Emmer v. Commissioner

Decision Date14 March 1978
Docket Number6770-75,6638-75,Docket No. 6637-75,4162-76.
PartiesHerbert Emmer and Carol Emmer, et al. v. Commissioner.
CourtU.S. Tax Court

Harry Janin and Alan R. Bialeck, 425 Park Ave., New York, N.Y., for the petitioners in docket Nos. 6637-75 and 6638-75. Jerome Kamerman and David S. Zeidman, 500 5th Ave., New York, N.Y., for the petitioners in docket Nos. 6770-75 and 4162-76. Michael P. Casterton, for the respondent.

Memorandum Findings of Fact and Opinion


Respondent determined deficiencies in petitioners' Federal income taxes as follows:

                Docket                     Year
                 No.         1970       1971       1972       1973
                6637-75 .. $ 5,369.41 $11,346.35 $12,266.11   -0-
                6638-75 ..  10,733.13   7,064.89   2,991.69   -0-
                6770-75 ..   9,285.61     -0-       -0-       -0-
                4162-76 ..     -0-      2,231.18   2,166.25 $1,895.24

Certain concessions having been made by the parties, the following issues remain for decision:

1. Whether certain payments made by petitioner 535 Display Company, Inc., formerly Display Designers and Producers, Inc. (hereinafter Display), to petitioner George Mayer (Mayer) in 1970, 1971, 1972, and 1973 were taxable to him as compensation for services or as capital gain.

2. Whether Display was entitled to business expense deductions for 1970, 1971, and 1972 for the payments made to Mayer.

3. Whether the payments made by Display to Mayer in 1970, 1971, and 1972 constituted constructive dividends to petitioner Herbert Emmer.

4. If Herbert Emmer received constructive dividends from Display, whether he is entitled to a deduction under section 4832 for imputed interest payments to Mayer.

5. Whether Mayer received ordinary income from Display in 1970 in the amount of $48,800.

6. Whether coverage and/or contributions under Display's pension trust plan were based on discriminatory classifications as proscribed by section 401(a)(3) and (4) so that a portion of its claimed deduction of $7,114 for contributions to the plan in 1970 should be disallowed.

Findings of Fact
1. General

At the time their petition was filed, petitioners Herbert Emmer and Carol Emmer, husband and wife, were legal residents of Searingtown, New York. The Emmers filed their 1970 joint Federal income tax return with the Internal Revenue Service, New York, New York. Their 1971 and 1972 joint Federal income tax returns were filed with the Internal Revenue Service, Andover, Massachusetts. Petitioner Carol Emmer is a party herein only by reason of having filed a joint return with her husband, Herbert Emmer (hereinafter referred to as Emmer).

Petitioners George Mayer and Phyllis Mayer, husband and wife, were legal residents of Forest Hills, New York, when their petition was filed. Their 1970 through 1973 joint Federal income tax returns (using a cash basis) were filed with the District Director of Internal Revenue, Brooklyn, New York. A 1970 amended joint Federal income tax return was filed on January 25, 1973, with the same office.

Petitioner 535 Display Company, Inc. (Display), formerly Display Designers and Producers, Inc., is a New York corporation. On or about December 3, 1975, Display made an assignment for the benefit of its creditors to Robert M. Fisher. At the time its petition was filed, Display's principal place of business was located in New York, New York. It maintained its books and records on the accrual method of accounting with a calendar year accounting period. Display's Federal income tax returns for 1970, 1971, and 1972 were filed with the Internal Revenue Service, Andover, Massachusetts.

2. Nature and Treatment of Display's Payments to Mayer

Prior to July 1, 1968, Mayer owned all of the capital stock of Display, a subchapter S corporation. Display was engaged in producing creative point-of-purchase advertising displays to promote its customers' products. Using wood, metal, and plastics, Display created a variety of fixtures, racks, and other items to command attention to, and help merchandise, products at the retail level. Prior to July 1, 1968, Mayer solicited orders for Display. Following acceptance of the proposed design, usually created by free-lance artists working on a commission basis, Mayer arranged for the manufacture and delivery of the displays to the customers. Display did not do any of the actual manufacturing, but rather it used various suppliers and fabricators. Display's business was a service business in which it acted in effect as a broker.

Although in a competitive business, Display did not advertise. Its principal customer was Pan American World Airways, Inc. (Pan Am), which accounted for 70 percent of Display's sales for the calendar year 1967 and 77 percent for the 6 months ended June 30, 1968. None of Display's customers were bound by long-term contracts which would require them to give Display any particular amount of business. Ordinarily, a customer would contact the various companies in the industry when it needed a point-of-purchase display. Once the customer selected the company, its order would specify a stated design and quantity at an agreed price. Because of the desired individuality of each display, it was impossible for Display to maintain a ready stock of designs for customers.

Emmer was Pan Am's sales promotion manager and was responsible for the creative and artistic aspects of direct mail, literature, posters, and displays, and the budgeting and purchasing of materials. During 1967 and 1968 Emmer gave Display a large part of Pan Am's business, in part because of his personal relationship with Mayer. However, considerations of design, price, and services often resulted in other companies getting Pan Am's business. Because of the competitiveness of the industry and Display's relatively small size, it was essential that Display protect its close relationship with Pan Am.

Mayer was also the sole stockholder of Dynamic Advertising Company, Inc. (Dynamic) during 1968. Dynamic had only one client, American Sugar Company, to which it rendered art services. This client gave Dynamic only enough business to occupy Dynamic's sole employee, who had worked on the account for many years. Upon the death of this employee, shortly after June 30, 1968, American Sugar Company discontinued dealing with Dynamic.

Until late 1967, Mayer, who was at that time approximately 60 years old, was in good health and acted as Display's principal executive. However, toward the end of that year, Mayer suffered a heart attack and remained away from work for a number of days.

In the spring of 1968, Mayer approached Emmer and told him that he was in ill health, and that he wanted to take it a little easier, and that he would be able to do so if Emmer would leave his position at Pan Am and join Display. During this initial informal conversation, Mayer and Emmer discussed Display's business in general and the importance of Pan Am to Display's future. For financial reasons, Emmer who was earning $18,000 a year at Pan Am and had a net worth of only approximately $25,000 to $30,000, was reluctant to consider the proposition. In addition, Emmer had had no experience in running his own company. However, Mayer eventually convinced him to give the matter serious consideration. Mayer thought that Emmer could take over the company, even though he had no experience in operating a business, because he was young enough and had the Pan Am account.

In the course of their discussions, Mayer indicated that he would need $25,000 per year for 10 years if Emmer came with him. Emmer eventually agreed to join Display, and thereafter retained Steven J. Kumble (Kumble) as his attorney to work out an agreement with Mayer.

Mayer and Emmer met on several occasions with Kumble and Gerald Barandes (Barandes), counsel for Mayer and Display, to work out an agreement. On March 19, 1968, an initial memorandum outlining the principal provisions of the proposed agreement was prepared by Kumble and forwarded to Barandes. This memorandum provided, inter alia, for payments to Mayer of $17,500 per year for 10 years. Barandes increased this amount to $25,000 per year, and made other revisions. Eventually a final Purchase Agreement with draft collateral agreements was prepared and signed on May 25, 1968.

The following is a summary of the pertinent provisions of the Purchase Agreement:

1. Mayer was to sell to Emmer, for a stated consideration of $10, 50 percent of Display's outstanding stock, together with an option to purchase the remaining 50 percent during the month of June 1970 at a price of $15. Closing of the initial sale was set for July 1, 1968.

2. Display's balance sheet, as of December 31, 1967, was attached to the Purchase Agreement and was represented by Mayer as accurately reflecting all tangible assets and liabilities. Mayer assumed responsibility for any undisclosed liabilities. It was agreed that no distributions would be made from the corporation to Mayer prior to closing, except that Mayer would be entitled to a distribution of profits for the 6 months ended June 30, 1968.

3. Mayer agreed to liquidate and dissolve Dynamic and to arrange for Dynamic to sell all of its "business and good will," including its name, to Display for $10.

4. Mayer agreed to repay his indebtedness in the amount of $16,682.89 to Display and to make an additional capital contribution of $18,872. Thereafter, Display was to repay its indebtedness in the amount of $35,555.44 to Dynamic.

5. Mayer and Display were to enter into an Employment and Consulting Agreement (a draft of which was attached).

6. Emmer and Display were to enter into an Employment Agreement (a draft of which was attached). Mayer agreed to personally guarantee Display's payment of Emmer's salary for the first year of Emmer's employment.

Display's Employment and Consulting Agreement with Mayer (hereinafter sometimes referred to as the Employment Agreement), referred to in ...

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