Frank v. Comm'r of Internal Revenue

• Citation: 22 T.C. 945
• Decision Date: 16 July 1954
• Docket Number: Docket No. 34568.
• Parties: JOSEPH FRANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

22 T.C. 945

JOSEPH FRANK, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 34568.

Tax Court of the United States.

Filed July 16, 1954.

1. Petitioner excluded $10,000 of a lump-sum settlement against his employer from his 1946 return as being damages arising out of a physical assault and exempt from taxation. Held, that the evidence not only does not establish, but tends to refute, petitioner's claim that $10,00, or any part, of the lump-sum settlement was received by him as damages for physical assault, and his claim is accordingly denied.

2. At the request of petitioner's counsel, the actual payment of $13,034.29 of the lump-sum settlement was deferred from 1946 until 1947, although the corporation charged off the full amount of the settlement on its books in 1946, and had sufficient bank balances to pay the full amount in that year. Held, that the $13,034.29 payment in 1947 was constructively received by petitioner in 1946, and respondent did not err in so determining. Frank E. Wood, Jr., Esp., for the petitioner.

Robert E. Johnson, Esq., for the respondent.

Respondent has determined a deficiency in income tax against petitioner for the year 1946 of $12,221.52. The issues for decision are (1) whether $10,000 of a lump-sum settlement of petitioner's claims against his employer at the termination of his employment constituted the payment of damages for physical assault; (2) whether a part of the settlement actually received in 1947 and reported as income for that year was, by reason of constructive receipt, taxable income for 1946; and (3) whether part of an amount paid as attorneys' fees, for which petitioner has claimed deduction, was an expense in the sale of a capital asset and an offset against the selling price in determining capital gain, and not therefore deductible. The last of the issues stated was raised by respondent in an amended answer.

Petitioner also sought to raise an issue with respect to a claimed deduction for the year 1947. as to 1947, however, the respondent has made no determination of deficiency against petitioner, and this Court is accordingly without jurisdiction as to that year.

FINDINGS OF FACT.

Petitioner is an individual and resides in Wyoming, Ohio. He filed his income tax returns for the calendar years 1946 and 1947 with the collector of internal revenue for the first district of Ohio.

In 1926 he began employment with The Interstate Folding Box Company, hereafter referred to as Interstate. Prior to his employment with Interstate, petitioner had worked as an accountant with the Sexton Manufacturing Company, in Illinois. Interstate was a closely held family corporation. Practically all of its stock was owned by members of the Bergstein family. it kept its books of account and filed its returns on the basis of a fiscal year ending July 31.

Petitioner's startingsalary withInterstate was $50 a week. He served as assistant to the individual in charge of Interstate's bookkeeping and cost accounting. In or about 1930, he became secretary of the company and a member of its board of directors, which position he held until his employment was terminated in 1946. At that time, he was drawing a weekly salary of $100, plus a bonus at the end of the year. During the last 15 years of his employment, he was Interstate's principal inside accountant.

When his employment with Interstate was concluded, petitioner was the owner of 100 shares of Interstate stock. Fifty of these shares were acquired December 28, 1936, but the certificate therefor was dated as if the shares had been purchased on July 31, 1934. Appropriate adjustments were made for interest on petitioner's unpaid balance and for the dividends which had been paid on the stock in the interim. The remaining 50 shares were acquired on July 31, 1939. Both purchases were subject to written terms and conditions set forth in letters dated December 28, 1936, and July 31, 1939. Both letters contained the following provisions:

If your connection with the company should be severed for any other reason whatsoever, it is mutually agreed that the stock shall be sold to the company and the company agrees to purchase, within 90 days thereafter, the stock at a price which shall be determined in the following manner:

To the par value of $100 per share shall be added the pro rata portion of each share of the accumulated surplus between July 31, 1934[ ^*] and the date of the last closing of the books prior to the aforesaid date. If, since the last closing of the books interest is charged and dividends credited, the respective amounts shall be cancelled and if already paid shall be refunded.

Book value, as well as the surplus, at the beginning as well as the end of the period, shall be determined by reference to the audit reports of the accountants regularly employed by the corporation.

* With respect to the 1939 purchase, the date shown was July 31, 1939.

The agreement under which petitioner's bonus was paid was oral and its exact terms are not shown. the starting point in its computation purportedly was Interstate's net profits before taxes ¹ as taken from its books, and variously referred to as “Profit Per Work Sheet,” “Balance Per Work Sheet,” and “Profit Per Original Closing Journal Entry.” To such starting amounts, various additions were made to arrive at “Adjusted Income” or “Adjusted Income for Bonus Computation.” items so added included “Excess Salaries,” “Royalties,” “Grand Avenue Building Rent,” and “Welfare” or “Welfare Work Expense.” the item “‘Excess Salaries” represented, for most of the years shown, 20 per cent of the salaries which had been paid to members of the Bergstein family. The amount of petitioner's bonus for each of the years prior to the fiscal year 1946 was then computed by taking 2 per cent of the “Adjusted Income” or “Adjusted Income for Bonus Computation,” with a further adjustment to allow a credit to petitioner for a ratable portion of the income tax paid by Interstate for the year. The credit allowed for income tax was determined according to the ration of petitioner's stock holdings to the total stock outstanding. Although some questions between Interstate and petitioner occasionally arose with respect to the bonus payments, petitioner, prior to the fiscal year 1946, had always accepted Interstate's final figures.

On or about July 2, 1946, Samuel Bergstein, president of Interstate, and petitioner had a disagreement, as the result of which petitioner, on or about July 29, 1946, but by letter dated July 20, 1946, resigned his position as secretary of Interstate, to be effective as of August 1, 1946. He continued with Interstate for approximately 2 months past August 1, 1946, however, in order that someone familiar with Interstate's books might be present when the annual audit was made by its outside auditors, a firm of Chicago accountants. during his stay after August 1, 1946, petitioner received $300 a week, but no bonus.

A few days before petitioner left Interstate, probably in late September 1946, the auditor who was then making the annual audit of Interstate's books came to petitioner's office proposing settlement of petitioner's stock and bonus claims for $25,000, of which $6,000 was to cover the bonus and $29,000 the stock. Shortly afterwards, possibly in October, the auditor gave petitioner a tabulation showing a bonus computation for 1946 of $5,923.57. In making this computation, a starting figure of $220,038.45, designated as “Profit Per Work Sheet,” was adjusted to an ultimate figure of $267,612.45. To the latter amount, the rate of 2 per cent was applied, as in prior years. The settlement offer of $25,000 was rejected by petitioner. In talking with Robert Bergstein, vice president of Interstate, petitioner next received an offer of a lump-sum settlement of $30,000 to cover his stock and bonus claims. This offer was also rejected and Berstein suggested that the matter be turned over to their respective attorneys for the purpose of negotiation and settlement. A series of conferences between counsel were had over a period of approximately 2 months and an agreement was reached in December of that year, whereby petitioner was to receive $50,641.30 in settlement of all of his claims against Interstate. Petitioner personally attended only the first and last conferences.

At one point during the negotiations, Interstate submitted a balance sheet and an analysis of its surplus as of July 31, 1946, and a statement of its operations for the year ended that date. The balance sheet and the analysis of surplus and the statement of operations included Interstate's wholly owned subsidiary, Grand Avenue Building Corporation.² The analysis of surplus indicated a surplus for Interstate at July 31, 1946, of $545,989.12, and a surplus for Grand Avenue Building Corporation of $7,868.01, or a consolidated surplus of $553,857.13.

Petitioner and accountants employed by him made their own analysis of Interstate's surplus and profits. It was petitioner's position that several items had been charged or expensed which were not proper expense items. He also took the position that Interstate had grossly understated many of its assets. In his recomputation, he increased assets by $604,335.19, as being the amount by which the appraised value of the buildings, machinery, and fixtures exceeded book value of the assets as reflected in the auditor's report. He also added $23,941.75 to the book value of the land owned by Interstate, which land was carried on Interstate's books at its cost 40 years earlier. He added $45,220.78 as a proper amount representing profits on orders for items already manufactured but not yet charged out. He took the position that over the years $140,000 in royalties had been paid to the “Bergstein Trust and Patent Trusts” by licensees of patents which had been developed by and belonged to Interstate, but which stood in the name of Samuel Bergstein, and that such royalties should be...