixed at 85 per cent. of the net profits arising from the conduct of the business, as declared on December 31st of each year.

"Carried; Jacob H. Becker not voting.

"On the motion of Jacob H. Becker it was ordered that the salary of the secretary be fixed at 5 per cent. of the net profits arising from the conduct of the business as declared on December 31st of each year.

"Carried; John McCormick not voting."

The directors have held few, if any, formal meetings since the one first held; it being understood that no further meetings were necessary. The corporation was organized in 1902. It did not open a new set of books of account, but used those which had been used in the individual business carried on by Jacob H. Becker prior to the incorporation. One of the accounts in the books was headed "Jacob H. Becker Capital Account," and under this heading was entered all the residue between the gross cost and the gross receipts of the business until the year 1911, when a capital account was opened, and also a salary account. Prior to the opening of these latter accounts all sums paid to the general manager or secretary were credited to the "Jacob H. Becker Capital Account."

Neither the general manager nor the secretary withdrew all the sums to which they were entitled under the contract, but allowed much of it to remain in the business. In the first year, or 1902, the residuum amounted to about $2,500, of which the general manager was entitled for services to about $2,000; in 1903, the fund was $4,957; in 1904, it was $9,450; in 1905, it was $18,983; in 1906, it was $22,543; in 1907, it was $28,684; in 1908, it was $16,930; in 1909, the fund was $33,258. In other words, the percentage of profits to the corporation increased from 1 per cent. in 1902 to over 18 per cent. in 1907 upon the capital and surplus to 9½ per cent. in 1909.

Mr. Becker testified as follows concerning the withdrawal of his salary:

"Q. Did you withdraw all of that salary at any time? A. No, sir.

"Q. You allowed it to remain there, and continued that right along? A. Yes.

"Q. Were any dividends ever declared by that corporation? A. No, sir.

"Q. They remained in service? A. Yes, sir.

"Q. And you have acted continuously as general manager from 1902 up to the present date? A. Yes, sir.

"Q. There has been no change in your contract? No change in the agreement between you and the corporation as to the percentage? A. No, sir."

At the conclusion of the evidence, and upon consent of both sides, two questions were submitted to the jury, who rendered special verdicts with respect thereto. The questions submitted by the court were:

(1) "Q. Whether the resolution and subsequent conduct of the corporation were the means of distributing both salaries and profits?"

(2) "Q. What was the reasonable value of such service as Becker rendered to the company from 1909 to 1914, inclusive, and by that I mean, what would the company have to pay for a man of his (Becker's) general capacity to do what he did in the running of the business?"

The jury answered the first question in the affirmative, holding that the resolution relied upon by defendant was a means of distributing both salary and profits. In answer to the second question the jury found the reasonable value of the services of Becker to the corporation to be as follows: for 1909, $12,000; for 1910, $13,000; for 1911, $14,000; and for 1912, 1913, and 1914, $15,000 for each of said years. A general verdict was thereupon directed by the court in plaintiff's favor for $880.27, based upon the findings of the jury, and upon the stipulation relative to the bad debts, and upon the ruling by the court that the deduction of the $37,000 judgment in defendant's 1914 return had been properly disallowed.

There is no substantial dispute as to the facts, but the questions are as to the application of the law to the facts. The questions must be decided according to the provisions of the acts of Congress which were in force when the taxes herein involved were levied. These acts, so far as they are material to the facts of this case, must now be referred to.

The Act of August 5, 1909, 36 Stat. 112, known as the Corporation Excise Tax Law, provided in section 38 as follows:

"Sec. 38. That every corporation, joint stock company or association, organized for profit and having a capital stock represented by shares * * * shall be subject to pay annually a special excise tax with respect to the carrying on or doing business by such corporation, joint stock company or association, * * * equivalent to one per centum upon the entire net income over and above five thousand dollars received by it from all sources during such year * * *.

"Second. Such net income shall be ascertained by deducting from the gross amount of the income of such corporation, joint stock company or association, or insurance company, received within the year from all sources, (first) all the ordinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties * * *; (second) all losses actually sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation of property, if any. * * *"

And the Income Tax Act of October 3, 1913, 38 Stat. 114, 172, 173, provided as follows:

"G. (a) That the normal tax hereinbefore imposed upon individuals likewise shall be levied, assessed, and paid annually upon the entire net income arising or accruing from all sources during the preceding calendar year to every corporation, joint-stock company or association * * *.

"(b) Such net income shall be ascertained by deducting from the gross amount of the income of such corporation * * * received within the year from all sources (first) all the ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties * * *; (second) all losses actually sustained within the year and not compensated by insurance or otherwise. * * *"

The statutes show that the tax was to be levied upon net income, and that in ascertaining net income the law required that there should be deducted from the gross income of the corporation (1) all the ordinary and necessary expenses actually paid within the year out of income, and (2) all losses actually sustained within the year and not compensated by insurance or otherwise. If, in assessing the taxes which the United States imposed upon defendant, the above requirements were observed, the judgment rendered below must be affirmed. If they were disregarded or misapplied, the judgment cannot be sustained in its present form.

The first question to be considered is whether an error was committed in not deducting from the gross income the so-called salary of "85 per cent. of the net profits" which the corporation agreed to pay annually to Jacob H. Becker as general manager of its business. The United States, in fixing the amount of the tax assessed against defendant, declined to deduct 85 per cent. of the profits as being the salary of Becker for his services, and instead deducted in each year only $10,000, claiming that such amount was a reasonable compensation for the services he rendered. There can be no doubt that the corporation was entitled to deduct from the income it received all the ordinary and necessary expenses incurred in carrying on its business, including a reasonable compensation to its officers and employees. But the salaries which...