Don E. Williams Co. v. Comm'r of Internal Revenue

• Decision Date: 14 May 1974
• Docket Number: Docket No. 5946-71.
• Citation: 14 UCC Rep.Serv. 1165,62 T.C. 166
• Parties: DON E. WILLIAMS COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

14 UCC Rep.Serv. 1165

62 T.C. 166

DON E. WILLIAMS COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5946-71.

United States Tax Court

Filed May 14, 1974.

Donald P. Cooney, for the petitioner.

Allan E. Lang, for the respondent.

Petitioner contributed to its profit-sharing plan for 3 taxable years by issuing its demand, interest-bearing, promissory notes secured by pledges of its principal shareholders. Petitioner paid the notes in each of the succeeding years. Held, the promissory notes do not constitute ‘payment’ required by sec. 404(a), I.R.C. 1954, and petitioner's deductions for the contributions are denied. Logan Engineering Co., 12 T.C. 860 (1949), followed. Sachs v. Commissioner, 208 F.2d 313 (C.A. 3, 1953); Time Oil Co. v. Commissioner, 258 F.2d 237 (C.A. 9, 1958); Wasatch Chemical Co. v. Commissioner, 313 F.2d 843 (C.A. 10, 1963), not followed.

OPINION

GOFFE, Judge:

The Commissioner determined deficiencies in petitioner's income tax for the taxable years ended April 30, 1967, April 30, 1968, and April 30, 1969, in the amounts of $15,162.87, $1,360.64, and $530.42, respectively. The sole issue for decision is whether petitioner's promissory notes issued and delivered to the trustees of the trust for its profit-sharing plan constitute ‘payment’ as required by section 404(a) of the Internal Revenue Code of 1954¹ thus entitling petitioner to deductions for the face amounts of the notes in the taxable years the notes were issued.

All of the facts have been stipulated. The stipulation of facts and exhibits are incorporated herein and adopted as our findings of fact. Only the facts necessary to an understanding of our opinion will be summarized herein.

Petitioner is a corporation organized under the laws of the State of Illinois with principal offices in Moline, Ill. Its principal business activity is that of a manufacturers representative and wholesaler for factory tools and supplies.

Petitioner maintains its books and records and files its income tax returns on the accrual method of accounting using a fiscal year ending on April 30. Its returns for the taxable years before us were filed with the district director of internal revenue at Chicago, Ill.

Petitioner has a profit-sharing plan which has been ‘qualified’ since 1964. The trustees of the trust for the profit-sharing plan are its bank and the three principal shareholders of petitioner, who are also petitioner's officers.

Toward the end of each of its taxable years before us, the board of directors of petitioner authorized contributions to petitioner's profit-sharing plan and in the month immediately following the close of its taxable years petitioner delivered to the trustees its interest-bearing secured demand promissory notes for face amounts equal to the deductions claimed as employer contributions to the profit-sharing plan. Such amounts were accrued as liabilities on the books of petitioner at the close of each of the taxable years. The notes issued in 1967 and 1968 bore interest at the rate of 6 percent and the note issued in 1969 bore interest at the rate of 8 percent. Interest was payable at maturity. The officers and principal shareholders of petitioner, each as principals, jointly and severally, executed the notes as accommodation makers. The notes were secured solely by collateral owned by the accommodation makers and consisted of some stock in petitioner owned by one shareholder and the respective interests of two of the shareholders in the profit-sharing plan. The value of the collateral pledged by the two shareholders combined with the net worth of the third shareholder, who pledged nothing, exceeded the face amounts of the notes.

Toward the end of each of its taxable years, petitioner paid each of the demand notes it had issued at the beginning of such year, together with the accrued interest thereon.

Petitioner deducted on its income tax returns the face amounts of the notes issued to the trustees of the profit-sharing plan and the Commissioner, in his statutory notice of deficiency, disallowed the deductions claimed, less the payments on the notes, on the grounds that the notes did not represent ‘payments' of the contributions within the meaning of section 404(a).

Section 404(a) and its predecessor, section 23(p) of the Internal Revenue Code of 1939, allow deductions for contributions paid by an employer to a qualified profit-sharing plan. Such contributions are, by the terms of section 404(a), not deductible as trade or business expenses under section 162 nor are they deductible as expenses for the production of income under section 212. The deduction is allowable only if paid within the taxable year or, in the case of taxpayers on the accrual method of accounting, if paid within the time in which the income tax return of the employer is due to be filed. Sec. 1.404(a)-1(c), ² Income Tax Regs. Other exceptions provide for situations not applicable here.

It is clear from the regulations that the contribution must be paid. The validity of the regulations is not challenged. Petitioner contends that the notes which it issued represent payment and respondent contends that notes do not represent payment for the purposes of section 404(a). Respondent relies upon four of our decisions and petitioner relies upon the decisions of three Courts of Appeals which reversed three of these cases.

The four cases involved, in chronological order, are Logan Engineering Co., 12 T.C. 860 (1949); Slaymaker Lock Co., 18 T.C. 1001 (1952), reversed sub nom. Sachs v. Commissioner, 208 F.2d 313 (C.A. 3, 1953); Time Oil Co., 26 T.C. 1061 (1956), revd. 258 F.2d 237 (C.A. 9, 1958); Wasatch Chemical Co., 37 T.C. 817 (1962), revd. 313 F.2d 843 (C.A. 10, 1963).

An appeal in the instant case would lie in the Court of Appeals for the Seventh Circuit which has not considered the issue.

With all due respect to the Courts of Appeals for the Third, Ninth, and Tenth Circuits, we decline to follow their decisions. Instead, we shall continue to follow our decisions, two of which were reviewed by the Court and not burdened with concurring or dissenting opinions. We do so because we continue to believe our decision was correct in the first case, Logan Engineering Co., supra. In that case, we construed section 23 (p)(1) of the Internal Revenue Code of 1939, the predecessor of section 404(a) with which we are now concerned. We pointed out that the word ‘paid’ used in the statute should be given its ordinary and usual meaning, ‘to liquidate in cash.’ P. G. Lake, Inc. v. Commissioner, 148 F.2d 989 (C.A. 5, 1945); cf. Commissioner v. Drovers Journal Pub. Co., 135 F.2d 276, 278 (C.A. 7, 1943). However, delivery of a check satisfies the requirement of a liquidation in cash because it represents a conditional payment, but a promissory note is merely a negotiable promise to pay. Estate of Modie J. Spiegel, 12 T.C. 524 (1949).

We based our decision in Logan Engineering on legislative intent derived from the Report of the Ways and Means Committee on the Revenue Revision Act of 1948, H. Rept. No. 2087, 80th Cong., 2d Sess., p. 13, wherein it stated, concerning section 23(p)(1)(E), that ‘An employer on the accrual basis of accounting may under existing law deduct contributions actually paid within the first 60 days of the subsequent year.’ The report explained the committee's recommendation to extend the time from 1 month to 2 months and 15 days within which an accrual basis employer could pay the contribution to the pension or profit-sharing plan after the close of the taxable year and yet be entitled to deduct the contribution. Sioux Tribe v. United States, 316 U.S. 317, 329-330 (1942). The above-quoted language appears in the regulations set forth in footnote 2 which petitioner does not challenge as invalid.

We followed Logan Engineering Co., supra, in Slaymaker Lock Co., supra, which was reversed sub nom. Sachs v. Commissioner, supra, by the Court of Appeals for the Third Circuit.

The Third Circuit bases its decision on Miller v. Commissioner, 164 F.2d 268 (C.A. 3, 1947y, which involved section 24(c)(1) of the Internal Revenue Code of 1939. That section covered the payment of expenses and interest following the close of a taxable year and is the predecessor of section 267 of the Internal Revenue Code of 1954.

Section 267, by its specific terms, applies to the disallowance of deductions for payments to related taxpayers; i.e., losses, interest, trade or business expenses deductible under section 162, and expenses incurred in the production of income under section 212. The deduction with which we are concerned is allowable only under section 404(a) and that section specifically precludes allowance of a deduction for such contributions under section 162 or section 212.

Because section 404(a) specifically prohibits deduction of the employer contribution under section 162 or section 212, and section 267, by its own terms, applies only to losses, taxes, and deductions allowable under sections 162 and 212, section 267 cannot have any bearing upon ‘payment’ under section 404(a). The Third Circuit in Sachs incorrectly drew an analogy between ‘payment’ under section 404(a) and ‘payment’ under other Code sections. ‘Payment’ under section 404(a) should, instead, be interpreted independently in the light of the intent of Congress as we explained above.

We also disagree with the Third Circuit when it suggests that there is little difference between a demand promissory note and a check drawn on a bank account. The notes in Sachs were payable at a bank. In the instant case, the notes were not payable at a bank.

Illinois law, which applies here, embodies alternative B of section 3-121 of the Uniform Commercial Code which provides that a note ‘payable at a bank is not of itself an order or authorization of the bank to pay it.’ The analogy of a promissory note payable at a bank and a check as bank draft upon which the Third Circuit relied in Sachs,...