Friednash v. Commissioner of Internal Revenue, 13454.

• Decision Date: 19 January 1954
• Docket Number: No. 13454.,13454.
• Parties: FRIEDNASH v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Ninth Circuit

209 F.2d 601 (1954)

FRIEDNASH v. COMMISSIONER OF INTERNAL REVENUE.

No. 13454.

United States Court of Appeals, Ninth Circuit.

January 19, 1954.

Preston D. Orem, Los Angeles, Cal., for petitioner.

Charles S. Lyon, Asst. Atty. Gen., Ellis N. Slack, A. F. Prescott, Carlton Fox, Fred Youngman, Sp. Assts. to the Atty. Gen., Charles W. Davis, Chief Counsel, Washington, D. C., for respondent.

Before HEALY, BONE and POPE, Circuit Judges.

HEALY, Circuit Judge.

This case, here on petition to review a decision of the Tax Court, involves the following situation as found by the Court.

During and prior to 1944 the petitioner, Hyman Friednash, was engaged in the operation of a number of retail liquor stores in southern California. For reasons unnecessary to state the properties used in connection with his liquor business were carried in the name of his wife, Geneva Friednash. Petitioner's brother, Henry Friednash, had worked for him from time to time in one or another of these establishments. While so employed Henry learned that a restaurant and bar known as the Tahiti Cafe was for sale. He urged petitioner and Geneva to buy the property and let him operate it on a partnership basis. The two were reluctant to do that, but they finally agreed to acquire the property and let Henry operate it as an employee. The Tahiti was accordingly purchased at a total cost of $27,500.

As of January 1, 1944, the following agreement, dictated by petitioner, was entered into:

"I, Geneva Friednash, and Henry Friednash do hereby enter into an agreement that said Henry Friednash will be the Acting Manager of the Tahiti Cafe located at 819 National Avenue, National City, and for his services will participate in the net profits of the business to the extent of fifty per cent over and above a monthly salary of Five Hundred Dollars per month, said net profits of the business to be figured after a full year's business and a division of profits made to December 31st, 1944, and subsequent years.

"This agreement can become null and void within thirty days after written notice by either party concerned."

Henry was in complete charge of the Tahiti throughout the year 1944, the tax year in question. He hired and fired the employees (who included seven bartenders), bought the liquor and other supplies, and performed other duties required in the management of the business, working long hours seven day a week. Petitioner and Geneva retained control over the finances. All of the food and liquor bills and other major expenses were paid through the main office of Bay City Liquor House, the name under which petitioner conducted all of his liquor business. Henry deposited all receipts of the business in a nearby bank in a special account on which he had no authority to draw checks. From time to time petitioner would have these funds transferred to his own account or that of the Bay City Liquor House. Henry's salary of $500 per month was paid to him by petitioner bimonthly. Petitioner kept one set of books at his main Bay City Liquor House office in which all the records for his business, including Tahiti, were kept. The Tahiti was operated until September 1945, when petitioner sold it for $60,000 without Henry's consent and against his wishes, Henry later purchasing an interest in the business from the new owner.

The net profits of the Tahiti in 1944, after deducting Henry's salary of $6,195, were $75,354.24. Petitioner had an audit made of his books in April 1945 which disclosed that Henry's 50% share of the profits for 1944 amounted to $37,672.62, this amount being credited to Henry in petitioner's books in April 1945 "as of December 31, 1944." Henry made no withdrawals from the account in 1944, saying he had no need for the money, but petitioner paid over the amount to him at intervals during the two years subsequent to April 1945.

Petitioner and his wife, Geneva, filed their returns on an accrual basis. In computing their 1944 community income from the Tahiti they deducted as an expense of doing business the salary paid to Henry and also his half of the net profits for that year, amounting, as above stated, to $37,672.62, in all $43,867.62. Henry, who made his returns on a cash basis, reported for 1944 only the income actually paid him in that year, amounting, as aforesaid, to $6,195.

The Commissioner thought Henry's compensation as deducted by petitioner and Geneva in their community return was excessive, and in his notice of deficiency he determined that $24,000 was reasonable compensation, the balance being disallowed. Further, in the notice of deficiency to petitioner he determined that under Section 24(c) of the Internal Revenue Code only the compensation paid to Henry during 1944 or within 2½ months after the close of the taxable year was allowable as a deduction.¹ The amount of petitioner's taxable income for the year was increased accordingly.

On proceedings for redetermination the Tax Court held that Henry's agreed compensation, including the portion of the 1944 profits belonging to and credited to him on petitioner's books, was not excessive or unreasonable, and on that phase it reversed the Commissioner. However, as to the applicability of Section 24(c) of the Internal Revenue Code, it rejected petitioner's contention that Henry constructively received his full...